Exhibit 13
FINANCIALS
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THE PNC FINANCIAL SERVICES GROUP, INC.
FINANCIAL REVIEW
26 Selected Consolidated Financial Data
28 Overview
30 Review Of Businesses
31 Regional Community Banking
Wholesale Banking
32 Corporate Banking
33 PNC Real Estate
Finance
34 PNC Business Credit
35 PNC Advisors
36 BlackRock
37 PFPC
38 Consolidated Statement Of Income Review
40 Consolidated Balance Sheet Review
48 Risk Factors
53 Risk Management
64 2001 Versus 2000
66 Forward-Looking Statements
REPORTS ON CONSOLIDATED FINANCIAL STATEMENTS
67 Management's Responsibility For Financial Reporting
67 Report Of Deloitte & Touche LLP, Independent Auditors
CONSOLIDATED FINANCIAL STATEMENTS
68 Consolidated Statement Of Income
69 Consolidated Balance Sheet
70 Consolidated Statement Of Shareholders' Equity
71 Consolidated Statement Of Cash Flows
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
72 NOTE 1 - Accounting Policies
81 NOTE 2 - NBOC Acquisition
82 NOTE 3 - Regulatory Matters
83 NOTE 4 - Discontinued Operations
83 NOTE 5 - Fourth Quarter 2001 Actions
84 NOTE 6 - Sale Of Subsidiary Stock
84 NOTE 7 - Cash Flows
84 NOTE 8 - Trading Activities
85 NOTE 9 - Securities
87 NOTE 10 - Loans And Commitments To Extend Credit
88 NOTE 11 - Nonperforming Assets
89 NOTE 12 - Allowances For Credit Losses And Unfunded Loan Commitments And
Letters Of Credit
89 NOTE 13 - Premises, Equipment And Leasehold Improvements
89 NOTE 14 - Goodwill And Other Intangible Assets
90 NOTE 15 - Securitizations
92 NOTE 16 - Deposits
92 NOTE 17 - Borrowed Funds
92 NOTE 18 - Capital Securities Of Subsidiary Trusts
92 NOTE 19 - Shareholders' Equity
93 NOTE 20 - Financial Derivatives
93 NOTE 21 - Employee Benefit Plans
96 NOTE 22 - Stock-Based Compensation Plans
98 NOTE 23 - Income Taxes
98 NOTE 24 - Legal Proceedings
99 NOTE 25 - Earnings Per Share
100 NOTE 26 - Segment Reporting
102 NOTE 27 - Comprehensive Income
103 NOTE 28 - Fair Value Of Financial Instruments
104 NOTE 29 - Commitments And Guarantees
106 NOTE 30 - Unused Line Of Credit
106 NOTE 31 - Parent Company
107 NOTE 32 - Subsequent Event
STATISTICAL INFORMATION
108 Selected Quarterly Financial Data
109 Analysis Of Year-To-Year Changes In Net Interest Income
110 Average Consolidated Balance Sheet And Net Interest Analysis
112 Summary Of Loan Loss Experience
112 Allocation Of Allowance For Credit Losses
113 Short-Term Borrowings
113 Loan Maturities And Interest Sensitivity
113 Time Deposits Of $100,000 Or More
113 Common Stock Prices/Dividends Declared
25
FINANCIAL REVIEW
SELECTED CONSOLIDATED FINANCIAL DATA
THE PNC FINANCIAL SERVICES GROUP, INC.
--------------------------------------------------------------------
Year ended December 31
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Dollars in millions, except per share data 2002 2001(a) 2000 1999 1998
========================================================= ============== ============ =========== =========== ============
SUMMARY OF OPERATIONS
Interest income $3,172 $4,137 $4,732 $4,583 $5,024
Interest expense 975 1,875 2,568 2,239 2,536
- --------------------------------------------------------- -------------- ------------ ----------- ----------- ------------
Net interest income 2,197 2,262 2,164 2,344 2,488
Provision for credit losses 309 903 136 163 225
Noninterest income before net securities gains 3,108 2,521 2,930 2,438 2,076
Net securities gains 89 131 20 22 16
Noninterest expense 3,227 3,414 3,103 2,838 2,698
- --------------------------------------------------------- -------------- ------------ ----------- ----------- ------------
Income from continuing operations before minority
interest and income taxes 1,858 597 1,875 1,803 1,657
Minority interest in income of consolidated entities 37 33 27 15 6
Income taxes 621 187 634 586 571
- --------------------------------------------------------- -------------- ------------ ----------- ----------- ------------
Income from continuing operations 1,200 377 1,214 1,202 1,080
Income (loss) from discontinued operations, net of
tax (16) 5 65 62 35
- --------------------------------------------------------- -------------- ------------ ----------- ----------- ------------
Income before cumulative effect of accounting
change 1,184 382 1,279 1,264 1,115
Cumulative effect of accounting change, net of tax (5)
- --------------------------------------------------------- -------------- ------------ ----------- ----------- ------------
Net income $1,184 $377 $1,279 $1,264 $1,115
========================================================= ============== ============ =========== =========== ============
PER COMMON SHARE
Basic earnings (loss)
Continuing operations $4.23 $1.27 $4.12 $3.98 $3.53
Discontinued operations (.05) .02 .23 .21 .11
- --------------------------------------------------------- -------------- ------------ ----------- ----------- ------------
Before cumulative effect of accounting change 4.18 1.29 4.35 4.19 3.64
Cumulative effect of accounting change (.02)
- --------------------------------------------------------- -------------- ------------ ----------- ----------- ------------
Net income $4.18 $1.27 $4.35 $4.19 $3.64
========================================================= ============== ============ =========== =========== ============
Diluted earnings (loss)
Continuing operations $4.20 $1.26 $4.09 $3.94 $3.49
Discontinued operations (.05) .02 .22 .21 .11
- --------------------------------------------------------- -------------- ------------ ----------- ----------- ------------
Before cumulative effect of accounting change 4.15 1.28 4.31 4.15 3.60
Cumulative effect of accounting change (.02)
- --------------------------------------------------------- -------------- ------------ ----------- ----------- ------------
Net income $4.15 $1.26 $4.31 $4.15 $3.60
========================================================= ============== ============ =========== =========== ============
Book value (At December 31) $24.03 $20.54 $21.88 $19.23 $18.86
Cash dividends declared $1.92 $1.92 $1.83 $1.68 $1.58
========================================================= ============= ============ =========== =========== ============
This Financial Review should be read in conjunction with The PNC Financial
Services Group, Inc. and subsidiaries ("Corporation" or "PNC") Consolidated
Financial Statements and Statistical Information included herein. Certain
prior-period amounts have been reclassified to conform with the current year
presentation. For information regarding certain business risks, see the Risk
Factors, Risk Management, Credit Risk and Liquidity sections in this Financial
Review. Also, see the Forward-Looking Statements section in this Financial
Review for certain other factors that could cause actual results to differ
materially from forward-looking statements or historical performance.
26
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At or Year ended December 31
-----------------------------------------------------------------------
Dollars in millions 2002 2001(a) 2000 1999 1998
========================================================= =============== ============ =========== ============= ============
BALANCE SHEET HIGHLIGHTS
Assets $66,377 $69,638 $69,921 $69,360 $70,829
Earning assets 54,833 57,875 59,373 60,268 63,547
Loans, net of unearned income 35,450 37,974 50,601 49,673 57,633
Allowance for credit losses 673 560 598 600 678
Securities 13,763 13,908 5,902 5,960 4,472
Loans held for sale 1,607 4,189 1,655 3,477 467
Total deposits 44,982 47,304 47,664 45,802 46,150
Transaction deposits 32,349 32,590 29,922 26,538 26,798
Borrowed funds 9,116 12,090 11,718 14,229 15,939
Allowance for unfunded loan commitments and
letters of credit 84 70 77 74 75
Shareholders' equity 6,859 5,823 6,656 5,946 6,043
Common shareholders' equity 6,849 5,813 6,344 5,633 5,729
- --------------------------------------------------------- --------------- ------------ ----------- ------------- ------------
SELECTED RATIOS
FROM CONTINUING OPERATIONS
Return on
Average common shareholders' equity 19.08% 5.65% 20.52% 21.29% 20.14%
Average assets 1.80 .53 1.76 1.76 1.55
Net interest margin 3.99 3.84 3.64 3.86 3.99
Noninterest income to total revenue 59.1 53.8 57.5 51.0 45.4
Efficiency (b) 58.62 65.48 56.82 55.32 54.74
FROM NET INCOME
Return on
Average common shareholders' equity 18.83 5.65 21.63 22.41 20.81
Average assets 1.78 .53 1.68 1.69 1.49
Net interest margin 3.99 3.81 3.37 3.68 3.85
Noninterest income to total revenue 59.1 53.9 59.7 52.9 47.0
Efficiency (b) 59.08 65.36 55.16 54.63 54.69
Loans to deposits 79 80 106 108 125
Dividend payout 46.07 151.65 42.06 40.22 43.43
Leverage (c) 8.1 6.8 8.0 6.6 7.3
Common shareholders' equity to assets 10.32 8.35 9.07 8.12 8.09
Average common shareholders' equity to average
assets 9.44 9.14 8.44 8.12 7.56
========================================================= =============== ============ =========== ============= ============
(a) See 2001 Strategic Repositioning in the Consolidated Balance Sheet Review
section of this Financial Review for further information regarding items
impacting the comparability of 2001 amounts with other periods presented.
(b) The efficiency ratio is noninterest expense divided by the sum of
taxable-equivalent net interest income and noninterest income. Amortization
of goodwill and other intangibles, distributions on capital securities and
mortgage banking risk management activities are excluded for purposes of
computing this ratio. Excluding the impact of charges in 2001 related to
strategic initiatives and additions to reserves related to insured residual
value exposures, the efficiency ratios from continuing operations and from
net income were 58.14% and 58.07%, respectively.
(c) The leverage ratio represents Tier 1 capital divided by adjusted average
total assets as defined by regulatory capital requirements for bank holding
companies. The ratio includes discontinued operations for the years 1998
and 1999.
27
OVERVIEW
THE PNC FINANCIAL SERVICES GROUP, INC.
The Corporation is one of the largest diversified financial services companies
in the United States, operating businesses engaged in regional community
banking; wholesale banking, including corporate banking, real estate finance and
asset-based lending; wealth management; asset management and global fund
processing services. The Corporation provides certain products and services
nationally and others in PNC's primary geographic markets in Pennsylvania, New
Jersey, Delaware, Ohio and Kentucky. The Corporation also provides certain
banking, asset management and global fund processing services internationally.
PNC's strategies to enhance shareholder value include expanding its
deposit-driven banking franchise through internal growth and, as opportunities
arise, through targeted acquisitions. In addition, the Corporation plans to
leverage its customer base and leading technology to grow the asset management
and processing businesses in an efficient and effective manner. Efforts in
recent years to reduce risk, grow deposits and diversify the Corporation's
revenue mix have enabled PNC to improve liquidity and build a strong capital
position.
SUMMARY FINANCIAL RESULTS
Consolidated net income for 2002 was $1.184 billion or $4.15 per diluted share
compared with $377 million or $1.26 per diluted share for 2001. Results for 2002
reflected the adoption of Statement of Financial Accounting Standards ("SFAS")
No. 142, "Goodwill and Other Intangible Assets," under which goodwill is no
longer amortized to expense. Results for 2001 reflected the cost of actions
taken during the year to accelerate the repositioning of PNC's lending business
and other strategic initiatives. These charges totaled $1.2 billion pretax and
reduced 2001 net income by $768 million or $2.65 per diluted share. Excluding
the effects of the strategic repositioning charges and goodwill amortization
expense, net income for 2001 would have been $1.238 billion, or $4.23 per
diluted share.
Results for 2002 included a loss from discontinued operations of $16
million, or $.05 per diluted share, compared with income from discontinued
operations in 2001 of $5 million, or $.02 per diluted share. Results for 2001
also included an after-tax loss of $5 million, or $.02 per diluted share,
related to the cumulative effect of the accounting change for the adoption of
SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," as
amended.
Return on average common shareholders' equity was 18.83% and return on
average assets was 1.78% for 2002 compared with 5.65% and .53%, respectively,
for 2001.
The residential mortgage banking business, which was sold in January 2001,
is reflected in discontinued operations throughout the Corporation's
consolidated financial statements. The remainder of the presentation in this
Financial Review reflects continuing operations, unless otherwise noted. See
Note 4 Discontinued Operations in the Notes to Consolidated Financial Statements
for additional information.
The Corporation's results for 2002 reflected significant progress in a
number of key areas:
- - As part of the Corporation's overall risk repositioning efforts,
institutional loans held for sale were reduced $2.3 billion, or 88%, from
December 31, 2001, with net gains in excess of valuation adjustments
totaling $147 million in 2002.
- - Total shareholders' equity increased $1.0 billion during 2002 to $6.9
billion at December 31, 2002.
- - Capital flexibility was strengthened during 2002 as the ratio of common
shareholders' equity to total assets increased to 10.3% at December 31,
2002 compared with 8.3% at December 31, 2001.
- - Lower cost funding sources increased as average total transaction deposits
increased $1.1 billion, to $30.7 billion, compared with the prior year.
- - In January 2003, PNC and Washington Mutual Bank, FA, agreed to a settlement
of all issues in dispute between them in connection with the sale of the
Corporation's residential mortgage banking business.
Management expects that 2003 will continue to be a challenging operating
environment that will limit opportunities for revenue growth. The Corporation's
success in 2003 will depend on the economy, interest rates, financial market
conditions, the impact of international hostilities and its success in
implementing current strategies, as well as PNC's ability to address its key
operating challenges. These challenges include the stability of asset quality,
revenue growth and development of value-added customer relationships. Other
factors that will affect the Corporation's success include leveraging
technology, execution of a share repurchase program, managing the
revenue/expense relationship including additional pension and stock-based
compensation costs, and regulatory actions. See also the Risk Factors, Risk
Management and Forward-Looking Statements sections of this Financial Review.
28
BALANCE SHEET HIGHLIGHTS
During 2002, the Corporation emphasized the growth and retention of value-added
transaction deposits while changing the mix of earning assets, including a
reduction of institutional loans held for sale. These actions have resulted in a
significant risk repositioning of the Corporation as reflected in the
Consolidated Balance Sheet and Consolidated Average Balance Sheet line items
discussed below.
Total assets were $66.4 billion at December 31, 2002 compared with $69.6
billion at December 31, 2001. Average interest earning assets were $55.3 billion
in 2002, down $4.0 billion from 2001 due primarily to a decrease in average
loans that was partially offset by increases in average securities and average
loans held for sale.
Average loans for 2002 were $37.1 billion compared with $44.8 billion in
2001, a decline of $7.7 billion or 17%. Loans represented 67% of average
interest-earning assets for 2002 compared with 76% for 2001. The decreases were
primarily due to a decline in residential mortgages and institutional lending
portfolios that more than offset an increase in PNC Business Credit loans
resulting from the acquisition in 2002 of a portion of National Bank of Canada's
("NBOC") U.S. asset-based lending business. The term "loans" in this report
excludes loans held for sale and securities that represent interests in pools of
loans.
Changes in loans held for sale are described in 2001 Strategic Repositioning
and in Loans Held for Sale in the Consolidated Balance Sheet Review section of
this Financial Review.
Average securities totaled $12.0 billion for 2002, an increase of $1.1
billion from 2001. Securities comprised 22% of average interest-earning assets
for 2002 compared with 18% for 2001. The increases were primarily due to net
securities purchases upon redeployment of funds resulting from loan downsizing
and interest rate risk management activities.
Funding cost is affected by the volume and composition of funding sources as
well as related rates paid thereon. Average deposits comprised 66% of total
sources of funds for 2002 compared with 64% for 2001, respectively, with the
remainder comprised primarily of wholesale funding obtained at prevailing market
rates.
Average interest-bearing demand and money market deposits totaled $22.1
billion for 2002 compared with $21.3 billion in 2001. The increase reflected
focused marketing efforts to grow and maintain more valuable transaction
accounts while higher cost, less valuable retail certificates of deposit were
not emphasized. Average borrowed funds for 2002 decreased $2.8 billion, to $10.7
billion, compared with 2001 commensurate with the decline in average earning
assets. See the Consolidated Average Balance Sheet and Net Interest Analysis for
additional information.
29
REVIEW OF BUSINESSES
PNC operates seven major businesses engaged in regional community banking;
wholesale banking, including corporate banking, real estate finance and
asset-based lending; wealth management; asset management and global fund
processing services. Treasury management activities, which include cash and
investment management, receivables management, disbursement services and global
trade services; capital markets products, which include foreign exchange,
derivatives trading and loan syndications; and equipment leasing products are
offered through Corporate Banking and sold by several businesses across the
Corporation.
Results of individual businesses are presented based on PNC's management
accounting practices and the Corporation's management structure. There is no
comprehensive, authoritative body of guidance for management accounting
equivalent to generally accepted accounting principles; therefore, the financial
results of individual businesses are not necessarily comparable with similar
information for any other company. Financial results are presented, to the
extent practicable, as if each business operated on a stand-alone basis. Also,
certain amounts for 2001 have been reclassified to conform with the 2002
presentation.
The management accounting process uses various balance sheet and income
statement assignments and transfers to measure performance of the businesses.
Methodologies are refined from time to time as management accounting practices
are enhanced and businesses change. There were no significant methodology
changes made during 2002 other than the impact of refinements to the
Corporation's reserve methodology related to loans and unfunded credit
facilities. Securities or borrowings and related net interest income are
assigned based on the net asset or liability position of each business. Capital
is assigned based on management's assessment of inherent risks and equity levels
at independent companies providing similar products and services. The allowance
for credit losses is allocated based on management's assessment of risk inherent
in the loan portfolios. The costs incurred by support areas not directly aligned
with the businesses are allocated primarily based on the utilization of
services.
Total business financial results differ from consolidated results from
continuing operations. This is primarily due to differences between management
accounting practices and generally accepted accounting principles such as
economic capital assignments rather than legal entity shareholders' equity, unit
cost allocations rather than actual expense assignments, and policies that do
not fully allocate holding company expenses; minority interest in income of
consolidated entities; eliminations and other corporate items. The impact of
these differences is reflected in the "Other" category. Other also includes
equity management activities and residual asset and liability management
activities which do not meet the criteria for disclosure as a separate
reportable segment. Other reflected a net loss of $72 million in 2002 compared
with a net loss of $190 million in 2001. The net loss was smaller in 2002
primarily due to lower net losses from equity management activities and a
benefit from the assignment of unassigned allowance for credit losses to the
Wholesale Banking businesses in 2002. Details of inter-segment revenues are
included in Note 26 Segment Reporting. The operating results and financial
impact of the disposition of the residential mortgage banking business,
previously PNC Mortgage, are included in discontinued operations.
"Other Information" included in the individual business tables that follow
is presented as of period end, except for net charge-offs, net gains (losses) on
loans held for sale and average full-time equivalent employees (FTEs).
RESULTS OF BUSINESSES (a)
--------------------- --------------------- -------------------- ----------------------
Return on
Operating Assigned
Earnings(Loss) Revenue (b) Capital(c) Average Assets
Year ended December 31 - dollars in --------------------- --------------------- -------------------- ----------------------
millions 2002 2001 2002 2001 2002 2001 2002 2001
======================================== ========== ========== ========== ========== ========= ========== =========== ==========
Banking Businesses
Regional Community Banking $697 $596 $2,098 $2,145 27% 22% $38,976 $40,285
Wholesale Banking
Corporate Banking 150 (375) 631 764 14 (30) 13,807 16,685
PNC Real Estate Finance 90 38 226 213 23 10 5,018 5,290
PNC Business Credit 40 22 193 134 16 13 3,837 2,463
- ---------------------------------------- ---------- ---------- ---------- ---------- ----------- ----------
Total wholesale banking 280 (315) 1,050 1,111 17 (17) 22,662 24,438
PNC Advisors 97 143 654 735 19 26 2,929 3,330
- ---------------------------------------- ---------- ---------- ---------- ---------- ----------- ----------
Total banking businesses 1,074 424 3,802 3,991 22 8 64,567 68,053
- ---------------------------------------- ---------- ---------- ---------- ---------- ----------- ----------
Asset Management and Processing
businesses
BlackRock 133 107 577 533 24 25 864 684
PFPC 65 36 817 846 31 17 1,888 1,771
- ----------------------------------------- --------- ---------- ---------- ---------- ----------- ----------
Total asset management and
processing 198 143 1,394 1,379 26 22 2,752 2,455
- ---------------------------------------- ---------- ---------- ---------- ---------- ----------- ----------
Total business results 1,272 567 5,196 5,370 23 10 67,319 70,508
Other (72) (190) 211 (440) (730) (74)
- ---------------------------------------- ---------- ---------- ---------- ---------- ----------- ----------
Results from continuing operations 1,200 377 5,407 4,930 19 6 66,589 70,434
Discontinued operations (16) 5 51
- ---------------------------------------- ---------- ---------- ---------- ---------- ----------- ----------
Results before cumulative effect of
accounting change 1,184 382 5,407 4,930 19 6 66,589 70,485
Cumulative effect of accounting change (5)
- ---------------------------------------- ---------- ---------- ---------- ---------- --------- ---------- ----------- ----------
Total consolidated (b) $1,184 $377 $5,407 $4,930 19 6 $66,589 $70,485
======================================== ========== ========== ========== ========== ========= ========== =========== ==========
(a) Amounts for 2002 reflect, where applicable, the adoption, effective January
1, 2002, of the new accounting standard under which goodwill is no longer
amortized to expense.
(b) Operating revenue is presented on a taxable-equivalent basis except for
BlackRock and PFPC. Total consolidated operating revenues included in the
table above exceeded total operating revenues on a book basis for 2002 and
2001 by $13 million and $16 million, respectively, due to
taxable-equivalent adjustments.
(c) Percentages for BlackRock reflect return on equity.
30
REGIONAL COMMUNITY BANKING
Year ended December 31
Taxable-equivalent basis
Dollars in millions 2002 2001
===================================== =========== ============
INCOME STATEMENT
Net interest income $1,409 $1,466
Noninterest income 689 679
- ------------------------------------- ----------- ------------
Operating revenue 2,098 2,145
Provision for credit losses 52 50
Noninterest expense 1,061 1,063
Goodwill amortization 36
- ------------------------------------- ----------- ------------
Operating income 985 996
Net securities (gains) (84) (86)
Strategic repositioning:
Vehicle leasing costs 135
Asset impairment and severance costs 13
- ------------------------------------- ----------- ------------
Pretax earnings 1,069 934
Income taxes 372 338
- ------------------------------------- ----------- ------------
Earnings $697 $596
===================================== =========== ============
AVERAGE BALANCE SHEET
Loans
Consumer
Home equity $7,101 $6,351
Indirect 541 814
Other consumer 632 777
- ------------------------------------- ----------- ------------
Total consumer 8,274 7,942
Residential mortgage 4,110 7,912
Commercial 3,599 3,557
Vehicle leasing 1,678 1,901
Other 119 133
- ------------------------------------- ----------- ------------
Total loans 17,780 21,445
Securities 11,139 10,241
Education and other loans held for
sale 1,319 1,293
Assigned assets and other assets 8,738 7,306
- ------------------------------------- ----------- ------------
Total assets $38,976 $40,285
- ------------------------------------- ----------- ------------
Deposits
Noninterest-bearing demand $5,046 $4,571
Interest-bearing demand 6,057 5,713
Money market 12,279 12,162
- ------------------------------------- ----------- ------------
Total transaction deposits 23,382 22,446
Savings 1,962 1,870
Certificates 10,045 11,906
- ------------------------------------- ----------- ------------
Total deposits 35,389 36,222
Other liabilities 958 1,345
Assigned capital 2,629 2,718
- ------------------------------------- ----------- ------------
Total funds $38,976 $40,285
- ------------------------------------- ----------- ------------
PERFORMANCE RATIOS
Return on assigned capital 27% 22%
Noninterest income to operating revenue 33 32
Efficiency 49 54
Efficiency, excluding strategic
repositioning 51 50
- ----------------------------------------- ------- ------------
OTHER INFORMATION
Total nonperforming assets $82 $52
Vehicle leasing outstandings,
net of unearned income $1,386 $1,930
Net charge-offs $56 $50
Average FTEs 9,657 9,953
ATMs 3,550 3,250
Branches 714 712
Financial consultants 645 568
Business banking centers 193 140
Checking relationships 1,542,000 1,440,000
Online banking users 606,752 421,325
Deposit households using online
banking 36.6% 27.2%
======================================= ========== ===========
Regional Community Banking provides deposit, lending, cash management and
investment services to two million consumer and small business customers within
PNC's geographic footprint.
The strategic focus of the Regional Community Bank is to generate
sustainable revenue growth by consistently increasing its base of satisfied and
loyal customers. Revenue growth is driven by building a base of transaction
deposit relationships which provide fee revenue and a low-cost funding source
for loans and investments. Additional revenue growth is generated by deepening
relationships with these customers through cross-selling of other products and
services. The significant growth in online banking users is helping to improve
customer loyalty and retention.
During 2002, Regional Community Banking increased the number of checking
relationships by 8% causing increases in transaction deposits and fee revenues.
Customer growth was driven by simultaneous improvements in the rates of customer
acquisition and retention. Despite this trend and success in keeping deposit
funding costs low, this business was adversely impacted by a reduction in
average residential mortgages and vehicle leases and lower investment yields in
the relatively low interest rate environment in 2002.
Regional Community Banking earnings were $697 million in 2002 compared with
$596 million in 2001. Excluding goodwill amortization expense in 2001, operating
income declined 5% in the comparison as the benefit of growth in average
transaction deposits and fee income was more than offset by lower net interest
income.
Operating revenue was $2.1 billion for both 2002 and 2001. Revenue was flat
in the year-to-year comparison primarily due to lower net interest income in
2002 partially offset by higher noninterest income.
The provision for credit losses for 2002 increased to $52 million compared
with $50 million in the prior year due to higher net charge-offs on residential
mortgage loans partially offset by the impact of refinements to the
Corporations' reserve methodology related to impaired loans and pooled reserves.
Total loans decreased 17% on average in 2002 compared with the prior year.
Home equity loans, the lead consumer lending product, grew 12% in the
comparison. The overall decline in loans primarily resulted from residential
mortgage prepayments and a decline in vehicle leases and indirect loans. In
addition, management elected to invest in mortgage-backed securities rather than
purchase residential mortgages as part of overall balance sheet and interest
rate management.
Total deposits declined 2% in the year-to-year comparison as increases in
transaction and savings deposits were more than offset by a decline in
certificates of deposit. Demand and money market deposits increased due to
ongoing strategic marketing efforts to add new accounts and retain existing
customers while higher cost, less valuable certificates of deposit were not
emphasized.
As previously reported, the Corporation decided to discontinue its vehicle
leasing business in the fourth quarter of 2001. As a result, this portfolio has
declined 28% since December 31, 2001 and is performing overall as expected. See
2001 Strategic Repositioning in the Consolidated Balance Sheet Review section
and Risk Factors section of this Financial Review for additional information.
31
WHOLESALE BANKING
CORPORATE BANKING
Year ended December 31
Taxable-equivalent basis
Dollars in millions 2002 2001
======================================= ========== ===========
INCOME STATEMENT
Net interest income $349 $508
Noninterest income 282 256
- --------------------------------------- ---------- -----------
Operating revenue 631 764
Provision for credit losses 203 57
Noninterest expense 359 378
Goodwill amortization 3
- --------------------------------------- ---------- -----------
Operating income 69 326
Strategic repositioning:
Institutional lending repositioning 891
Asset impairment and severance costs 16
Net (gains) on loans held for sale (155)
- --------------------------------------- ---------- -----------
Pretax earnings (loss) 224 (581)
Income tax expense (benefit) 74 (206)
- --------------------------------------- ---------- -----------
Earnings (loss) $150 $(375)
======================================= ========== ===========
AVERAGE BALANCE SHEET
Loans $9,477 $13,907
Loans held for sale 1,369 367
Other assets 2,961 2,411
- --------------------------------------- ---------- -----------
Total assets $13,807 $16,685
======================================= ========== ===========
Deposits $4,683 $4,729
Assigned funds and other liabilities 8,088 10,705
Assigned capital 1,036 1,251
- --------------------------------------- ---------- -----------
Total funds $13,807 $16,685
======================================= ========== ===========
PERFORMANCE RATIOS
Return on assigned capital 14% (30)%
Noninterest income to operating
revenue 45 34
Efficiency 46 71
Efficiency, excluding strategic
repositioning 57 49
- ----------------------------------------- -------- -----------
OTHER INFORMATION
Total nonperforming assets $187 $220
Net charge-offs $137 $209
Average FTEs 2,123 2,424
INSTITUTIONAL LENDING REPOSITIONING
Loans held for sale
Credit exposure $564 $4,594
Outstandings $245 $2,294
Exit portfolio
Credit exposure $413 $2,262
Outstandings $192
======================================= ========== ===========
Corporate Banking provides credit, equipment leasing, treasury management and
capital markets products and services to mid-sized corporations, government
entities and selectively to large corporations primarily within PNC's geographic
region. Additionally, PNC, through the Corporate Banking line of business,
administers Market Street Funding Corporation ("Market Street"), a multi-seller
asset-backed commercial paper conduit. The strategic focus for Corporate Banking
is to adapt its institutional expertise to the middle market with an emphasis on
higher-margin noncredit products and services, especially treasury management
and capital markets, and to improve the risk/return characteristics of the
lending business. Corporate Banking intends to continue its efforts to manage
credit risk, liquidate loans held for sale and sustain relationships with
traditional customers emphasizing noncredit products.
During 2002, Corporate Banking made significant progress in the
repositioning of its institutional lending business. The exit and held for sale
portfolios at December 31, 2002 had total credit exposure of $977 million
including outstandings of $245 million, a reduction in outstandings of
approximately 90% from December 31, 2001. The Corporation is continuing to
pursue liquidation of the remaining institutional held for sale portfolio. Gains
and losses may result from the liquidation of loans held for sale to the extent
actual performance differs from estimates inherent in the recorded amounts or if
valuations change. A total of $155 million of net gains on loans held for sale
was recognized in 2002. Gains realized in 2002 resulted from a more active
market than was anticipated at the time the loans were transferred to held for
sale, the negotiation of individual loan sales rather than bulk transactions,
and sales occurring faster than expected. Additionally, declines in credit
exposure resulting from payments, refinancings and reductions in credit
facilities also contributed to the gains in 2002. These gains were partially
offset by additional valuation adjustments required on certain credit facilities
remaining in the portfolio. See 2001 Strategic Repositioning in the Consolidated
Balance Sheet Review section and Critical Accounting Policies And Judgments in
the Risk Factors section of this Financial Review for additional information.
Corporate Banking earned $150 million in 2002 compared with a net loss of
$375 million in 2001. Operating income was $69 million in 2002 compared with
$326 million in 2001. The decline was due to higher credit costs and lower
revenue attributable to the institutional lending downsizing.
Operating revenue of $631 million for 2002 decreased $133 million compared
with 2001. Net interest income for 2002 decreased $159 million compared with
2001 primarily due to the impact on treasury management deposits of a decline in
interest rates combined with the reduction in average loans resulting from the
ongoing institutional lending downsizing. Noninterest income increased $26
million compared with 2001 primarily due to higher treasury management fees in
2002 and valuation losses associated with equity investments in 2001.
Total credit costs were $203 million for 2002 compared with $733 million for
2001. Credit costs for 2002 consisted of the provision for credit losses while
the 2001 period included $57 million reflected in provision for credit losses
and $676 million reflected in the institutional lending repositioning charge
that represented net charge-offs. Valuation adjustments totaling $215 million
for loans already designated as held for sale are also reflected in the 2001
institutional lending repositioning charge. Net charge-offs were $137 million
for 2002 compared with $209 million in 2001 excluding the repositioning amount
described above. The provision for credit losses for 2002 covered charge-offs of
$90 million related to two Market Street liquidity facilities and included a $24
million reserve for a single airline industry credit and the impact of
refinements to the Corporation's reserve methodology related to impaired loans
and pooled reserves. See Market Street in the Risk Management section of this
Financial Review for additional information.
Treasury management, capital markets and equipment leasing products offered
through Corporate Banking are sold by several businesses across the Corporation
and related revenue net of expense is included in the results of those
businesses. Consolidated revenue from treasury management was $343 million for
2002, an increase of $12 million compared with 2001, as higher fee revenue was
partially offset by lower income earned on customers' deposit balances.
Consolidated revenue from capital markets was $104 million for 2002, a decrease
of $19 million compared with 2001 primarily due to lower transaction volume
attributable to the weak economic and market conditions.
Nonperforming assets were $187 million at December 31, 2002 compared with
$220 million at December 31, 2001. The decrease was primarily due to the
Corporation's continued liquidation of the institutional lending held for sale
portfolio.
32
WHOLESALE BANKING
PNC REAL ESTATE FINANCE
Year ended December 31
Taxable-equivalent basis
Dollars in millions 2002 2001
====================================== =========== ===========
INCOME STATEMENT
Net interest income $117 $118
Noninterest income
Commercial mortgage banking 65 58
Other 44 37
- -------------------------------------- ----------- -----------
Total noninterest income 109 95
- -------------------------------------- ----------- -----------
Operating revenue 226 213
Provision for credit losses (10) 16
Noninterest expense 160 139
Goodwill amortization 18
- -------------------------------------- ----------- -----------
Operating income 76 40
Strategic repositioning:
Institutional lending
repositioning 34
Severance costs 1
Net (gains) on loans held for sale (3)
- -------------------------------------- ----------- -----------
Pretax earnings 79 5
Minority interest (benefit) expense (2)
Income tax (benefit) expense (9) (33)
- -------------------------------------- ----------- -----------
Earnings $90 $38
====================================== =========== ===========
AVERAGE BALANCE SHEET
Loans
Commercial real estate $2,230 $2,337
Commercial - real estate related 1,471 1,751
- -------------------------------------- ----------- -----------
Total loans 3,701 4,088
Commercial mortgages held for sale 271 273
Other loans held for sale 141 6
Other assets 905 923
- -------------------------------------- ----------- -----------
Total assets $5,018 $5,290
====================================== =========== ===========
Deposits $750 $518
Assigned funds and other liabilities 3,876 4,375
Assigned capital 392 397
- -------------------------------------- ----------- -----------
Total funds $5,018 $5,290
====================================== =========== ===========
PERFORMANCE RATIOS
Return on assigned capital 23% 10%
Noninterest income to operating revenue 48 45
Efficiency 63 60
Efficiency, excluding strategic
repositioning 64 58
- ---------------------------------------- --------- -----------
OTHER INFORMATION
Total nonperforming assets $2 $6
Net (recoveries) charge-offs $(6) $30
Average FTEs 789 743
Institutional lending repositioning
Loans held for sale
Credit exposure $49 $324
Outstandings $44 $244
Exit portfolio
Credit exposure $25 $30
Outstandings $4 $5
- -------------------------------------- ----------- -----------
COMMERCIAL MORTGAGE
SERVICING PORTFOLIO (a)
January 1 $68 $54
Acquisitions/additions 19 25
Repayments/transfers (13) (11)
- -------------------------------------- ----------- -----------
Total $74 $68
====================================== =========== ===========
(a) Dollars in billions.
PNC Real Estate Finance specializes in financial solutions for the acquisition,
development, permanent financing and operation of commercial real estate
nationally. PNC Real Estate Finance offers treasury and investment management,
access to the capital markets, commercial mortgage loan servicing and other
products and services to clients that develop, own, manage or invest in
commercial real estate. PNC's commercial real estate financial services platform
provides processing services through Midland Loan Services, Inc. ("Midland").
Midland is a leading third-party provider of loan servicing and technology to
the commercial real estate finance industry. Columbia Housing Partners, L.P.
("Columbia Housing") is a national syndicator of affordable housing equity.
Certain incremental activities related to Columbia Housing will continue to
require regulatory approvals due to the existence of the Corporation's
regulatory agreements.
PNC Real Estate Finance seeks to have a more balanced and valuable revenue
stream by focusing on real estate processing businesses and increasing the value
of its lending business by seeking to sell more fee-based products to lending
customers.
PNC Real Estate Finance earned $90 million in 2002 compared with $38 million
in 2001. Excluding goodwill amortization expense in 2001, operating income
increased $18 million in 2002 compared with the prior year due to the impact of
higher gains on sales of commercial mortgage loans and lower credit costs in
2002 partially offset by higher noninterest expense. Average loans decreased 9%
in the year-to-year comparison reflecting the impact of the institutional
lending repositioning.
Operating revenue was $226 million for 2002 compared with $213 million for
2001. The increase was primarily due to higher gains on sales of commercial
mortgage loans.
Noninterest expense increased $21 million for 2002 compared with the prior
year primarily due to impairment charges related to affordable housing
partnership assets and a full year of expenses for a lending business acquired
in the fourth quarter of 2001.
The commercial mortgage servicing portfolio grew 9% to $74 billion at
December 31, 2002. Midland, as a third-party servicer, is required to comply
with various contractual obligations, including the obligation to advance funds
for delinquent borrower payments and property protection purposes, and to
monitor property taxes and insurance. A total of $80 million of advances were
outstanding at December 31, 2002. Midland has priority to recover these advances
before the security holders of the related securitizations.
The provision for credit losses for the year ended December 31, 2002
reflected the benefit of a net recovery in the exited warehouse lending business
of $6 million and the impact of refinements to the Corporation's reserve
methodology related to impaired loans and pooled reserves.
During 2002, PNC Real Estate Finance made significant progress in downsizing
its institutional lending business. The exit and held for sale portfolios at
December 31, 2002 had total credit exposure of $74 million including
outstandings of $48 million, a reduction in outstandings of approximately 81%
since December 31, 2001. Of these amounts, $49 million of credit exposure and
$44 million of outstandings were classified as held for sale as of December 31,
2002. The Corporation is continuing to pursue liquidation of the remaining
institutional lending held for sale portfolio. Gains and losses may result from
the liquidation of loans held for sale to the extent actual performance differs
from estimates inherent in the recorded amounts or if valuations change. See
2001 Strategic Repositioning in the Consolidated Balance Sheet Review section of
this Financial Review for additional information.
33
WHOLESALE BANKING
PNC BUSINESS CREDIT
Year ended December 31
Taxable-equivalent basis
Dollars in millions 2002 2001
====================================== =========== ===========
INCOME STATEMENT
Net interest income $134 $104
Noninterest income 59 30
- -------------------------------------- ----------- -----------
Operating revenue 193 134
Provision for credit losses 64 19
Noninterest expense 53 29
Goodwill amortization 2
- -------------------------------------- ----------- -----------
Operating income 76 84
Strategic repositioning:
Institutional lending
repositioning 48
Net losses on loans held for sale 11
- -------------------------------------- ----------- -----------
Pretax earnings 65 36
Income taxes 25 14
- -------------------------------------- ----------- -----------
Earnings $40 $22
====================================== =========== ===========
AVERAGE BALANCE SHEET
Loans $3,535 $2,331
Loans held for sale 68 72
Other assets 234 60
- -------------------------------------- ----------- -----------
Total assets $3,837 $2,463
====================================== =========== ===========
Deposits $84 $77
Assigned funds and other liabilities 3,503 2,223
Assigned capital 250 163
- -------------------------------------- ----------- -----------
Total funds $3,837 $2,463
====================================== =========== ===========
PERFORMANCE RATIOS
Return on assigned capital 16% 13%
Noninterest income to operating
revenue 31 22
Efficiency 29 30
Efficiency, excluding strategic
repositioning 27 22
- ----------------------------------------- -------- -----------
OTHER INFORMATION
Total nonperforming assets $142 $109
Net charge-offs $32 $19
Marketing locations 23 14
Average FTEs 241 137
INSTITUTIONAL LENDING REPOSITIONING
Loans held for sale
Credit exposure $13 $40
Outstandings $9 $30
====================================== =========== ===========
PNC Business Credit provides asset-based lending, treasury management and
capital markets products and services to middle market customers nationally. PNC
Business Credit's lending services include loans secured by accounts receivable,
inventory, machinery and equipment, and other collateral, and its customers
include manufacturing, wholesale, distribution, retailing and service industry
companies.
In January 2002, PNC Business Credit acquired a portion of NBOC's U.S.
asset-based lending business in a purchase business combination. See Note 2 NBOC
Acquisition for additional information.
PNC Business Credit earned $40 million in 2002 compared with $22
million in 2001. Operating income for 2002 was $76 million compared with $84
million in 2001. Operating income for 2002 included revenue and expense
resulting from the NBOC acquisition and a $28 million benefit resulting from a
reduction in the NBOC put option liability. The impact of these items was more
than offset by an increase of $45 million in the provision for credit losses.
Operating revenue was $193 million for 2002, a $59 million increase compared
with 2001 as both net interest income and noninterest income increased. The
increase in net interest income for 2002 reflected a net increase of $1.2
billion or 52% in total average loans for the period resulting primarily from
the NBOC acquisition. Noninterest income for 2002 included a $28 million benefit
resulting from a reduction in the put option liability related to the NBOC
acquisition. Noninterest income for 2001 included gains on sales of equity
interests received as compensation in conjunction with lending relationships.
There were no such gains in 2002.
The provision for credit losses for 2002 was $64 million compared with $19
million for 2001. Net charge-offs were $32 million for 2002 compared with $19
million a year ago. The provision for credit losses increased in 2002 as
additions to reserves were made due to a decline in credit quality and the
impact of refinements to the Corporation's reserve methodology related to
impaired loans and pooled reserves. PNC Business Credit loans, including those
acquired in the NBOC acquisition, are secured loans to borrowers, many who are
highly leveraged, experiencing rapid growth, or have elected to utilize
asset-based financing. As a result, the risk profile of these loans typically
reflects a higher risk of default and a greater proportion being classified as
nonperforming. The impact of these loans on the provision for credit losses and
the level of nonperforming assets may be even more pronounced during periods of
economic downturn consistent with PNC Business Credit's recent experience. PNC
Business Credit attempts to manage this risk through the stringent control of
the borrowers' collateral. Therefore, net charge-offs on asset-based loans have
historically been relatively low due to recoveries provided by the underlying
collateral. Compensation for this higher risk of default is obtained by way of
higher interest rates charged.
Total noninterest expense increased $24 million to $53 million for 2002
primarily due to costs added with the NBOC acquisition.
Nonperforming assets were $142 million at December 31, 2002 compared with
$109 million at December 31, 2001. The increase was primarily due to the
transfer of a single credit to nonperforming status that was partially offset by
reductions to credits through managed liquidation and run-offs.
PNC Business Credit's balance sheet included several credits that were part
of the Corporation's institutional lending repositioning. Credit exposure of $13
million, including $9 million of outstandings classified as held for sale,
remained at December 31, 2002.
34
PNC ADVISORS
Year ended December 31
Taxable-equivalent basis
Dollars in millions 2002 2001
====================================== =========== ============
INCOME STATEMENT
Net interest income $100 $128
Noninterest income
Investment management and trust 334 393
Brokerage 131 130
Other 89 84
- -------------------------------------- ----------- ------------
Total noninterest income 554 607
- -------------------------------------- ----------- ------------
Operating revenue 654 735
Provision for credit losses 4 2
Noninterest expense 497 497
Goodwill amortization 7
- -------------------------------------- ----------- ------------
Pretax earnings 153 229
Income taxes 56 86
- -------------------------------------- ----------- ------------
Earnings $97 $143
====================================== =========== ============
AVERAGE BALANCE SHEET
Loans
Consumer $1,228 $1,103
Residential mortgage 501 848
Commercial 460 528
Other 320 384
- -------------------------------------- ----------- ------------
Total loans 2,509 2,863
Other assets 420 467
- -------------------------------------- ----------- ------------
Total assets $2,929 $3,330
====================================== =========== ============
Deposits $2,007 $2,058
Assigned funds and other liabilities 399 730
Assigned capital 523 542
- -------------------------------------- ----------- ------------
Total funds $2,929 $3,330
====================================== =========== ============
PERFORMANCE RATIOS
Return on assigned capital 19% 26%
Noninterest income to operating revenue 85 83
Efficiency 76 68
- -------------------------------------- ----------- ------------
OTHER INFORMATION
Total nonperforming assets $5 $4
Net charge-offs $4 $2
Brokerage assets administered (in
billions) $32 $28
Full service brokerage offices 106 113
Financial consultants 615 681
Margin loans $260 $309
Average FTEs 3,351 3,598
- -------------------------------------- ----------- ------------
ASSETS UNDER MANAGEMENT (a)(b)
Personal investment management and
trust $41 $47
Institutional trust 9 13
- -------------------------------------- ----------- ------------
Total $50 $60
ASSET TYPE (b)
Equity $26 $36
Fixed income 17 17
Liquidity 7 7
- -------------------------------------- ----------- ------------
Total $50 $60
====================================== =========== ============
(a) Excludes brokerage assets administered
(b) At December 31 - in billions.
PNC Advisors provides a full range of tailored investment, trust and private
banking products and services to affluent individuals and families, including
full-service brokerage through J.J.B. Hilliard, W.L. Lyons, Inc. ("Hilliard
Lyons") and investment consulting and trust services to the ultra-affluent
through Hawthorn. PNC Advisors also serves as investment manager and trustee for
employee benefit plans and charitable and endowment assets and provides defined
contribution plan services and investment options through its Vested Interest(R)
product.
PNC Advisors continues to emphasize deepening customer relationships through
a focused retention program and a broad array of products. The business was
adversely affected in 2002 by the depressed financial markets and the impact on
its clients. The business is addressing the industry-wide issue of appropriate
expense levels in light of the challenging equity markets and loss of client
wealth.
PNC Advisors earned $97 million in 2002 compared with $143 million in 2001.
The earnings decline was driven by lower operating revenue and the impact of
litigation costs.
Operating revenue for 2002 decreased $81 million compared with the prior
year. The run-off of residential mortgages along with a narrower net interest
margin, resulted in a $28 million decline in net interest income. Investment
management and trust fees declined $59 million, resulting from depressed
financial market conditions, a net outflow of customers, and the recognition of
a positive revenue accrual adjustment of $15 million in 2001.
PNC Advisors provides investment management services directly, through funds
and accounts managed by BlackRock and through funds managed by unaffiliated
investment managers. In July 2002, the Corporation and BlackRock entered into a
revised agreement with respect to investment management services. The agreement
includes a reduction in the rate of fees received from BlackRock based on
current market conditions and the impact of a reduction in the level of PNC
Advisors' customer assets managed by BlackRock. This agreement reduced PNC
Advisors' investment management and trust fees by $6 million in 2002.
On January 14, 2003, an arbitration panel with the National Association of
Securities Dealers ruled against Hilliard Lyons and some of its employees with
respect to a claim filed by First of Michigan Corporation (now Fahnestock & Co.,
Inc.) arising out of Hilliard Lyons' hiring of brokers and support staff from
First of Michigan in late 1997 and spring 1998. The events underlying First of
Michigan's claims all occurred prior to PNC's acquisition of Hilliard Lyons in
December 1998. The award in favor of First of Michigan in the amount of $22
million (including $16 million in damages and $6 million in interest and costs)
resulted in a 2002 pretax charge at PNC Advisors of $10 million, after taking
into account the application of related reserves and accruals.
Assets under management and related noninterest income are closely tied to
the performance of the equity markets. Management expects that revenues in this
business will continue to be challenged until equity market conditions and
investment performance improve for a sustained period. Assets under management
decreased $10 billion primarily due to the decline in the value of the equity
component of customers' portfolios. Brokerage assets administered by Hilliard
Lyons were $32 billion at December 31, 2002 compared with $28 billion at
December 31, 2001 and were also impacted by weak equity market conditions.
During the second quarter of 2002, Hilliard Lyons acquired from Regional
Community Banking the branch-based brokerage business that formerly operated
under the PNC Brokerage brand name. This business was combined with Hilliard
Lyons' brokerage operations and now provides services in the branch network
under the PNC Investments brand name. However, the revenue and expense related
to the branch-based brokerage business continues to be included in the results
of Regional Community Banking. Consolidated revenue from brokerage was $195
million for 2002 compared with $206 million for 2001.
35
BLACKROCK
Year ended December 31
Dollars in millions 2002 2001
====================================== =========== ============
INCOME STATEMENT
Investment advisory and
administrative fees $519 $495
Other income 58 38
- -------------------------------------- ----------- ------------
Total revenue 577 533
Operating expense 321 292
Fund administration
and servicing costs - affiliates 40 61
Amortization of goodwill and other
intangible assets 1 10
- -------------------------------------- ----------- ------------
Total expense 362 363
- -------------------------------------- ----------- ------------
Operating income 215 170
Nonoperating income 9 11
- -------------------------------------- ----------- ------------
Pretax earnings 224 181
Income taxes 91 74
- -------------------------------------- ----------- ------------
Earnings $133 $107
====================================== =========== ============
PERIOD-END BALANCE SHEET
Intangible assets $183 $182
Other assets 681 502
- -------------------------------------- ----------- ------------
Total assets $864 $684
====================================== =========== ============
Liabilities $229 $198
Stockholders' equity 635 486
- -------------------------------------- ----------- ------------
Total liabilities and
stockholders' equity $864 $684
- -------------------------------------- ----------- ------------
PERFORMANCE DATA
Return on equity 24% 25%
Operating margin (a) 40 36
Diluted earnings per share $2.04 $1.65
- -------------------------------------- ----------- ------------
OTHER INFORMATION
Average FTEs 823 758
====================================== =========== ============
ASSETS UNDER MANAGEMENT(B)
Separate accounts
Fixed income $157 $119
Liquidity 6 7
Liquidity - securities lending 6 11
Equity 10 10
Alternative investment products 5 5
- -------------------------------------- ----------- ------------
Total separate accounts 184 152
- -------------------------------------- ----------- ------------
Mutual funds (c)
Fixed income 19 16
Liquidity 66 62
Equity 4 9
- -------------------------------------- ----------- ------------
Total mutual funds 89 87
- -------------------------------------- ----------- ------------
Total assets under management $273 $239
====================================== =========== ============
(a) Excludes the impact of fund administration and servicing costs - affiliates.
(b) December 31 - in billions.
(c)Includes BlackRock Funds, BlackRock Provident Institutional Funds, BlackRock
Closed End Funds, Short Term Investment Fund and BlackRock Global Series
Funds.
The financial information presented above reflects BlackRock on a stand-alone
basis. BlackRock is approximately 69% owned by PNC and is consolidated into
PNC's financial statements. Accordingly, approximately 31% of BlackRock's
earnings were recognized as a minority interest expense in the Consolidated
Statement Of Income.
BlackRock is one of the largest publicly traded investment management firms
in the United States with approximately $273 billion of assets under management
at December 31, 2002. BlackRock manages assets on behalf of institutions and
individuals worldwide through a variety of fixed income, liquidity and equity
mutual funds, separate accounts and alternative investment products. Mutual
funds include the flagship fund families - BlackRock Funds and BlackRock
Provident Institutional Funds. In addition, BlackRock provides risk management
and investment system services to institutional investors under the BlackRock
Solutions brand name. BlackRock continues to focus on delivering superior
relative investment performance to clients while pursuing strategies to build on
core strengths and to selectively expand the firm's expertise and breadth of
distribution.
BlackRock earned $133 million in 2002 compared with $107 million in
2001. Total revenue for 2002 increased $44 million, or 8%, compared with 2001 as
a result of higher fees from separate account assets, institutional liquidity
fund assets and new closed-end fund offerings. BlackRock also benefited in the
comparison from the cessation of goodwill amortization expense in 2002.
Excluding goodwill amortization, expenses increased $8 million, or 2%, in
the year-to-year comparison in support of revenue growth and business expansion.
Operating expense growth in 2002 was partially offset by lower fund
administration and servicing costs-affiliates.
The lower levels of PNC client assets invested in the BlackRock Funds and
the effect of the revised investment services agreement resulted in a reduction
in fund administration and servicing costs-affiliates of approximately $21
million for the year ended December 31, 2002. In July 2002, BlackRock and the
Corporation entered into a revised agreement with respect to investment
management services. The agreement includes a reduction in the rate of fees paid
to PNC Advisors based on current market conditions and the impact of a reduction
in the level of PNC Advisors' customer assets managed by BlackRock. PNC
client-related assets subject to fund administration and servicing payments
declined approximately $4.8 billion for the year ended December 31, 2002.
During 2002, BlackRock adopted a new long-term incentive and retention
program for key employees, subject to approval by BlackRock's stockholders at
their next annual meeting in May 2003. The program seeks to provide continuity
of the management team while promoting development of the firm's future leaders.
See BlackRock Long-Term Incentive and Retention Plan in this Financial Review
for further information.
BlackRock is listed on the New York Stock Exchange under the symbol BLK.
Additional information about BlackRock is available in its SEC filings at
www.sec.gov.
36
PFPC
Year ended December 31
Dollars in millions 2002 2001
===================================== =========== ============
INCOME STATEMENT
Fund servicing revenue $817 $846
Operating expense 669 644
Goodwill amortization 40
(Accretion)/amortization of
other intangibles, net (19) (15)
- ------------------------------------- ----------- ------------
Operating income 167 177
Nonoperating income (a) 10 14
Debt financing 88 94
Facilities consolidation and other
charges (19) 36
- --------------------------------------- --------- ------------
Pretax earnings 108 61
Income taxes 43 25
- ------------------------------------- ----------- ------------
Earnings $65 $36
====================================== =========== ===========
AVERAGE BALANCE SHEET
Intangible assets $1,028 $1,065
Other assets 860 706
- ------------------------------------- ----------- ------------
Total assets $1,888 $1,771
- ------------------------------------- ----------- ------------
Assigned funds and other liabilities $1,680 $1,563
Assigned capital 208 208
- ------------------------------------- ----------- ------------
Total funds $1,888 $1,771
====================================== =========== ===========
PERFORMANCE RATIOS
Return on assigned capital 31% 17%
Operating margin 23 17
- ------------------------------------- ----------- ------------
OTHER INFORMATION
Average FTEs 5,834 5,737
- ------------------------------------- ----------- ------------
SERVICING STATISTICS (b)
Accounting/administration assets
Domestic $481 $514
Foreign 29 21
- ------------------------------------- ----------- ------------
Total $510 $535
Custody assets $336 $357
Shareholder accounts (in millions) 51 49
===================================== =========== ============
(a) Net of nonoperating expense.
(b) At December 31. Dollars in billions.
PFPC is the largest full-service mutual fund transfer agent and second largest
provider of mutual fund accounting and administration services in the United
States, offering a wide range of fund services to the investment management
industry. PFPC also provides processing solutions to the international
marketplace through its Ireland and Luxembourg operations.
The financial results for this business may be significantly impacted by the
net gain or loss of large clients or groups of smaller clients and by shifts in
client assets between higher and lower margin products. During 2002, PFPC was
adversely impacted by depressed financial market conditions, a shift in client
assets from equity to fixed income products and client attrition. Management is
addressing the revenue/expense relationship of this business given current
conditions. PFPC is focused on retaining its long-standing customers and has
recently won several pieces of new business, partially offsetting the revenue
impact of client attrition, including the loss of one large transfer agency
client that will occur in the first quarter of 2003.
PFPC is also focusing technological resources on targeting Web-based
initiatives, streamlining operations and developing flexible system architecture
and client-focused servicing solutions. To meet the growing needs of the
European marketplace, PFPC is also continuing to expand offshore.
PFPC earned $65 million in 2002 compared with $36 million in 2001.
Earnings for 2002 improved compared with the prior year due to a reduction in
the facilities consolidation reserve originally established in 2001, a one-time
revenue adjustment of $13 million related to the renegotiation of a customer
contract in 2002 and the cessation of goodwill amortization expense in 2002.
Excluding those items, earnings declined due to lower fund servicing revenue and
narrower operating margins in this business.
In the fourth quarter of 2001, PFPC incurred $36 million of pretax charges
largely related to a plan to consolidate certain facilities as a follow-up to
the integration of the Investor Services Group acquisition. The charges
primarily reflected termination costs related to exiting certain lease
agreements and the abandonment of related leasehold improvements. During 2002,
the facilities strategy was modified and certain originally contemplated
relocations will not occur. PFPC also benefited in 2002 from the adoption of the
new goodwill accounting standard that reduced amortization expense by $40
million compared with 2001. These benefits were partially offset by higher
staff-related costs and $8 million of charges related to an equity investment.
The cost of integration, technology and infrastructure investments, coupled with
a shift in both product and client mix, continued to exert pressure on operating
margins. Margins are expected to remain under pressure at least until equity
markets and investor sentiment and demand improve for a sustained period.
Fund servicing revenue and operating expenses have been adjusted in both
periods presented to reflect the reclassification of distribution and
underwriting fees received and passed through to external brokers under selling
agreements which had been previously presented on a net basis. This
reclassification had no impact on operating income.
Revenue of $817 million for 2002 decreased $29 million compared with 2001,
despite the one-time benefit of $13 million described above. The positive impact
of new sales of accounting/administration services and offshore growth could not
overcome revenue declines resulting from client attrition and equity market
declines that impacted both transfer agency activity levels and net asset
valuations.
Operating expense increased $25 million or 4% in the year-to-year comparison
primarily due to increased staff levels for new product support. In the second
half of 2002, PFPC began a series of initiatives designed to improve efficiency.
These included such items as consolidating transfer agency platforms, increasing
automation and executing planned facilities consolidation. PFPC's goal is to
achieve at least $50 million in run rate expense reductions over time before
considering the impact of reinvestment in technology and new business.
Accordingly, during 2002 the workforce was reduced as average FTEs declined from
6,082 in January to 5,401 in December.
Operating income for 2002 and 2001 included accretion of a discounted client
contract liability of $35 million and $30 million, respectively.
Accounting/administration net assets have decreased compared with the 2001
period as the impact of depressed financial markets and changes in domestic
client mix have more than offset successful offshore sales efforts. Custody
assets have declined primarily due to changes in client relationships.
37
CONSOLIDATED STATEMENT OF INCOME REVIEW
NET INTEREST INCOME
Changes in net interest income and margin result from the interaction among the
volume and composition of earning assets, related yields and associated funding
costs. Accordingly, portfolio size, composition and yields earned and funding
costs can have a significant impact on net interest income and margin. See the
Average Consolidated Balance Sheet and Net Interest Analysis for additional
information.
Taxable equivalent net interest income was $2.210 billion for 2002, down $68
million, or 3%, from $2.278 billion for 2001. The decline in net interest income
for 2002 compared with the prior year reflected the effects of a lower rate
environment and growth in average transaction deposits in 2002 that was more
than offset by the impact of the continued downsizing of the loan portfolio. The
net interest margin widened 15 basis points to 3.99% for 2002 compared with
3.84% for 2001. The widening of the net interest margin for 2002 resulted from
the impact of changes in balance sheet composition and a lower interest rate
environment, combined with a steep yield curve. See Interest Rate Risk in the
Risk Management section of this Financial Review for additional information.
PROVISION FOR CREDIT LOSSES
The provision for credit losses was $309 million for 2002 compared with $903
million for 2001. Provision expense for 2001 reflected $714 million for net
charge-offs associated with institutional lending repositioning initiatives.
Excluding this amount, the provision for credit losses increased $120 million in
2002. The provision for 2002 reflected additions to reserves for PNC Business
Credit and Corporate Banking and losses in Corporate Banking primarily related
to Market Street Funding Corporation ("Market Street") liquidity facilities. See
Credit Risk in the Risk Management section and Critical Accounting Policies And
Judgments in the Risk Factors section of this Financial Review for additional
information regarding credit risk.
Net charge-offs were $223 million, or .60%, of average loans for 2002
compared with $948 million or 2.12%, respectively, for 2001. Net charge-offs for
2001 included $804 million related to institutional lending repositioning
initiatives. Excluding this amount, net charge-offs increased $79 million in
2002 primarily due to two charge-offs totaling $90 million related to Market
Street liquidity facilities. See Market Street Funding Corporation in this
Financial Review for additional information.
NONINTEREST INCOME
Noninterest income was $3.197 billion for 2002 compared with $2.652 billion for
2001.
Asset management fees totaled $853 million for 2002, up $5 million compared
with 2001. The increase primarily reflected an increase in separate account base
fee revenue arising from growth in assets under management at BlackRock,
partially offset by lower asset management fees at PNC Advisors primarily due to
weak equity markets in 2002 and the recognition of $15 million of revenue
accrual adjustments that benefited 2001. Consolidated assets under management
were $313 billion at December 31, 2002, an increase of $29 billion compared with
December 31, 2001, due to growth at BlackRock.
Fund servicing fees decreased $17 million, to $816 million, for 2002
compared with 2001. Excluding a one-time benefit of approximately $13 million
related to the renegotiation of a client contract recognized during 2002 at
PFPC, fund servicing fees decreased $30 million in 2002. Depressed financial
market conditions, pricing and other competitive factors including customer
attrition contributed to the decline in 2002.
Service charges on deposits were $227 million for 2002 compared with $218
million for 2001. The increase in 2002 reflected the benefit of an increase in
average transaction deposits that offset the impact of price reductions from
comparable services.
Brokerage fees declined $11 million, to $195 million, for 2002 compared with
the prior year as lower sales commissions resulted from the impact of depressed
financial market conditions and lower trading volumes.
Consumer services revenue increased $10 million, to $239 million, for 2002
compared with 2001, reflecting additional fees from ATM and debit card
transactions arising from increased transaction volumes.
Corporate services revenue totaled $526 million for 2002 compared with $60
million for 2001. Net gains in excess of valuation adjustments related to the
liquidation of institutional loans held for sale totaled $147 million in 2002,
while revenue in 2001 was adversely impacted by valuation adjustments on loans
held for sale of $259 million. Excluding these items, corporate services revenue
increased $60 million in 2002 primarily due to growth in treasury management
fees and higher gains from commercial mortgage loan sales.
38
Equity management (private equity activities) net losses on portfolio
investments were $51 million in 2002 compared with net losses of $179 million in
2001. See Equity Management Asset Valuation in the Critical Accounting Policies
And Judgments section of this Financial Review for further information.
Net securities gains were $89 million for 2002 compared with $131 million
for 2001.
Other noninterest income totaled $303 million for 2002 compared with $306
million for 2001. Other noninterest income for 2002 included a $28 million
benefit resulting from a reduction in the put option liability related to the
NBOC acquisition, a $14 million gain on the sale of a real estate investment and
a lower level of asset write-downs compared with the prior year. The impact of
these items was more than offset by lower revenue from trading activities in
2002 and lower gains related to securitizations in 2002. Net trading income
included in other noninterest income was $91 million for 2002 compared with $142
million in 2001. See Note 8 Trading Activities for further information. Gains
from securitization transactions totaled $12 million in 2002 compared with $31
million in 2001. See Note 15 Securitizations for further information.
NONINTEREST EXPENSE
Total noninterest expense was $3.227 billion for 2002 compared with $3.414
billion for 2001, a decline of $187 million. Noninterest expense for 2001
included the impact of charges totaling $135 million in connection with the
vehicle leasing business including exit costs and additions to reserves related
to insured residual value exposures, integration and severance costs of $56
million related to other strategic initiatives, and goodwill amortization
expense of $117 million. Excluding these items, noninterest expense increased
$121 million in 2002 compared with the prior year. The increase in noninterest
expense in 2002 was primarily attributable to increases of $29 million, $25
million and $24 million at BlackRock, PFPC and PNC Business Credit,
respectively. These increases reflected higher operating expenses to support
revenue growth at PNC Business Credit and BlackRock and new product support at
PFPC. In addition, noninterest expense for 2002 included $30 million of legal
and consulting fees related to regulatory compliance and legal proceedings.
Partially offsetting these increases in 2002 was the benefit of a $19 million
reduction in facilities consolidation reserves at PFPC. The PFPC reserves were
originally established in 2001 as part of the other strategic initiatives
referred to above and are primarily related to a previously announced plan to
consolidate selected facilities. The facilities strategy has been modified and
certain originally contemplated relocations will not occur.
39
CONSOLIDATED BALANCE SHEET REVIEW
2001 STRATEGIC REPOSITIONING
PNC took several actions in 2001 to accelerate the strategic repositioning of
its lending businesses that began in 1998. A total of $12.0 billion of credit
exposure, including $6.2 billion of outstandings, were designated for exit or
transferred to held for sale during 2001, of which $10.1 billion and $4.3
billion, respectively, related to the institutional lending portfolio. The
remaining $1.9 billion of credit exposure and outstandings related to PNC's
vehicle leasing business that is being discontinued.
At December 31, 2002, PNC's vehicle leasing business had $1.4 billion in
assets that have been designated for exit comprised of vehicle leases with an
aggregate residual value of $1.0 billion and $.4 billion of estimated future
customer lease payments. As of December 31, 2002 there were approximately 64,800
active vehicle leases scheduled to mature over the next five years as follows:
22,900, 22,500, 13,000, 6,400, and less than 100 in years 2003, 2004, 2005, 2006
and 2007, respectively. The associated residual values are as follows: $400
million, $370 million, $180 million, $70 million and less than $.5 million,
respectively. See 2001 Strategic Repositioning and Critical Accounting Policies
And Judgments in the Risk Factors section of this Financial Review for
additional information regarding certain risks associated with executing these
strategies.
Details of the credit exposure and outstandings by business in the
institutional lending held for sale and exit portfolios are included in the
Wholesale Banking sections of the Review of Businesses within this Financial
Review. A rollforward of the institutional lending held for sale portfolio
follows:
ROLLFORWARD OF INSTITUTIONAL LENDING HELD FOR SALE PORTFOLIO
Credit Outstandings
In millions Exposure
================================ =============== =============
January 1, 2002 $4,958 $2,568
Additions 119 249
Sales (2,205) (1,278)
Payments and other exposure
reductions (1,996) (1,046)
Valuation adjustments, net (250) (195)
- -------------------------------- --------------- -------------
DECEMBER 31, 2002 $626 $298
================================ =============== =============
The liquidation of institutional loans held for sale resulted in net gains in
excess of valuation adjustments of $147 million in 2002. Gains realized in 2002
resulted from a more active market than was anticipated at the time the loans
were transferred to held for sale, the negotiation of individual loan sales
rather than bulk transactions, and sales occurring faster than expected.
Additionally, declines in credit exposure resulting from payments, refinancings
and reductions in credit facilities also contributed to the gains in 2002. These
gains were partially offset by additional valuation adjustments required on
certain credit facilities remaining in the portfolio. Details by Wholesale
Banking business follow.
INSTITUTIONAL LENDING HELD FOR SALE ACTIVITY
Year ended Net gains
December 31, 2002 on Valuation
In millions liquidation adjustments Total
============================= =========== =========== =========
Corporate Banking $368 $(213) $155
PNC Real Estate Finance 20 (17) 3
PNC Business Credit 9 (20) (11)
- ----------------------------- ----------- ----------- ---------
Total $397 $(250) $147
============================= =========== =========== =========
In addition to the actions taken regarding the institutional lending held for
sale and exit portfolios, the Corporation also recorded charges in 2001 totaling
$208 million in connection with other actions and additions to reserves.
Reserves related to these actions totaled $133 million at December 31, 2002. The
following table summarizes the changes to these reserves for 2002:
ROLLFORWARD OF OTHER RESERVES RELATED TO FOURTH QUARTER 2001 ACTIONS
---------------------------------------------
2001 Utilized Utilized AT
In millions Charge in 2001 in 2002 DEC. 31, 2002
==================================================================
Vehicle leasing $135 $(11) $(5) $119
Asset impairment
and severance
costs 37 (24) (13)
Facilities
consolidation and
other charges 36 (22) 14
- ----------------------------------------------------------------
Total $208 $(35) $(40) $133
================================================================
The fourth quarter 2001 charge of $135 million in connection with the vehicle
leasing business included exit costs and additions to reserves related to
insured residual value exposures. At December 31, 2002, the related liability
had been reduced to $119 million as a result of goodwill impairment of $11
million recorded in the fourth quarter of 2001 and a net $5 million reduction
related to severance and contractual payments recorded in 2002 in connection
with PNC's exit of this business.
The liability for asset impairment and severance costs was eliminated in
2002 as a result of asset write-downs and severance benefits paid totaling $24
million in the fourth quarter of 2001 and $13 million of severance benefits paid
in 2002.
In the fourth quarter of 2001, PFPC incurred $36 million of pretax charges
primarily related to a plan to consolidate certain facilities. The charges
primarily reflected costs related to exiting certain lease agreements and the
abandonment of related leasehold improvements. During the third quarter of 2002,
the Corporation recognized a $19 million reduction of these charges as the
facilities strategy has been modified and certain originally contemplated
relocations will not occur.
40
See 2001 Strategic Repositioning in the Risk Factors section of this
Financial Review for additional information regarding certain risks associated
with executing these strategies.
LOANS
Loans were $35.5 billion at December 31, 2002 compared with $38.0 billion at
December 31, 2001. The decline of $2.5 billion from the prior year was due to
the impact of residential mortgage loan prepayments and sales, transfers to held
for sale and the managed reduction of institutional loans, which more than
offset the impact in 2002 of the NBOC acquisition and growth in home equity
loans.
DETAILS OF LOANS
December 31 - in millions 2002 2001
================================== ============== ============
Commercial
Retail/wholesale $4,161 $3,856
Manufacturing 3,454 3,352
Service providers 1,906 2,136
Real estate related 1,481 1,720
Financial services 1,218 1,362
Communications 124 139
Health care 458 517
Other 2,185 2,123
- ---------------------------------- -------------- ------------
Total commercial 14,987 15,205
- ---------------------------------- -------------- ------------
Commercial real estate
Real estate projects 1,750 1,780
Mortgage 517 592
- ---------------------------------- -------------- ------------
Total commercial real estate 2,267 2,372
- ---------------------------------- -------------- ------------
Consumer
Home equity 8,108 7,016
Automobile 484 773
Other 1,262 1,375
- ---------------------------------- -------------- ------------
Total consumer 9,854 9,164
- ---------------------------------- -------------- ------------
Residential mortgage 3,921 6,395
Lease financing
Equipment 3,560 3,356
Vehicle 1,521 2,201
- ---------------------------------- -------------- ------------
Total lease financing 5,081 5,557
- ---------------------------------- -------------- ------------
Other 415 445
Unearned income (1,075) (1,164)
- ---------------------------------- -------------- ------------
Total, net of unearned income $35,450 $37,974
================================== ============== ============
Loan portfolio composition continued to be diversified across PNC's footprint
among numerous industries and types of businesses. At December 31, 2002, loans
of $35.5 billion included $1.4 billion of vehicle leases, net of unearned
income, and $4 million of commercial loans that have been designated for exit.
LOANS HELD FOR SALE
Loans held for sale totaled $1.6 billion at December 31, 2002, a decline of $2.6
billion, or 62%, from the balance at December 31, 2001. See 2001 Strategic
Repositioning in this Financial Review for further information regarding the
institutional lending held for sale portfolio, which accounted for $2.3 billion
of the decline from the prior year. Education loans classified as held for sale
declined $.3 billion to $1.0 billion at December 31, 2002. Substantially all
education loans are classified as held for sale. Approximately $72 million of
loans held at December 31, 2002 by companies formed with American International
Group, Inc. ("AIG") are classified as loans held for sale in the consolidated
financial statements, compared with $276 million of such loans at December 31,
2001. See Note 32 Subsequent Event.
DETAILS OF LOANS HELD FOR SALE
December 31 - in millions 2002 2001
======================================= =========== ===========
Institutional lending repositioning
Commercial
Manufacturing $126 $810
Communications 32 690
Health care 21 73
Financial services 17 40
Service providers 16 333
Retail/wholesale 12 114
Real estate related 2 30
Other 27 223
- -------------------------------------- ------------ -----------
Total commercial 253 2,313
- -------------------------------------- ------------ -----------
Commercial real estate 45 248
Lease financing 7
- -------------------------------------- ------------ -----------
Total institutional lending
repositioning 298 2,568
Education loans 1,035 1,340
Other 274 281
- -------------------------------------- ------------ -----------
Total loans held for sale $1,607 $4,189
====================================== ============ ===========
See Critical Accounting Policies And Judgments in the Risk Factors section of
this Financial Review for additional information regarding loans held for sale.
NONPERFORMING, PAST DUE AND POTENTIAL PROBLEM ASSETS
Nonperforming assets include nonaccrual loans, troubled debt restructurings,
nonaccrual loans held for sale and foreclosed assets. In addition, certain
performing assets have interest payments that are past due or have the potential
for future repayment problems.
41
NONPERFORMING ASSETS BY TYPE
December 31 - dollars in millions 2002 2001
========================================== ========= ==========
Nonaccrual loans
Commercial $226 $188
Lease financing 57 11
Consumer 11 3
Commercial real estate 7 4
Residential mortgage 7 5
- ------------------------------------------ --------- ----------
Total nonaccrual loans 308 211
- ------------------------------------------ --------- ----------
Troubled debt restructured 1
- ------------------------------------------ --------- ----------
Total nonperforming loans 309 211
Nonperforming loans held for sale (a) 97 169
Foreclosed assets
Commercial real estate 1
Residential mortgage 6 3
Other 6 7
- ------------------------------------------ --------- ----------
Total foreclosed assets 12 11
- ------------------------------------------ --------- ----------
Total nonperforming assets $418 $391
========================================== ========= ==========
Nonperforming loans to total loans .87% .56%
Nonperforming assets to total loans,
loans held for sale and foreclosed
assets 1.13 .93
Nonperforming assets to total assets .63 .56
========================================== ========= ==========
(a) Includes troubled debt restructured loans held for sale of $17 million and
$6 million as of December 31, 2002 and 2001, respectively.
Of the total nonperforming loans at December 31, 2002 and 2001, approximately
41% and 47%, respectively, are related to PNC Business Credit. These loans are
to borrowers that often are highly leveraged, experiencing rapid growth, or have
elected to utilize asset-based financing. As a result, the risk profile of these
loans typically reflects a higher risk of default and a greater proportion of
such loans being classified as nonperforming. Such loans are secured by accounts
receivable, inventory, machinery and equipment, and other collateral. This
secured position helps to mitigate risk of loss on these loans by reducing the
reliance on cash flows for repayment. The above table excludes $40 million and
$18 million of nonperforming equity management assets carried at estimated fair
value at December 31, 2002 and December 31, 2001 and included in other assets on
the Consolidated Balance Sheet. Nonperforming equity management assets at
December 31, 2002 include $12 million of troubled debt restructured assets.
The amount of nonperforming loans that were current as to principal and
interest was $107 million at December 31, 2002 and $93 million at December 31,
2001. The amount of nonperforming loans held for sale that were current as to
principal and interest was $46 million at December 31, 2002 and $8 million at
December 31, 2001.
NONPERFORMING ASSETS BY BUSINESS
December 31 - in millions 2002 2001
================================== =============== ==========
Regional Community Banking $82 $52
Corporate Banking 187 220
PNC Real Estate Finance 2 6
PNC Business Credit 142 109
PNC Advisors 5 4
- ---------------------------------- --------------- ----------
Total nonperforming assets $418 $391
================================== =============== ==========
At December 31, 2002, Corporate Banking and PNC Business Credit had
nonperforming loans held for sale of $83 million and $14 million, respectively.
CHANGE IN NONPERFORMING ASSETS
In millions 2002 2001
====================================== ============= ===========
January 1 $391 $372
Transferred from accrual 887 852
Returned to performing (30) (28)
Principal reductions (421) (278)
Asset sales (181) (27)
Charge-offs and other (228) (500)
- -------------------------------------- ------------- -----------
December 31 $418 $391
====================================== ============= ===========
Credit quality was adversely impacted in 2002 and continued weakness or further
weakening of the economy, or other factors that affect asset quality, could
result in an increase in the number of delinquencies, bankruptcies or defaults,
and a higher level of nonperforming assets, net charge-offs and provision for
credit losses in future periods. See the Forward-Looking Statements section of
this Financial Review for additional factors that could cause actual results to
differ materially from forward-looking statements or historical performance.
ACCRUING LOANS AND LOANS HELD FOR SALE PAST DUE 90 DAYS OR MORE
----------------- -------------------------
Percent of Total
Amount Outstandings
----------------- -------------------------
December 31
Dollars in millions 2002 2001 2002 2001
==================== ========= ========= =========== ===========
Consumer $40 $36 .41% .39%
Residential
mortgage 38 56 .97 .88
Commercial real
estate 10 11 .44 .46
Commercial 41 54 .27 .36
Lease financing 1 2 .02 .05
- -------------------- --------- ---------
Total loans 130 159 .37 .42
Loans held for sale 32 33 1.99 .79
- ----------------------- ------ ---------
Total loans and
loans held for
sale $162 $192 .44% .46%
======================= ====== ========= =========== ===========
Loans and loans held for sale not included in nonperforming or past due
categories, but where information about possible credit problems causes
management to be uncertain about the borrower's ability to comply with existing
repayment terms over the next six months, totaled $297 million and $38 million,
respectively, at December 31, 2002, compared with $87 million and $213 million,
respectively, at December 31, 2001. Approximately 44% of these loans are in the
PNC Business Credit portfolio and all of the loans held for sale relate to the
institutional lending repositioning.
42
CREDIT RISK
Credit risk represents the possibility that a borrower, counterparty or insurer
may not perform in accordance with contractual terms. Credit risk is inherent in
the financial services business and results from extending credit to customers,
purchasing securities and entering into financial derivative transactions. The
Corporation seeks to manage credit risk through, among others, diversification,
limiting credit exposure to any single industry or customer, requiring
collateral, selling participations to third parties, and purchasing
credit-related derivatives.
ALLOWANCES FOR CREDIT LOSSES AND UNFUNDED LOAN COMMITMENTS AND LETTERS OF CREDIT
The Corporation maintains an allowance for credit losses to absorb losses from
the loan portfolio. The allowance is determined based on quarterly assessments
of the probable estimated losses inherent in the loan portfolio. The methodology
for measuring the appropriate level of the allowance consists of several
elements, including specific allocations to impaired loans, allocations to pools
of non-impaired loans and unallocated reserves. While allocations are made to
specific loans and pools of loans, the total reserve is available for all loan
losses. Enhancements and refinements to the reserve methodology during 2002
resulted in a reallocation of the allowance for credit losses among the
Corporation's businesses and from unallocated to specific and pool categories.
In addition to the allowance for credit losses, the Corporation maintains an
allowance for unfunded loan commitments and letters of credit. This amount,
reported as a liability on the Consolidated Balance Sheet, is determined using
estimates of the probability of the ultimate funding and losses related to those
credit exposures. The methodology used is similar to the methodology used for
determining the adequacy of the allowance for credit losses.
Specific allowances are established for loans considered impaired by a
method prescribed by SFAS No. 114, "Accounting by Creditors for Impairment of a
Loan." All nonperforming loans are considered impaired under SFAS No. 114.
Specific allowances are determined for individual loans over a dollar threshold
by PNC's Special Asset Committee based on an analysis of the present value of
its expected future cash flows discounted at its effective interest rate, its
observable market price or the fair value of the underlying collateral. A
minimum specific allowance is established on all impaired loans at the
applicable pool reserve allocation for similar loans.
Allocations to non-impaired commercial and commercial real estate loans
(pool reserve allocations) are assigned to pools of loans as defined by PNC's
business structure and internal risk rating categories. Key elements of the pool
reserve methodology include expected default probabilities ("EDP"), loss given
default ("LGD") and exposure at default ("EAD"). EDPs are derived from
historical default analyses and are a function of the borrower's risk rating
grade and expected loan term. LGDs are derived from historical loss data and are
a function of the loan's collateral value and other structural factors that may
affect the ultimate ability to collect on the loan. EADs are derived from
banking industry and PNC's own exposure at default data. Enhancements and
refinements to the reserve methodology in 2002 consisted of updating data
elements in the pool reserve model. Specifically, the EDP, EAD and LGD
parameters were enhanced to reflect updated historical performance data.
This methodology is sensitive to changes in key risk parameters such as EDPs
and LGDs. In general, a given change in any of the major risk parameters will
have a commensurate change in the pool reserve allocations to non-impaired
commercial loans. Additionally, other factors such as the rate of migration in
the severity of problem loans or changes in the maturity distribution of the
loans will contribute to the final pool reserve allocations.
Consumer (including residential mortgage) loan allocations are made at a
total portfolio level by consumer product line based on historical loss
experience. A four-quarter average loss rate is computed as net charge-offs for
the prior four quarters as a percentage of the average loan outstandings in
those quarters. This loss rate is applied to loans outstanding at the end of the
current period.
The final loan reserve allocations are based on this methodology and
management's judgment of other qualitative factors which may include, among
others, regional and national economic conditions, business segment and
portfolio concentrations, historical versus estimated losses, model risk and
changes to the level of credit risk in the portfolio.
Unallocated reserves are established to provide coverage for probable losses
not considered in the specific, pool and consumer reserve methodologies, such
as, but not limited to, potential judgment and data errors. Furthermore, events
may have occurred as of the reserve evaluation date that are not yet reflected
in the risk measures or characteristics of the portfolio due to inherent lags in
information. Management's evaluation of these and other relevant factors
determines the level of unallocated reserves established at the evaluation date.
The Reserve Adequacy Committee provides oversight for the allowance
evaluation process, including quarterly evaluations and methodology and
estimation changes. The results of the evaluations are reported to the Credit
Committee of the Board of Directors.
43
ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES
--------------------- ---------------------
2002 2001
--------------------- ---------------------
December 31 Loans to Loans to
Dollars in Total Total
millions Allowance Loans Allowance Loans
================= ========= =========== ========== ==========
Commercial $504 42.3% $392 40.0%
Commercial
real estate 52 6.4 63 6.3
Consumer 28 27.8 39 24.1
Residential
mortgage 10 11.0 8 16.8
Lease financing
and other 79 12.5 58 12.8
- ----------------- --------- ----------- ---------- ----------
Total $673 100.0% $560 100.0%
================= ========= =========== ========== ==========
For purposes of this presentation, the unallocated portion of the allowance for
credit losses of $112 million at December 31, 2002 and $143 million at December
31, 2001 has been assigned to loan categories based on the relative specific and
pool allocation amounts. The unallocated portion of the allowance for credit
losses represents 17% of the total allowance and .32% of total loans at December
31, 2002, compared with 26% and .38%, respectively, at December 31, 2001.
Enhancements and refinements to the reserve methodology during 2002 resulted in
a reallocation of the allowance for credit losses among the Corporation's
businesses and from unallocated to specific and pool categories.
The provision for credit losses for 2002 and the evaluation of the
allowances for credit losses and unfunded loan commitments and letters of credit
as of December 31, 2002 reflected changes in loan portfolio composition, the net
impact of downsizing credit exposure, the impact of refinements to the
Corporation's reserve methodology and changes in asset quality. The provision
includes amounts for probable losses on loans and credit exposure related to
unfunded loan commitments and letters of credit.
ROLLFORWARD OF ALLOWANCE FOR CREDIT LOSSES
In millions 2002 2001
==================================== ============ ===========
January 1 $560 $598
Charge-offs (267) (985)
Recoveries 44 37
- ------------------------------------ ------------ -----------
Net charge-offs (223) (948)
Provision for credit losses 309 903
Acquired allowance 41
Net change in allowance for unfunded
loan commitments and letters
of credit (14) 7
- ------------------------------------ ------------ -----------
December 31 $673 $560
==================================== ============ ===========
ROLLFORWARD OF ALLOWANCE FOR UNFUNDED LOAN
COMMITMENTS AND LETTERS OF CREDIT
In millions 2002 2001
==================================== ============ ============
January 1 $70 $77
Net change in allowance for unfunded
loan commitments and letters
of credit 14 (7)
- ------------------------------------ ------------ ------------
December 31 $84 $70
==================================== ============ ============
The allowance as a percent of nonperforming loans and total loans was 218% and
1.90%, respectively, at December 31, 2002. The comparable year end 2001
percentages were 265% and 1.47%, respectively.
CHARGE-OFFS AND RECOVERIES
Percent of
Year ended December 31 Net Average
Dollars in millions Charge-offs Recoveries Charge-offs Loans
=================== =========== ========== =========== ==========
2002
Commercial $194 $26 $168 1.06%
Commercial real
estate 3 1 2 .08
Consumer 40 14 26 .27
Residential mortgage 5 1 4 .09
Lease financing 25 2 23 .55
- -------------------- --------- --------- -----------
Total $267 $44 $223 .60
==================== ========= ========= =========== =========
2001
Commercial $876 $17 $859 4.37%
Commercial real
estate 37 1 36 1.40
Consumer 42 16 26 .29
Residential mortgage 2 1 1 .01
Lease financing 28 2 26 .62
- -------------------- --------- --------- -----------
Total $985 $37 $948 2.12
==================== ========= ========= =========== =========
Net charge-offs were $223 million for 2002 compared with $948 million in 2001.
For 2001, total net charge-offs included $804 million related to institutional
lending repositioning initiatives, of which $673 million related to charges on
loans transferred to held for sale.
44
CREDIT-RELATED INSTRUMENTS
CREDIT DEFAULT SWAPS
Credit default swaps provide, for a fee, an assumption of a portion of the
credit risk associated with the underlying financial instruments. The
Corporation primarily uses such contracts to mitigate credit risk associated
with commercial lending activities. At December 31, 2002, credit default swaps
with $184 million in notional value were used by the Corporation to hedge credit
risk associated with commercial lending activities and are included in the Other
Derivatives table in the Financial And Other Derivatives section of this
Financial Review. Net losses realized in connection with credit default swaps
for 2002 were not significant.
INTEREST RATE DERIVATIVE RISK PARTICIPATION AGREEMENTS
The Corporation enters into risk participation agreements to share credit
exposure with other financial counterparties related to interest rate derivative
contracts. Risk participation agreements executed by the Corporation to mitigate
credit risk had a total notional value of $43 million at December 31, 2002.
Additionally, risk participation agreements entered into in which the
Corporation assumed credit exposure had a total notional value of $109 million
at December 31, 2002. These agreements are considered to be financial guarantees
and therefore are not included in the Financial And Other Derivatives section of
this Financial Review.
SECURITIES
Total securities at December 31, 2002 were $13.8 billion compared with $13.9
billion at December 31, 2001. Securities represented 21% of total assets at
December 31, 2002 compared with 20% at December 31, 2001.
At December 31, 2002, the securities available for sale balance included a
net unrealized gain of $274 million, which represented the difference between
fair value and amortized cost. The comparable amount at December 31, 2001 was a
net unrealized loss of $132 million. Net unrealized gains and losses in the
securities available for sale portfolio are included in accumulated other
comprehensive income or loss, net of tax or, for the portion attributable to a
hedged risk as part of a fair value hedge strategy, in net income. The expected
weighted-average life of securities available for sale was 2 years and 8 months
at December 31, 2002 compared with 4 years at December 31, 2001.
Securities designated as held to maturity are carried at amortized cost and
were assets of companies formed with AIG that were consolidated in PNC's
financial statements. In January 2003, these securities were sold and these
companies were liquidated. See Note 32 Subsequent Events. The expected
weighted-average life of securities held to maturity was 20 years and 2 months
at December 31, 2002 compared with 18 years and 11 months at December 31, 2001.
DETAILS OF SECURITIES
Amortized Fair
In millions Cost Value
======================================== ========== ==========
DECEMBER 31, 2002
SECURITIES AVAILABLE FOR SALE
Debt securities
U.S. Treasury and government agencies $813 $826
Mortgage-backed 8,916 9,103
Asset-backed 2,699 2,780
State and municipal 61 63
Other debt 58 61
Corporate stocks and other 597 585
- ---------------------------------------- ---------- ----------
Total securities available for sale $13,144 $13,418
- ---------------------------------------- ---------- ----------
SECURITIES HELD TO MATURITY
Debt securities
U.S. Treasury and government agencies $276 $309
Asset-backed 8 8
Other debt 61 61
- ---------------------------------------- ---------- ----------
Total securities held to maturity $345 $378
======================================== ========== ==========
December 31, 2001
SECURITIES AVAILABLE FOR SALE
Debt securities
U.S. Treasury and government agencies $808 $807
Mortgage-backed 9,669 9,578
Asset-backed 2,799 2,776
State and municipal 62 64
Other debt 75 75
Corporate stocks and other 264 245
- ---------------------------------------- ---------- ----------
Total securities available for sale $13,677 $13,545
- ---------------------------------------- ---------- ----------
SECURITIES HELD TO MATURITY
Debt securities
U.S. Treasury and government agencies $260 $257
Asset-backed 8 8
Other debt 95 95
- ---------------------------------------- ---------- ----------
Total securities held to maturity $363 $360
======================================== ========== ==========
EQUITY MANAGEMENT ACTIVITIES
At December 31, 2002, equity management (private equity activities) investments
carried at estimated fair value totaled approximately $530 million.
Approximately 56% of the amount is invested directly in a variety of companies
and approximately 44% is invested in various limited partnerships. Equity
management funding commitments totaled $173 million at December 31, 2002. The
valuation of equity management assets is subject to the performance of the
underlying companies as well as market conditions and may be volatile. There is
a time lag in the Corporation's receipt of the financial information that is the
primary basis for the valuation of the limited partnership interests.
Consequently, PNC will recognize in the first quarter of 2003 valuation changes
related to limited partnership investments that reflect the impact of fourth
quarter 2002 market conditions and performance of the underlying companies. The
Corporation continues to make private equity investments at a more moderate pace
than prior
45
years and consistent with current market conditions. More emphasis is being
placed on the management of capital for other investors. See Equity Management
Asset Valuation in the Risk Factors section of this Financial Review for
additional information.
FUNDING SOURCES
Total funding sources were $54.1 billion at December 31, 2002 and $59.4 billion
at December 31, 2001, a decrease of $5.3 billion corresponding to a decrease of
$3.3 billion in total assets and increases in accrued expenses and other
liabilities and in total shareholders' equity of $.9 billion and $1.0 billion,
respectively. Total deposits decreased $2.3 billion from December 31, 2001
primarily due to a $1.1 billion decrease in deposits in foreign offices and a
$.9 billion decrease in retail certificates of deposit. Borrowed funds decreased
consistent with declines in total assets and earning assets.
DETAILS OF FUNDING SOURCES
December 31 - in millions 2002 2001
================================== ============== ===========
Deposits
Demand and money market $32,349 $32,589
Savings 2,014 1,942
Retail certificates of deposit 9,839 10,727
Other time 317 472
Deposits in foreign offices 463 1,574
- ---------------------------------- -------------- -----------
Total deposits 44,982 47,304
- ---------------------------------- -------------- -----------
Borrowed funds
Federal funds purchased 38 167
Repurchase agreements 814 954
Bank notes and senior debt 4,400 6,362
Federal Home Loan Bank borrowings 1,256 2,047
Subordinated debt 2,423 2,298
Other borrowed funds 185 262
- ---------------------------------- -------------- -----------
Total borrowed funds 9,116 12,090
- ---------------------------------- -------------- -----------
Total $54,098 $59,394
================================== ============== ===========
LIQUIDITY
Liquidity represents the Corporation's ability to obtain cost-effective funding
to meet the needs of customers as well as the Corporation's financial
obligations. Liquidity is centrally managed by Asset and Liability Management,
with oversight provided by the Executive Asset and Liability Committee and the
Finance Committee of the Board of Directors.
The Corporation's main sources of funds to meet its liquidity requirements
are access to the capital markets, sale of liquid assets, secured advances from
the Federal Home Loan Bank, its core deposit base and the capability to
securitize assets.
Access to capital markets is a key factor affecting liquidity
management. Access to such markets is in part based on the Corporation's credit
ratings, which are influenced by a number of factors including capital ratios,
asset quality and earnings. Additional factors that impact liquidity include the
maturity structure of existing assets, liabilities, and off-balance-sheet
positions, the level of liquid securities and loans available for sale, and the
Corporation's ability to securitize and sell various types of loans.
Liquid assets consist of short-term investments and securities available for
sale. At December 31, 2002, such assets totaled $17.1 billion, with $9.5 billion
pledged as collateral for borrowings, trust and other commitments. Secured
advances from the Federal Home Loan Bank, of which PNC Bank, N.A. ("PNC Bank")
PNC's principal bank subsidiary, is a member, are generally secured by
residential mortgages, other real-estate related loans and mortgage-backed
securities. At December 31, 2002, total unused borrowing capacity from the
Federal Home Loan Bank under current collateral requirements was $10.0 billion.
Funding can also be obtained through alternative forms of borrowing, including
federal funds purchased, repurchase agreements and short-term and long-term debt
issuance.
Liquidity for the parent company and PNC's non-bank subsidiaries is also
generated through the issuance of securities in public or private markets and
lines of credit. At December 31, 2002, the Corporation had unused capacity under
effective shelf registration statements of approximately $3.3 billion of debt or
equity securities and $400 million of trust preferred capital securities. The
parent company had an unused line of credit of $460 million at December 31,
2002, which expires in 2003.
The principal source of parent company revenue and cash flow is the
dividends it receives from PNC Bank. PNC Bank's dividend level may be impacted
by its capital needs, supervisory policies, corporate policies, contractual
restrictions and other factors. Also, there are statutory limitations on the
ability of national banks to pay dividends or make other capital distributions.
The amount available for dividend payments to the parent company by all bank
subsidiaries without prior regulatory approval was approximately $460 million at
December 31, 2002.
In addition to dividends from PNC Bank, other sources of parent company
liquidity include cash and short-term investments, as well as dividends and loan
repayments from other subsidiaries. As of December 31, 2002, the parent company
had approximately $719 million in funds available from its cash and short-term
investments or other funds available from unrestricted subsidiaries. Management
expects that the parent company will have sufficient liquidity available to meet
current obligations to its debt holders, vendors, and others and to pay
dividends at current rates through 2003.
46
The following tables set forth contractual obligations and various
commitments representing required and potential cash outflows as of December 31,
2002.
CONTRACTUAL OBLIGATIONS Payment Due By Period
-------------- --------------- --------------- ------------------
December 31, 2002 - in millions Less than One to three Four to five After five
Total one year years years years
=================================================== ============ ============== =============== =============== ==================
Minimum annual rentals on noncancellable leases $1,016 $154 $263 $199 $400
Remaining contractual maturities of time deposits 10,619 5,718 3,360 824 717
Borrowed funds 9,116 3,122 3,195 1,754 1,045
Capital securities of subsidiary trusts (a) 848 848
------------ -------------- --------------- --------------- ------------------
Total contractual cash obligations $21,599 $8,994 $6,818 $2,777 $3,010
=================================================== ============ ============== =============== =============== ==================
(a) Reflects the maturity of junior subordinated debentures held by subsidiary
trusts.
OTHER COMMITMENTS (a) Amount Of Commitment Expiration By Period
Total -------------- --------------- --------------- ------------------
December 31, 2002 - in millions Amounts Less than One to three Four to five After five
Committed one year years years years
=================================================== ============ ============== =============== =============== ==================
Standby letters of credit $3,681 $1,980 $1,402 $288 $11
Loan commitments 23,643 14,393 6,491 2,603 156
Asset-backed commercial paper conduit 3,215 3,164 51
Other commitments (b) 690 390 162 125 13
------------ -------------- --------------- --------------- ------------------
Total commitments $31,229 $19,927 $8,106 $3,016 $180
=================================================== ============ ============== =============== =============== ==================
(a) Other commitments are funding commitments that could potentially require
performance in the event of demands by third parties or contingent events.
Loan commitments are reported net of participations, assignments and
syndications.
(b) Includes standby bond repurchase agreements, NBOC acquisition put option
and equity funding commitments related to equity management and affordable
housing.
CAPITAL
The access to and cost of funding new business initiatives, including
acquisitions, the ability to engage in expanded business activities, the ability
to pay dividends, the level of deposit insurance costs, and the level and nature
of regulatory oversight depend, in large part, on a financial institution's
capital strength. At December 31, 2002, each bank subsidiary of the Corporation
was considered "well-capitalized" based on regulatory capital ratio
requirements. See Supervision And Regulation in the Risk Factors section of this
Financial Review and Note 1 Accounting Policies and Note 3 Regulatory Matters
for additional information.
RISK-BASED CAPITAL
December 31 - dollars in millions 2002 2001
======================================== ============ ===========
Capital components
Shareholders' equity
Common $6,849 $5,813
Preferred 10 10
Trust preferred capital securities 848 848
Minority interest 234 134
Goodwill and other intangibles (2,446) (2,174)
Net unrealized securities
(gains)/losses (179) 86
Net unrealized gains on cash flow
hedge derivatives (135) (98)
Equity investments in nonfinancial
companies (34)
Other, net (26) (20)
- ---------------------------------------- ------------ -----------
Tier I risk-based capital 5,121 4,599
Subordinated debt 1,350 1,616
Minority interest 36 36
Eligible allowance for credit losses 726 707
- ---------------------------------------- ------------ -----------
Total risk-based capital $7,233 $6,958
======================================== ============ ===========
Assets
Risk-weighted assets, including
off-balance-sheet instruments and
market risk equivalent assets $58,030 $58,958
Adjusted average total assets 62,967 67,604
======================================== ============ ===========
Capital ratios
Tier I risk-based 8.8% 7.8%
Total risk-based 12.5 11.8
Leverage 8.1 6.8
======================================== ============ ===========
47
The capital position is managed through balance sheet size and composition,
issuance of debt and equity instruments, treasury stock activities, dividend
policies and retention of earnings.
In January 2002, the Board of Directors authorized the Corporation to
purchase up to 35 million shares of its common stock through February 29, 2004.
These shares may be purchased in the open market or in privately negotiated
transactions. This authorization terminated any prior authorization. During
2002, a total of 320,000 shares were repurchased under this program, all in the
first quarter. Under this program, the Corporation currently expects to purchase
between $250 million and $1 billion of its common stock during 2003. The extent
and timing of any future share repurchases will depend on a number of factors
including, among others, market and general economic conditions, regulatory
capital considerations, alternative uses of capital and the potential impact on
PNC's credit rating. Under applicable regulations, as long as PNC remains
subject to its written agreement with the Federal Reserve, it must obtain prior
regulatory approval to repurchase its common stock in amounts that exceed 10
percent of consolidated net worth in any 12-month period.
RISK FACTORS
The Corporation is subject to a number of risks including, among others, those
described below and in the Risk Management and Forward-Looking Statements
sections of this Financial Review. These factors and others could impact the
Corporation's business, financial condition, results of operations and cash
flows.
BUSINESS AND ECONOMIC CONDITIONS
The Corporation's business and results of operations are sensitive to general
business and economic conditions in the United States. These conditions include
the level and movement of interest rates, inflation, monetary supply,
fluctuations in both debt and equity capital markets, and the strength of the
U.S. economy, in general, and the regional economies in which the Corporation
conducts business. A sustained weakness or further weakening of the economy
could decrease the value of loans held for sale, decrease the demand for loans
and other products and services offered by the Corporation, increase usage of
unfunded commitments or increase the number of customers and counterparties who
become delinquent, file for protection under bankruptcy laws or default on their
loans or other obligations to the Corporation. An increase in the number of
delinquencies, bankruptcies or defaults could result in a higher level of
nonperforming assets, net charge-offs, provision for credit losses, and
valuation adjustments on loans held for sale. Changes in interest rates could
affect the value of certain on-balance-sheet and off-balance-sheet financial
instruments of the Corporation. Changes in interest rates could also affect the
value of assets under management. In a period of rapidly rising interest rates,
certain assets under management would likely be negatively impacted by reduced
asset values and increased redemptions. Also, changes in equity markets could
affect the value of equity investments and the value of net assets under
management and administration. Declines in the equity markets adversely affected
results in 2002 and 2001 and could continue to negatively affect noninterest
revenues in future periods.
2001 STRATEGIC REPOSITIONING
The Corporation took several actions in 2001 to accelerate the strategic
repositioning of its lending business that began in 1998. These actions entail a
degree of risk pending completion.
At December 31, 2002, $626 million of institutional lending credit exposure
including $298 million of outstandings were classified as held for sale. A total
of $92 million of these loans was included in nonperforming assets at that date.
The loans are carried at the lower of cost or estimated fair market value. The
estimation of fair market values involves a number of judgments, and is
inherently uncertain. In addition, the value of loan assets is affected by a
variety of company, industry, economic and other factors, and can be volatile.
If the value of loans held for sale deteriorates prior to disposition, valuation
adjustments will be made through charges to earnings. Moreover, deterioration in
the condition of the borrowers could lead to additional loans being placed on
nonperforming status. See Critical Accounting Policies And Judgments for
additional information.
During the fourth quarter of 2001, the Corporation decided to discontinue
its vehicle leasing business and recorded charges and a liability of $135
million related to exit costs and additions to reserves related to insured
residual value exposures. At December 31, 2002, approximately $1.4 billion of
vehicle leases remained on the Corporation's books. Until the remaining leases
mature, the Corporation will continue to
48
be subject to risks inherent in the vehicle leasing business, including credit
risk and the risk that vehicles returned during or at the conclusion of the
lease term cannot be disposed of at a price at least as great as the
Corporation's remaining investment in the vehicles after application of any
available residual value insurance or related reserves. The assumptions that
were used to establish these reserves in 2001 are monitored and evaluated on an
ongoing basis. Accordingly, these reserves were considered adequate at December
31, 2002. See 2001 Strategic Repositioning in the Consolidated Balance Sheet
Review section of this Financial Review for additional information.
CRITICAL ACCOUNTING POLICIES AND JUDGMENTS
The Corporation's consolidated financial statements are prepared based on the
application of certain accounting policies, the most significant of which are
described in Note 1 Accounting Policies in the Notes to Consolidated Financial
Statements. Certain of these policies require numerous estimates and strategic
or economic assumptions that may prove inaccurate or be subject to variations
which may significantly affect PNC's reported results and financial position for
the period or in future periods. The use of estimates, assumptions, and
judgments are necessary when financial assets and liabilities are required to be
recorded at, or adjusted to reflect, fair value. Assets and liabilities carried
at fair value inherently result in more financial statement volatility. Fair
values and the information used to record valuation adjustments for certain
assets and liabilities are based on either quoted market prices or are provided
by other independent third-party sources, when available. When such information
is not available, management estimates valuation adjustments primarily by using
internal cash flow and other financial modeling techniques. Changes in
underlying factors, assumptions, or estimates in any of these areas could have a
material impact on PNC's future financial condition and results of operations.
In addition, changes to be adopted in 2003 in how certain guarantees and
other contingencies will be accounted for under the Financial Accounting
Standards Board's ("FASB") FASB Interpretation No. ("FIN") 45 and in how
investments in variable interest entities will be accounted for under FIN 46 may
have a material impact on PNC's financial condition and results of operations.
See Note 1 Accounting Policies and Note 29 Commitments And Guarantees for
further information.
ALLOWANCES FOR CREDIT LOSSES AND UNFUNDED LOAN COMMITMENTS AND LETTERS OF CREDIT
The allowances for credit losses and unfunded loan commitments and letters of
credit are calculated with the objective of maintaining reserve levels believed
by management to be sufficient to absorb estimated probable credit losses.
Management's determination of the adequacy of the allowances is based on
periodic evaluations of the credit portfolio and other relevant factors.
However, this evaluation is inherently subjective as it requires material
estimates, including, among others, expected default probabilities, loss given
default, exposure at default, the amounts and timing of expected future cash
flows on impaired loans, value of collateral, estimated losses on consumer loans
and residential mortgages, and general amounts for historical loss experience.
The process also considers economic conditions, uncertainties in estimating
losses and inherent risks in the various credit portfolios. All of these factors
may be susceptible to significant change. Also, the allocation of the allowance
for credit losses to specific loan pools is based on historical loss trends and
management's judgment concerning those trends.
Commercial loans are the largest category of credits and are the most
sensitive to changes in assumptions and judgments underlying the determination
of the allowance for credit losses. Approximately $504 million, or 75%, of the
total allowance for credit losses at December 31, 2002 has been allocated to the
commercial loan category. This allocation also considers other relevant factors
such as actual versus estimated losses, regional and national economic
conditions, business segment and portfolio concentrations, industry competition
and consolidation, the impact of government regulations, and risk of potential
estimation or judgmental errors. To the extent actual outcomes differ from
management estimates, additional provision for credit losses may be required
that would adversely impact earnings in future periods. See the following for
additional information: Allowances For Credit Losses And Unfunded Loan
Commitments And Letters Of Credit in the Credit Risk section of the Consolidated
Balance Sheet Review; Note 1 Accounting Policies; Note 12 Allowances For Credit
Losses And Unfunded Loan Commitments And Letters of Credit; and Allocation Of
Allowance For Credit Losses in the Statistical Information section.
49
LOANS HELD FOR SALE
At the time management intends to sell credit exposure, management designates
the exposure as held for sale. At the initial transfer date to held for sale,
any lower of cost or market ("LOCOM") adjustment is recorded as a charge-off,
which on an outstanding loan results in a new cost basis. On the unfunded
portion of the total exposure, a liability is established. Any subsequent
adjustment as a result of LOCOM is recorded as a valuation allowance through
noninterest income on the loan portion classified as held-for-sale. Any
permanent reduction of the exposure, such as sale or termination of the exposure
may have an impact on the exposure's valuation allowance or liability. This
change in valuation allowance or liability is recorded through noninterest
income. Although the market value for certain held for sale assets may be
readily obtainable, other assets require significant judgments by management as
to the value that could be realized at the balance sheet date. These assumptions
include, but are not limited to, the cash flows generated from the asset, the
timing of a sale, the value of any collateral, the market conditions for the
particular credit, overall investor demand for these assets and the
determination of a proper discount rate. Changes in market conditions and actual
liquidation experience may result in additional valuation adjustments that could
adversely impact earnings in future periods. See the Loans Held For Sale section
in the Consolidated Balance Sheet Review and Note 1 Accounting Policies for
additional information.
EQUITY MANAGEMENT ASSET VALUATION
Equity management (private equity) assets are valued at each balance sheet date
based on primarily either, in the case of limited partnership investments, the
financial statements received from the general partner or, with respect to
direct investments, the estimated fair value of the investments. Changes in the
value of equity management investments are reflected in the Corporation's
results of operations. Due to the nature of the direct investments, management
must make assumptions as to future performance, financial condition, liquidity,
availability of capital, and market conditions, among others, to determine the
estimated fair value of the investments.
Market conditions and actual performance of the companies invested in could
differ from these assumptions and from the assumptions made by the general
partners, respectively, resulting in lower valuations that could adversely
impact earnings in future periods. Accordingly, the valuations may not represent
amounts that will ultimately be realized from these investments. See Equity
Management Activities in the Consolidated Balance Sheet Review and Note 1
Accounting Policies for additional information.
LEASE RESIDUALS
Leases are carried at the aggregate of lease payments and the estimated residual
value of the leased property, less unearned income. The Corporation provides
financing for various types of equipment, aircraft, energy and power systems,
rolling stock and vehicles through a variety of lease arrangements. A
significant portion of the residual value is covered by residual value insurance
or guaranteed by governmental entities. Residual values are subject to judgments
as to the value of the underlying equipment that can be affected by changes in
economic and market conditions and the financial viability of the residual
guarantors and insurers. To the extent not guaranteed or assumed by a third
party, or otherwise insured against, the Corporation bears the risk of ownership
of the leased assets including the risk that the actual value of the leased
assets at the end of the lease term will be less than the residual value which
could result in a charge and adversely impact earnings in future periods. See
Note 1 Accounting Policies for additional information.
GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill arising from business acquisitions represents the value attributable to
unidentifiable intangible elements in the business acquired. The majority of the
Corporation's goodwill relates to value inherent in fund servicing and banking
businesses. The value of this goodwill is dependent upon the Corporation's
ability to provide quality, cost effective services in the face of competition
from other market leaders on a national and global basis. This ability in turn
relies upon continuing investments in processing systems, the development of
value-added service features, and the ease of use of the Corporation's services.
50
As such, goodwill value is supported ultimately by revenue which is driven
by the volume of business transacted and, for certain businesses, the market
value of assets under administration. A decline in earnings as a result of a
lack of growth or the Corporation's inability to deliver cost effective services
over sustained periods can lead to impairment of goodwill which could result in
a charge and adversely impact earnings in future periods.
Total goodwill was $2.3 billion and other intangible assets, net of
accumulated amortization, totaled $333 million at December 31, 2002. See Note 1
Accounting Policies and Note 14 Goodwill And Other Intangible Assets for
additional information.
SUPERVISION AND REGULATION
The Corporation operates in highly regulated industries. Applicable laws and
regulations restrict permissible activities and investments and require
compliance with protections for loan, deposit, brokerage, fiduciary, mutual fund
and other customers, among other things. They also restrict the Corporation's
ability to repurchase stock or to receive dividends from its bank subsidiaries
and impose capital adequacy requirements. The consequences of noncompliance can
include substantial monetary and nonmonetary sanctions. In addition, the
Corporation is subject to comprehensive examination and supervision by, among
other regulatory bodies, the Federal Reserve Board ("FRB") and the Office of the
Comptroller of the Currency ("OCC"). These regulatory agencies generally have
broad discretion to impose restrictions and limitations on the operations of a
regulated entity where the agencies determine, among other things, that such
operations are unsafe or unsound, fail to comply with applicable law or are
otherwise inconsistent with laws and regulations or with the supervisory
policies of these agencies. This supervisory framework could materially impact
the conduct, growth and profitability of the Corporation's operations. For more
information, see the "Supervision and Regulation" section of Part I, Item 1 of
the Corporation's 2002 Annual Report on Form 10-K and Note 3 Regulatory Matters.
In July 2002, the Corporation announced that in order to settle an inquiry
by the Securities and Exchange Commission ("SEC") in connection with three 2001
transactions that gave rise to a financial statement restatement announced by
the Corporation on January 29, 2002, PNC had consented to an SEC cease and
desist order. The Corporation did not admit or deny the SEC's findings. At
the same time, the Corporation announced that it had entered into a written
agreement with the Federal Reserve Bank of Cleveland ("Federal Reserve") and
that its principal subsidiary, PNC Bank, had entered into a written agreement
with the OCC. These agreements address such issues as risk, management and
financial controls. The Corporation and PNC Bank also entered into agreements
with the Federal Reserve and the OCC, respectively, requiring the Corporation
and PNC Bank to provide a plan for PNC Bank to meet the "well capitalized" and
"well managed" criteria within a 180-day period.
As of December 19, 2002, the Federal Reserve and the OCC notified the
Corporation and PNC Bank, respectively, that PNC Bank now met both the "well
capitalized" and "well managed" criteria. This removed the limitations placed
in July 2002 on the Corporation's engaging in new activities or making new
investments and on PNC Bank's financial subsidiary activities. However, the
written agreements remain in place, and the Corporation and PNC Bank in certain
circumstances must continue to obtain prior approval from the Federal Reserve or
the OCC, respectively, before making acquisitions or engaging in new activities.
In addition, under applicable regulations, as long as the Corporation remains
subject to the written agreement with the Federal Reserve, the Corporation must
obtain prior regulatory approval to repurchase its common stock in amounts that
exceed 10 percent of consolidated net worth in any 12-month period. The
Corporation has incurred, and may continue to incur, additional operating costs
in connection with compliance with these agreements including, among others,
incremental staff and continued higher legal and consulting expenses. Further,
the reputational risk created by the SEC cease and desist order and the written
agreements with the Federal Reserve and the OCC could still have an impact on
such matters as business generation and retention, the ability to attract and
retain management, liquidity and funding.
The Corporation believes that it has made substantial progress to date in
enhancing its risk management and governance practices and improving its
regulatory relations, while addressing the various requirements set forth in
its written agreements with the Federal Reserve and the OCC. There can be no
assurance, however, as to the precise timing for determining that all required
corrective actions have been taken to the appropriate satisfaction of the
Federal Reserve and the OCC. The Board and senior management team are
51
committed to the goal of establishing PNC as an industry leader in the areas of
governance, corporate conduct, risk management and regulatory relations, and to
meeting all of the Corporation's commitments to its regulators. While PNC
believes that substantial progress has been made in this pursuit to date, it
also recognizes that this remains an important ongoing effort requiring
dedication and a commitment of resources at all levels of the institution.
MONETARY AND OTHER POLICIES
The financial services industry is subject to various monetary and other
policies and regulations of the United States government and its agencies, which
include the FRB, the OCC and the Federal Deposit Insurance Corporation as well
as state regulators. The Corporation is particularly affected by the policies of
the FRB, which regulates the supply of money and credit in the United States.
The FRB's policies influence the rates of interest that PNC charges on loans and
pays on borrowings and interest-bearing deposits and can also affect the value
of on-balance-sheet and off-balance-sheet financial instruments. Those policies
also influence, to a significant extent, the cost of funding for the
Corporation.
COMPETITION
PNC operates in a highly competitive environment, both in terms of the products
and services offered and the geographic markets in which PNC conducts business.
This environment could become even more competitive in the future, as a result
of legislative, regulatory and technological changes and continued consolidation
in the financial services industry. The Corporation competes with local,
regional and national banks, thrifts, credit unions and non-bank financial
institutions, such as investment banking firms, investment advisory firms,
brokerage firms, investment companies, venture capital firms, mutual fund
complexes and insurance companies, as well as other entities that offer
financial and processing services, and through alternative delivery channels
such as the World Wide Web. Technological advances and legislation, among other
changes, have lowered barriers to entry, have made it possible for non-bank
institutions to offer products and services that traditionally have been
provided by banks, and have increased the level of competition faced by the
Corporation. Many of the Corporation's competitors benefit from fewer regulatory
constraints and lower cost structures, allowing for more competitive pricing of
products and services. As a result, PNC could lose business to competitors or be
forced to price its products and services on less advantageous terms to retain
customers.
DISINTERMEDIATION
Disintermediation is the process of eliminating the role of the intermediary in
completing a transaction. For the financial services industry, this means
eliminating or significantly reducing the role of banks and other depository
institutions in completing transactions that have traditionally involved banks.
Disintermediation could result in, among other things, the loss of customer
deposits and decreases in transactions that generate fee income.
ASSET MANAGEMENT PERFORMANCE
Asset management revenue is primarily based on a percentage of the value of
assets under management and performance fees expressed as a percentage of the
returns realized on assets under management. A decline in the value of debt and
equity instruments, among other things, could cause asset management revenue to
decline.
Investment performance is an important factor for the level of assets under
management. Poor investment performance could impair revenue and growth as
existing clients might withdraw funds in favor of better performing products.
Also, performance fees could be lower or nonexistent. Additionally, the ability
to attract funds from existing and new clients might diminish.
FUND SERVICING
Fund servicing fees are primarily derived from the market value of the assets
and the number of shareholder accounts administered by the Corporation for its
clients. A rise in interest rates or a sustained weakness or further weakening
or volatility in the debt and equity markets could influence an investor's
decision to invest or maintain an investment in a mutual fund or other pooled
investment product. As a result, fluctuations may occur in the level or value of
assets that the Corporation has under administration. A significant investor
migration from mutual fund and other pooled investments could have a negative
impact on the Corporation's revenues by reducing the assets and the number of
shareholder accounts it administers. The fund servicing business is also highly
competitive. There has been and continues to be merger, acquisition and
consolidation activity in the financial services industry. In the future,
mergers or consolidations of financial institutions or other financial
intermediaries could impact the number of existing or potential fund servicing
clients.
52
ACQUISITIONS
The Corporation expands its business from time to time by acquiring other
financial services companies. Factors pertaining to acquisitions that could
adversely affect the Corporation's business and earnings include, among others:
anticipated cost savings or potential revenue enhancements that may not be fully
realized or realized within the expected time frame; key employee, customer or
revenue loss following an acquisition that may be greater than expected; and
costs or difficulties related to the integration of businesses that may be
greater than expected. The Corporation could also be prevented from pursuing
attractive acquisition opportunities due to regulatory restraints.
TERRORIST ACTIVITIES AND INTERNATIONAL HOSTILITIES
The impact of terrorist activities and responses to such activities and of
possible international hostilities cannot be predicted at this time with respect
to severity or duration, but may adversely affect the general economy, financial
and capital markets, specific industries and the Corporation. The impact could
adversely affect the Corporation in a number of ways including, among others, an
increase in delinquencies, bankruptcies or defaults that could result in a
higher level of nonperforming assets, net charge-offs and provision for credit
losses.
RISK MANAGEMENT
In the normal course of business, the Corporation assumes various types of risk,
which include, among other things, credit risk, market risk and operational
risk. Credit risk and liquidity risk are described in the Consolidated Balance
Sheet Review section of this Financial Review. These factors and others could
impact the Corporation's business, financial condition, results of operations
and cash flows.
PNC has risk management processes designed to provide for risk
identification, measurement and monitoring. PNC has taken a number of actions to
enhance these processes, including centralization of the risk management
function, ongoing development of an enterprise-wide risk profile and the
addition of key risk management positions. The Corporation announced several
management appointments in 2002 and early 2003, including those described below,
to enhance the Corporation's risk management structure.
- - In April 2002 the Corporation created a new position, Chief Risk Officer.
The Chief Risk Officer directs credit policy, balance sheet risk management
and operational risk management, with the aim to help PNC sharpen its
strategic focus and integrated coordination of all risk management
activities throughout the Corporation. The Corporation's General Auditor
reports directly to the Audit Committee of the Board of Directors and
receives administrative support from the Chief Risk Officer.
- - The Corporation appointed a Chief Regulatory Officer effective August 1,
2002 and a Chief Compliance Officer effective October 1, 2002. The Chief
Regulatory Officer, a newly-created position, is responsible for the
management of all issues related to PNC's regulatory affairs and
compliance. The Chief Compliance Officer reports to the Chief Regulatory
Officer and is responsible for corporate compliance risk management
strategies, policies and program development across all PNC business units,
including PNC Bank.
- - In October 2002, PNC appointed a new Vice Chairman who has broad
administrative responsibilities including assisting the Corporation in
implementing corporate governance enhancements.
- - In January 2003, the Corporation appointed a Chief Market Risk Officer. The
Chief Market Risk Officer reports to the Chief Risk Officer and is
responsible for managing all aspects of market risk management processes,
including interest rate, liquidity and trading risk across PNC.
INTEREST RATE RISK
Interest rate risk arises primarily through the Corporation's traditional
business activities of extending loans and accepting deposits. Many factors,
including economic and financial conditions, movements in interest rates and
consumer preferences affect the spread between interest earned on assets and
interest paid on liabilities. In managing interest rate risk, the Corporation
seeks to minimize its reliance on a particular interest rate scenario as a
source of earnings while maximizing net interest income and net interest margin.
To further these objectives, the Corporation uses securities purchases and
sales, short-term and long-term funding, financial derivatives and other capital
markets instruments.
The Corporation actively measures and monitors components of interest rate
risk including term structure or repricing risk, yield curve or nonparallel rate
shift risk, basis risk and options risk. The Corporation measures and manages
both the short-term and long-term effects of changing interest rates. An income
simulation model measures the sensitivity of net interest income to changing
interest rates over the next twenty-four month period. An economic value of
equity model measures the sensitivity of the value of existing on-balance-sheet
and off-balance-sheet positions to changing interest rates.
The income simulation model is the primary tool used to measure the
direction and magnitude of changes in net interest income resulting from changes
in interest rates. Forecasting
53
net interest income and its sensitivity to changes in interest rates requires
that the Corporation make assumptions about the volume and characteristics of
new business and the behavior of existing positions. These business assumptions
are based on the Corporation's experience, business plans and published industry
experience. Key assumptions employed in the model include prepayment speeds on
mortgage-related assets and consumer loans, loan volumes and pricing, deposit
volumes and pricing, the expected life and repricing characteristics of
nonmaturity loans and deposits, and management's financial and capital plans.
Because these assumptions are inherently uncertain, the model cannot
precisely estimate net interest income or precisely predict the effect of higher
or lower interest rates on net interest income. Actual results will differ from
simulated results due to the timing, magnitude and frequency of interest rate
changes, the difference between actual experience and the assumed volume and
characteristics of new business and behavior of existing positions, and changes
in market conditions and management strategies, among other factors.
The Corporation models additional interest rate scenarios covering a wider
range of rate movements to identify yield curve, term structure and basis risk
exposures. These scenarios are developed based on historical rate relationships
or management's expectations regarding the future direction and level of
interest rates. Depending on market conditions and other factors, these
scenarios may be modeled more or less frequently. Such analyses are used to
identify risk and develop strategies.
An economic value of equity model is used by the Corporation to value all
current on-balance-sheet and off-balance-sheet positions under a range of
instantaneous interest rate changes. The resulting change in the value of equity
is a measure of overall long-term interest rate risk inherent in the
Corporation's existing on-balance-sheet and off-balance-sheet positions. The
Corporation uses the economic value of equity model to complement the net
interest income simulation modeling process.
The Corporation's interest rate risk management policies provide that net
interest income should not decrease by more than 3% if interest rates gradually
increase or decrease from current rates by 100 basis points over a twelve-month
period and that, in the subsequent year, net interest income should not decrease
by more than 6%. The policy further states that the economic value of equity
should not decrease by more than 1.5% of the book value of assets for a 200
basis point instantaneous increase or decrease in interest rates. In the
scenario with a 200 basis point decrease in interest rates, no rates are
reduced below zero.
At December 31, 2002, the Corporation's exposure to a 100 basis point
decline in interest rates in the second year exceeds the approved policy limit.
Consistent with the Corporation's policies, this exception has been reported to
and approved by the Finance Committee of the Board of Directors. In the current
low rate environment, management's actions have focused on reducing exposure to
more modest rate declines and on the effects of rate increases on net interest
income and the economic value of equity.
The following table sets forth the sensitivity results for the last two
years.
INTEREST SENSITIVITY ANALYSIS
December 31 2002 2001
==================================== =============== ===========
NET INTEREST INCOME SENSITIVITY SIMULATION
Effect on net interest income in
first year from gradual interest
rate change over 12 months of:
100 basis point increase .4% (.3)%
100 basis point decrease (2.9)% (2.8)%
Effect on net interest income in
second year from gradual interest rate
change over the preceding 12 months of:
100 basis point increase 2.8% (.4)%
100 basis point decrease (11.4)% (9.4)%
ECONOMIC VALUE OF EQUITY SENSITIVITY MODEL
Effect on value of on- and
off-balance-sheet positions as a
percentage of assets from
instantaneous change in interest
rates of:
200 basis point increase (.7)% (1.4)%
200 basis point decrease (.4)% .5%
KEY PERIOD-END INTEREST RATES
One-month LIBOR 1.38% 1.87%
Three-year swap 2.40% 4.33%
======================================== =========== ===========
In addition to measuring the effect on net interest income assuming parallel
changes in current interest rates, PNC routinely simulates the effects of a
number of nonparallel interest rate environments. The following table reflects
the percentage change in 2003 net interest income assuming the PNC economist's
most likely rate forecast, implied market forward rates, a lower/steeper rate
scenario and a higher/flatter rate scenario.
54
All changes in forecasted net interest income are relative to results in a
base rate scenario where current market rates are assumed to remain unchanged
over the forecast horizon.
NET INTEREST INCOME SENSITIVITY TO ALTERNATIVE RATE SCENARIOS
PNC Market
In millions Economist Forward Low/Steep High/Flat
===================== ========== ========= ========== =========
Change in forecasted net interest income:
First year
sensitivity .3% .3% .5% (1.2)%
- ---------------------- --------- --------- ---------- ---------
Second year
sensitivity 1.2% 1.0% .7% (2.6)%
========================= ====== ========= ========== =========
The graph below presents the final December 2003 yield curves for each of the
alternative scenarios and for the base rate scenario in which rates are constant
throughout the year.
1-month LIBOR 2-year Swap 3-year Swap 5-year Swap
1.38 2.18 2.76 3.56
2.25 2.99 3.52 4.21
2.03 3.34 3.71 4.09
1.06 2.18 2.86 3.81
1.77 2.18 2.64 3.25
OPERATIONAL RISK
The Corporation is exposed to a variety of operational risks that can affect
each of its business activities, particularly those involving processing and
servicing. Operational risk is defined as the risk of loss resulting from
inadequate or failed internal processes, people or systems or from external
events. The risk of loss also includes losses that may arise from the potential
legal actions that could result from operational deficiencies or noncompliance
with contracts, laws or regulations. PNC monitors and evaluates operational risk
on an ongoing basis through systems of internal control, formal corporate-wide
policies and procedures, and an internal audit function.
TRADING ACTIVITIES
Most of PNC's trading activities are designed to provide capital markets
services to customers and not to position the Corporation's portfolio for gains
from market movements.
Trading activities are confined to financial instruments and financial
derivatives. PNC participates in derivatives and foreign exchange trading as
well as underwriting and "market making" in equity securities as an
accommodation to customers. PNC also engages in trading activities as part of
risk management strategies. Net trading income was $92 million in 2002 compared
with $147 million in 2001. See Note 8 Trading Activities for additional
information.
Risk associated with trading, capital markets and foreign exchange
activities is managed using a value-at-risk approach that combines interest rate
risk, foreign exchange rate risk, equity risk, spread risk and volatility risk.
Using this approach, exposure is measured as the potential market-to-market loss
within a 99% confidence interval of one-day moves in key market risk factors,
such as interest rates. The estimated average combined value-at-risk of all
trading operations using this measurement was $.7 million for both 2002 and
2001. The estimated combined period-end value-at-risk was $.5 million at
December 31, 2002 and $.9 million at December 31, 2001.
FINANCIAL AND OTHER DERIVATIVES
As required, effective January 1, 2001, the Corporation implemented SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities," as amended
by SFAS No. 137 and No. 138. The statement requires the Corporation to recognize
all derivative instruments at fair value as either assets or liabilities.
Financial derivatives are reported at fair value in other assets or other
liabilities. The cumulative effect of the change in accounting principle
resulting from the adoption of SFAS No. 133 was an after-tax charge of $5
million reported in the consolidated income statement and an after-tax
accumulated other comprehensive loss of $4 million in the consolidated balance
sheet. See Note 20 Financial Derivatives for additional information.
55
The Corporation uses a variety of financial derivatives as part of the
overall asset and liability risk management process to help manage interest
rate, market and credit risk inherent in the Corporation's business activities.
Substantially all such instruments are used to manage risk related to changes in
interest rates. Interest rate and total rate of return swaps, purchased interest
rate caps and floors and futures contracts are the primary instruments used by
the Corporation for interest rate risk management.
Interest rate swaps are agreements with a counterparty to exchange periodic
fixed and floating interest payments calculated on a notional amount. The
floating rate is based on a money market index, primarily short-term LIBOR.
Total rate of return swaps are agreements with a counterparty to exchange an
interest rate payment for the total rate of return on a specified reference
index calculated on a notional amount. Purchased interest rate caps and floors
are agreements where, for a fee, the counterparty agrees to pay the Corporation
the amount, if any, by which a specified market interest rate exceeds or is less
than a defined rate applied to a notional amount, respectively. Interest rate
futures contracts are exchange-traded agreements to make or take delivery of a
financial instrument at an agreed upon price and are settled in cash daily.
Financial derivatives involve, to varying degrees, interest rate, market and
credit risk. For interest rate swaps and total rate of return swaps, caps and
floors and futures contracts, only periodic cash payments and, with respect to
caps and floors, premiums, are exchanged. Therefore, cash requirements and
exposure to credit risk are significantly less than the notional value.
Not all elements of interest rate, market and credit risk are addressed
through the use of financial or other derivatives, and such instruments may be
ineffective for their intended purposes due to unanticipated market
characteristics among other reasons.
The following tables set forth changes, during 2002, in the notional value
of financial derivatives used for risk management and designated as accounting
hedges under SFAS No. 133.
FINANCIAL DERIVATIVES ACTIVITY
December 31 December 31 Weighted-Average
Dollars in millions 2001 Additions Maturities Terminations 2002 Maturity
======================================= ============ ============ ============= =============== ============ ===================
Interest rate risk management
Interest rate swaps
Receive fixed (a) $6,748 $2,975 $(1,300) $(2,600) $5,823 3 YRS. 2 MOS.
Pay fixed 107 5 (45) 67 4 YRS.
Basis swaps 87 45 (5) (75) 52 5 YRS. 10 MOS.
Interest rate caps 25 (9) 16 4 YRS. 8 MOS.
Interest rate floors 7 7 2 YRS. 3 MOS.
Futures contracts 398 378 (463) 313 7 MOS.
- --------------------------------------- ------------ ------------ ------------- --------------- ------------
Total interest rate risk
management 7,372 3,403 (1,305) (3,192) 6,278
- --------------------------------------- ------------ ------------ ------------- --------------- ------------
Commercial mortgage banking risk
management
Pay fixed interest rate swaps 105 800 (632) 273 10 YRS. 1 MO.
Total rate of return swaps 150 275 (325) 100 1 MO.
- --------------------------------------- ------------ ------------ ------------- --------------- ------------
Total commercial mortgage
banking risk management 255 1,075 (325) (632) 373
- --------------------------------------- ------------ ------------ ------------- --------------- ------------
Total $7,627 $4,478 $(1,630) $(3,824) $6,651
======================================= ============ ============ ============= =============== ============ ===================
(a) On January 24, 2003, $1.2 billion of receive-fixed interest rate swaps were
terminated. As cash flow hedge designated derivatives, unrealized gains or
losses are classified as accumulated other comprehensive income in the
consolidated balance sheet. Upon termination, the net unrealized gains
related to these swaps amounting to $34.5 million will be amortized from
other comprehensive income into earnings to match the earnings recognition
pattern of the hedged items.
56
The following tables set forth the notional value and the fair value of
financial derivatives used for risk management and designated as accounting
hedges under SFAS No. 133 at December 31, 2002 and December 31, 2001.
Weighted-average interest rates presented are based on contractual terms, if
fixed, or the implied forward yield curve at each respective date, if floating.
FINANCIAL DERIVATIVES - 2002
Weighted-Average Interest
Rates
Notional ------------------------------
December 31, 2002 - dollars in millions Value Fair Value Paid Received
============================================================= ================ ============== ================ =============
Interest rate risk management
Asset rate conversion
Interest rate swaps (a)
Receive fixed designated to loans $3,460 $172 2.00% 4.08%
Pay fixed designated to loans 67 (7) 6.04 2.80
Basis swaps designated to loans 52 3.52 3.47
Interest rate caps designated to loans (b) 16 NM NM
Interest rate floors designated to loans (c) 7 NM NM
Future contracts designated to loans 313 NM NM
- ------------------------------------------------------------- ---------------- --------------
Total asset rate conversion 3,915 165
- ------------------------------------------------------------- ---------------- --------------
Liability rate conversion
Interest rate swaps (a)
Receive fixed designated to borrowed funds 2,363 346 3.16 5.93
- ------------------------------------------------------------- ---------------- --------------
Total liability rate conversion 2,363 346
- ------------------------------------------------------------- ---------------- --------------
Total interest rate risk management 6,278 511
- ------------------------------------------------------------- ---------------- --------------
Commercial mortgage banking risk management
Pay fixed interest rate swaps
designated to loans held for
sale (a) 273 (13) 4.73 4.36
Pay total rate of return swaps designated to loans held for
sale (a) 100 (3) 5.21 .88
- ------------------------------------------------------------- ---------------- --------------
Total commercial mortgage banking risk management 373 (16)
- ------------------------------------------------------------- ---------------- --------------
Total financial derivatives designated for risk management $6,651 $495
============================================================= ================ ============== ================ =============
(a) The floating rate portion of interest rate contracts is based on
money-market indices. As a percent of notional value, 60% were based on
1-month LIBOR, 40% on 3-month LIBOR.
(b) Interest rate caps with notional values of $12 million require the
counterparty to pay the Corporation the excess, if any, of 3-month LIBOR
over a weighted-average strike of 6.50%. In addition, interest rate caps
with notional values of $4 million require the counterparty to pay the
excess, if any, of Prime over a weighted-average strike of 5.03%. At
December 31, 2002, 3-month LIBOR was 1.38% and Prime was 4.25%.
(c) Interest rate floors with notional values of $5 million require the
counterparty to pay the excess, if any, of the weighted-average strike of
4.50% over 3-month LIBOR. In addition, interest rate floors with notional
values of $2 million require the counterparty to pay the excess, if any, of
the weighted-average strike of 7.25% over Prime. At December 31, 2002,
3-month LIBOR was 1.38% and Prime was 4.25%.
NM- Not meaningful
57
FINANCIAL DERIVATIVES - 2001
Weighted-Average Interest Rates
Notional Estimated -----------------------------------
December 31, 2001 - dollars in millions Value Fair Value Paid Received
=============================================================== ============= =============== ================ ==================
Interest rate risk management
Asset rate conversion
Interest rate swaps (a)
Receive fixed designated to loans $4,335 $132 3.35% 5.23%
Pay fixed designated to loans 107 (5) 5.88 4.66
Basis swaps designated to loans 87 5.49 5.42
Interest rate caps designated to loans (b) 25 NM NM
Interest rate floors designated to loans (c) 7 NM NM
Future contracts designated to loans 398 NM NM
- --------------------------------------------------------------- ------------- ---------------
Total asset rate conversion 4,959 127
- --------------------------------------------------------------- ------------- ---------------
Liability rate conversion
Interest rate swaps (a)
Receive fixed designated to borrowed funds 2,413 135 5.20 5.94
- --------------------------------------------------------------- ------------- ---------------
Total liability rate conversion 2,413 135
- --------------------------------------------------------------- ------------- ---------------
Total interest rate risk management 7,372 262
- --------------------------------------------------------------- ------------- ---------------
Commercial mortgage banking risk management
Pay fixed interest rate swaps designated to loans held
for sale (a) 105 1 5.52 5.82
Pay total rate of return swaps designated to loans held for
sale (a) 150 5.89 1.39
- --------------------------------------------------------------- ------------- ---------------
Total commercial mortgage banking risk management 255 1
- --------------------------------------------------------------- ------------- ---------------
Total financial derivatives designated for risk management $7,627 $263
=============================================================== ============= =============== ================ ==================
</Table>
(a) The floating rate portion of interest rate contracts is based on
money-market indices. As a percent of notional value, 65% were based on
1-month LIBOR, 34% on 3-month LIBOR and the remainder on other short-term
indices.
(b) Interest rate caps with notional values of $15 million require the
counterparty to pay the Corporation the excess, if any, of 3-month LIBOR
over a weighted-average strike of 6.40%. In addition, interest rate caps
with notional values of $6 million require the counterparty to pay the
excess, if any, of 1-month LIBOR over a weighted-average strike of 6.00%.
The remainder is based on other short-term indices. At December 31, 2001,
3-month LIBOR was 1.88% and 1-month LIBOR was 1.87%.
(c) Interest rate floors with notional values of $5 million require the
counterparty to pay the excess, if any, of the weighted-average strike of
4.50% over 3-month LIBOR. The remainder is based on other short-term
indices. At December 31, 2001, 3-month LIBOR was 1.88%.
NM - Not meaningful
58
OTHER DERIVATIVES
To accommodate customer needs, PNC enters into customer-related financial
derivative transactions primarily consisting of interest rate swaps, caps,
floors and foreign exchange contracts. Risk exposure from customer positions is
managed through transactions with other dealers.
Additionally, the Corporation enters into other derivative transactions for
risk management purposes that are not designated as accounting hedges, primarily
consisting of interest rate floors and caps and basis swaps. Other noninterest
income for 2002 and 2001 included $7 million and $31 million, respectively, of
net gains related to the derivatives held for risk management purposes not
designated as accounting hedges. Prior to 2001, changes in the fair value of
these derivatives that were previously accounted for under the accrual method
were not reflected in operating results.
OTHER DERIVATIVES
-------------------------------------------------------------------- ----------------
At December 31, 2002
---------------------------------------------------- --------------- 2002
Positive Negative Average
Notional Fair Fair Net Asset Fair
In millions Value Value Value (Liability) Value
=========================================== ================== =============== ================= =============== ================
Customer-related
Interest rate
Swaps $26,773 $597 $(612) $(15) $(18)
Caps/floors
Sold 2,181 (32) (32) (33)
Purchased 1,951 26 26 27
Futures 1,090 2 2 2
Foreign exchange 3,190 55 (55) 4
Equity 1,385 62 (58) 4 5
Other 234 13 (3) 10 6
- ------------------------------------------- ------------------ --------------- ----------------- --------------- ----------------
Total customer-related 36,804 755 (760) (5) (7)
- ------------------------------------------- ------------------ --------------- ----------------- --------------- ----------------
Other risk management and proprietary
Interest-rate basis swaps 1,697 3 3 5
Other 509 7 (1) 6 6
- ------------------------------------------- ------------------ --------------- ----------------- --------------- ----------------
Total other risk management and
proprietary 2,206 10 (1) 9 11
- ------------------------------------------- ------------------ --------------- ----------------- --------------- ----------------
Total other derivatives $39,010 $765 $(761) $4 $4
=========================================== ================== =============== ================= =============== ================
OFF-BALANCE SHEET ACTIVITIES
PNC has reputation, legal, operational and fiduciary risks in virtually every
area of its business, many of which are not reflected in assets and liabilities
recorded on the balance sheet, and some of which are conducted through limited
purpose entities known as "special purpose entities." These activities are part
of the banking business and would be found in most larger financial institutions
with the size and activities of PNC. Most of these involve financial products
distributed to customers, trust and custody services, and processing and funds
transfer services, and the amounts involved can be quite large in relation to
the Corporation's assets, equity and earnings. Currently, the primary accounting
for these activities on PNC's records is to reflect the earned income, operating
expenses and any receivables or liabilities for transaction settlements. For
example: PNC Bank provides credit and liquidity to customers through loan
commitments and letters of credit (see the Other Commitments table in the
Liquidity section of the Consolidated Balance Sheet Review in this Financial
Review); BlackRock provides investment advisory and administration services for
others through registered investment companies, separate accounts, and other
legal entities - additional information about BlackRock is available in its
filings with the SEC and may be obtained electronically at www.sec.gov; PFPC
processes mutual fund transactions, provides securities lending services and
maintains custody of certain fund assets; PNC Advisors provides trust services
and holds assets for personal and institutional customers; Hilliard Lyons
maintains brokerage assets of customers; and Columbia Housing administers and
manages funds that invest in affordable housing projects that generate tax
credits to investors. In addition to these activities, PNC has other activities
or financial interests that involve credit risk and market risk (including
interest rate risk) that are not fully reflected on the balance sheet. The most
significant of these activities include the following:
- - PNC administers Market Street, a multi-seller asset-backed commercial paper
conduit -- see discussion that follows and the Other Commitments table
under Liquidity in the Consolidated Balance Sheet Review section of this
Financial Review.
- - Loan commitments and letters of credit -- see the Other Commitments table
under Liquidity and Credit Risk in the Consolidated Balance Sheet Review
section of this
59
Financial Review, and Note 10 Loans And Commitments To Extend Credit.
- - Financial and other derivatives - see Financial And Other Derivatives in
the Risk Management section of this Financial Review and Note 20 Financial
Derivatives.
- - Loan securitization and servicing activities - see Securitizations in the
Risk Management section of this Financial Review, Note 15 Securitizations
and the discussion of the NBOC servicing arrangement in Note 2 NBOC
Acquisition.
Except to the extent inherent in customary activities such as those
described above, PNC does not use off-balance sheet entities to fund its
business operations. The Corporation does not capitalize any off-balance-sheet
entity with PNC stock and has no commitments to provide financial backing to any
such entity by issuing PNC stock.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities." See Note 1 Accounting Policies for further information.
MARKET STREET FUNDING CORPORATION
Market Street is a multi-seller asset-backed commercial paper conduit that is
independently owned and managed. The activities of Market Street are limited to
the purchase or making of loans secured by interests primarily in pools of
receivables acquired from U.S. corporations unaffiliated with PNC that desire
access to the commercial paper market. Market Street funds the purchases by
issuing commercial paper. Market Street's commercial paper has been rated A1/P1
by Standard & Poor's and Moody's. Market Street had total assets of $3.0 billion
at December 31, 2002 compared with $5.2 billion at December 31, 2001. See Note 1
Accounting Policies for additional information.
PNC Bank provides certain administrative services, a portion of the
program-level credit enhancement and the majority of the liquidity facilities to
Market Street in exchange for fees negotiated based on market rates. Credit
enhancement is provided in part by PNC Bank in the form of a cash collateral
account which is funded by a credit loan facility with a five-year term expiring
December 31, 2004. At December 31, 2002, approximately $96 million was
outstanding on this facility compared with $166 million at December 31, 2001. An
additional $287 million was provided by a major insurer. Also at December 31,
2002, Market Street had liquidity facilities supporting individual pools of
receivables totaling $3.9 billion, of which $3.2 billion was provided by PNC
Bank. The comparable amounts at December 31, 2001 were $7.0 billion and $5.8
billion, respectively. Credit exposure related to PNC's liquidity facilities
provided to Market Street is included in net unfunded commitments as described
in Loans in the Consolidated Balance Sheet Review section of this Financial
Review.
As Market Street's program administrator, PNC received fees of $13.9 million
for the year ended December 31, 2002. Commitment fees related to PNC's portion
of the liquidity facilities amounted to $7.5 million for full year 2002.
Net charge-offs during 2002 included two charge-offs totaling $90 million
related to Market Street liquidity facilities.
During the second quarter of 2002 the Corporation learned of an apparent
fraud related to a seller of receivables to Market Street. In April 2002, PNC
funded approximately $50 million to Market Street under a liquidity facility
agreement. Reserves were specifically allocated to cover this exposure and a
charge-off of $45 million representing the total loan outstanding net of cash
collateral was recorded during the second quarter of 2002.
Also during the second quarter of 2002 the Corporation funded approximately
$63 million resulting from a draw on a liquidity facility with Market Street.
This loan was classified as a nonperforming asset at June 30, 2002. During the
second half of 2002, the Corporation charged off $45 million of this amount
against the allowance for credit losses. PNC is a beneficiary under an insurance
policy that provides protection against losses related to the underlying
collateral of student vocational loans. PNC is in litigation with the insurance
carrier regarding the policy covering these losses. Management continues to
vigorously pursue this claim and believes PNC is entitled to payment under the
policy. The potential exposure related to this liquidity draw without reference
to the insurance coverage was considered in determining the allocation of
reserves within the allowance for credit losses at December 31, 2002.
SECURITIZATIONS
From time to time the Corporation has sold loans in secondary market
securitization transactions. The Corporation uses securitizations to help manage
various balance sheet risks. Also, in such securitization transactions, the
Corporation may retain certain interest-only strips and servicing rights that
were created in the sale of the loans. The Corporation's liquidity is not
dependent on securitizations.
During 2002 and 2001, the Corporation sold loans totaling $277 million and
$1.5 billion, respectively, in secondary market securitization transactions,
resulting in pre-tax gains of $6 million and $13 million, respectively.
In addition to these transactions, in the first quarter of 2001 PNC
securitized $3.8 billion of residential mortgage loans by selling the loans into
a trust with PNC retaining 99% or $3.7 billion of the certificates. PNC also
securitized $175 million of commercial mortgage loans by selling the loans into
a trust with PNC retaining 99% or $173 million of the certificates. In each
case, the 1% interest in the trust was purchased by a publicly-traded entity
managed by a subsidiary
60
of PNC. A substantial portion of the entity's purchase price was financed by
PNC. The reclassification of these loans to securities increased the liquidity
of the assets and was consistent with PNC's ongoing balance sheet restructuring.
At the time of the residential mortgage securitization, gains of $25.9 million
were deferred and are recognized as principal payments are received or the
securities are sold to third parties. At December 31, 2001, these securities had
been reduced to $1.3 billion through sales and principal payments and the
remaining deferred gains were $7.8 million. In the first quarter of 2002, the
remaining securities were sold. The deferred gain remaining at the time of sale
of $6.0 million was recognized as other noninterest income.
No gain was recognized at the time of the commercial mortgage loan
securitization and none of the securities retained at the time of the
securitization remained on the balance sheet at December 31, 2001.
INTERNAL CONTROLS AND DISCLOSURE CONTROLS AND PROCEDURES
As of December 31, 2002, an evaluation was performed under the supervision and
with the participation of the Corporation's management, including the Chief
Executive Officer and the Vice Chairman and Chief Financial Officer, of the
effectiveness of the design and operation of the Corporation's disclosure
controls and procedures. Based on that evaluation, the Corporation's management,
including the Chief Executive Officer and the Vice Chairman and Chief Financial
Officer, concluded that the Corporation's disclosure controls and procedures
were effective as of December 31, 2002.
There have been no significant changes in the Corporation's internal
controls or in other factors that could significantly affect internal controls
subsequent to December 31, 2002, the date as of which the most recent evaluation
of such internal controls was performed.
STATUS OF DEFINED BENEFIT PENSION PLAN
The Corporation has a noncontributory, qualified defined benefit pension plan
("plan" or "pension plan") covering most employees. Contributions to the pension
plan are actuarially determined with assets transferred to a trust to fund
benefits payable to plan participants. Plan assets are currently approximately
60% invested in equity investments with most of the remainder invested in fixed
income instruments. Plan investment strategy is determined and reviewed by plan
fiduciaries. On an annual basis, management reviews the actuarial assumptions
related to the pension plan, including the discount rate, rate of compensation
increase and the expected return on plan assets.
The expense associated with the pension plan is calculated in accordance
with SFAS No. 87, "Employers' Accounting for Pensions," and utilizes assumptions
and methods determined in accordance therewith, including a policy of reflecting
trust assets at their fair market value. The expense is not significantly
affected by the discount rate or compensation increase assumptions, but is
significantly affected by the expected return on asset assumption, which has
been changed from 9.50% to 8.50% for 2003, increasing expense by approximately
$10 million. The expense is also significantly affected by actual trust returns,
with each one percentage point difference in actual return versus the
expectation causing the following year's expense to increase by as much as $2
million. Management currently estimates 2003 expense for the pension plan to be
approximately $50 million, compared with $15 million for 2002. The amortization
of actuarial losses and lower expected return on plan assets are the primary
reasons for the expected increases in pension expense in 2003.
In accordance with SFAS No. 87 and SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits," the Corporation may be
required to eliminate any prepaid pension asset and recognize a minimum pension
liability if the accumulated benefit obligation exceeds the fair value of plan
assets at year-end. The corresponding charge would be recognized as a component
of other comprehensive income and reduce total shareholders' equity, but would
not impact net income. At December 31, 2002, the fair value of plan assets was
$966 million, which exceeded the accumulated benefit obligation of $871 million.
The status at year-end 2003 will depend primarily upon 2003 trust returns and
the level of contributions made to the plan by the Corporation. While the
Corporation views as remote the possibility of a minimum pension liability, such
a liability would cause a significant reduction in shareholders' equity.
Contribution requirements are primarily affected by trust investment
performance and are not particularly sensitive to actuarial assumptions.
Although there were no required contributions to the pension plan during 2002,
the Corporation continued its strategy of fully funding the plan at maximum
tax-deductible levels, contributing $210 million. The Corporation expects to
contribute a similar amount during 2003. If future investment performance
exceeds that of recent years, the permitted tax-deductible contribution in
future years will be significantly reduced. In any case and irrespective of any
factors, any large near-term contributions to the plan will be at the discretion
of management as the minimum required contributions under current law are
expected to be zero for several years.
STOCK-BASED COMPENSATION
PNC will expense stock-based compensation using the fair value-based method,
beginning with grants made in 2003. Assuming recurring stock option grants of
similar size and value to those made during 2002, this impact is currently
estimated to be approximately 5 cents per share for the year ending December 31,
2003. The annual impact is expected to increase over the next three years under
the transitional
61
guidance provided by SFAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure." When fully implemented, the current expected impact
is a reduction of approximately 3 percent to earnings per share.
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which changed the accounting from amortizing goodwill to an
impairment-only approach. The amortization of goodwill, including goodwill
recognized relating to past business combinations, ceased upon adoption of the
new standard. Impairment testing for goodwill at a reporting unit level is
required on at least an annual basis. The standard also addresses other
accounting matters, disclosure requirements and financial statement presentation
issues relating to goodwill and other intangible assets. The Corporation adopted
SFAS No. 142 on January 1, 2002. As a result, during 2002 goodwill amortization
decreased by approximately $117 million and net income increased by
approximately $93 million. Refer to "Goodwill And Other Intangible Assets"
herein and to Note 14 Goodwill And Other Intangible Assets for additional
information.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which replaces SFAS No. 121. This
statement primarily defines one accounting model for long-lived assets to be
disposed of by sale, including discontinued operations, and addresses
implementation issues regarding the impairment of long-lived assets. The
standard was effective January 1, 2002 and did not have a material impact on the
Corporation's consolidated financial statements.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which replaces Emerging Issues Task Force
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." SFAS No. 146 addresses the accounting and reporting for
one-time employee termination benefits, certain contract termination costs, and
other costs associated with exit or disposal activities such as facility
closings or consolidations and employee relocations. The standard is effective
for exit or disposal activities initiated after December 31, 2002. The
Corporation adopted SFAS No. 146 prospectively as of January 1, 2003.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions." This statement clarified that, only if certain criteria
are met, an acquisition of a less-than-whole financial institution (such as a
branch acquisition) should be accounted for as a business combination. In
addition, SFAS No. 147 amends SFAS No. 144 to include in its scope long-term
customer-relationship intangible assets of financial institutions such as
depositor- and borrower-relationship intangible assets. As a result, those
intangible assets are subject to the same undiscounted cash flow recoverability
test and impairment loss recognition and measurement provisions that SFAS No.
144 requires for other long-lived assets that are held and used by a company.
SFAS No. 147 became effective October 1, 2002 and did not have a material impact
on the Corporation's consolidated financial statements.
In November 2002, the FASB issued FIN 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." FIN 45 elaborates on the existing disclosure
requirements for most guarantees, including loan guarantees such as standby
letters of credit and indemnifications. It also clarifies that at the time a
company issues a guarantee, the company must recognize an initial liability for
the fair or market value of the obligations it assumes under that guarantee and
must disclose that information in its interim and annual financial statements.
The provisions related to recognizing a liability at inception of the guarantee
for the fair value of the guarantor's obligations would not apply to guarantees
accounted for as derivatives. The initial recognition and measurement provisions
apply on a prospective basis to guarantees issued or modified after December 31,
2002. See Note 29 Commitments And Guarantees for the disclosures currently
required under FIN 45.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure." This statement amends SFAS No. 123, to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, this statement amends the disclosure requirements of SFAS No. 123 to
require disclosures in both annual and interim financial statements regarding
the method of accounting for stock-based employee compensation and the effect of
the method used on reported results. See "Stock-Based Compensation" herein and
Note 22 Stock-Based Compensation Plans for additional information.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable Interest
Entities." See Note 1 Accounting Policies for further information.
BLACKROCK LONG-TERM RETENTION AND INCENTIVE PLAN
In October 2002, BlackRock adopted a new long-term retention and incentive
program for key employees. The program permits BlackRock to grant up to 3.5
million stock options with an exercise price of market value, subject to vesting
at December 31, 2006, and up to $240 million in deferred compensation awards
(the "Compensation Awards"), with payment subject to the achievement of certain
performance hurdles no later than March 2007. BlackRock has awarded
approximately 3.37 million stock options and approximately $130 million in
Compensation Awards to more than 100 senior professionals. The remainder of the
program
62
has been reserved for grants over the next two years to professionals who
exhibit leadership qualities and demonstrate the potential to make significant
contributions to BlackRock over time. If the performance hurdles are achieved,
Compensation Awards will be funded with up to 4 million shares of BlackRock
common stock to be surrendered by PNC and distributed to program participants,
less income tax withholding. In addition, distributed shares to program
participants will include an option to put such distributed shares back to
BlackRock at fair market value. BlackRock will fund the remainder of the
Compensation Awards with up to $40 million in cash.
The Awards will vest at the end of any three-month period beginning in 2005
or 2006 during which the daily average closing price of BlackRock's common stock
is at least $65 per share. If that performance hurdle is not achieved, the
Compensation Committee of the Board of Directors of BlackRock may, in its sole
discretion, vest a portion of the Compensation Awards if BlackRock realizes
compound annual growth in diluted earnings per share of at least 10% from
January 1, 2002 to December 31, 2006 and BlackRock's publicly-traded stock
performs in the top half of its peer group during that time.
There will be no expense recognition associated with the Compensation Awards
unless vesting occurs or a partial vesting determination by the BlackRock
Compensation Committee is considered probable and estimable. Once this
determination is made, BlackRock will record compensation expense for the pro
rata portion of the Compensation Awards earned to date. Compensation expense for
the remaining Compensation Awards will be recognized by BlackRock ratably from
the determination date through the vesting date and could extend through March
31, 2007. In addition, at the time that the BlackRock common stock portion of
the Compensation Awards is distributed, BlackRock will record an increase in
stockholders' equity equal to the fair market value of the BlackRock common
stock distributed to employees from shares surrendered by PNC. There will be no
increase in BlackRock's fully diluted shares upon vesting of the Compensation
Awards because shares surrendered by PNC to fund the Compensation Awards are
already issued and outstanding.
The terms of the program are subject to approval by BlackRock's stockholders
at their next annual meeting in May 2003.
In connection with the adoption of the program, BlackRock and PNC have
amended the BlackRock Initial Public Offering Agreement, which provides that,
subject to certain notice requirements and evaluation and cure periods, PNC must
deposit its shares of stock of BlackRock into a voting trust and refrain from
soliciting proxies from holders of outstanding BlackRock capital securities if,
within twelve months following a change of control of PNC or a change of control
of BlackRock (as defined in the amended agreement), a majority of BlackRock's
independent directors determine that such change of control has a material
adverse effect on BlackRock and that adverse effect is not cured within a
further three month period. Following the deposit of PNC's shares into a voting
trust, PNC must, subject to the terms and conditions of the amended agreement,
take one of the three following courses of action: (i) within two years, dispose
of its ownership interest in BlackRock voting stock, such that neither PNC nor
its affiliates is the beneficial owner of more than 4.9% of any class of voting
stock of BlackRock (and any shares of class B common stock deposited by PNC into
the voting trust will be converted to class A common stock upon the election of
this option (i)); (ii) proceed as expeditiously as is commercially reasonable to
purchase all the outstanding BlackRock capital securities not held by PNC or
its affiliates at the applicable Change of Control Price (which is defined in
the amended agreement); or (iii) proceed as expeditiously as is commercially
reasonable to sell its ownership interest in BlackRock capital securities, such
that neither PNC nor its affiliates is the beneficial owner of more than 4.9%
of any class of voting stock of BlackRock, to a third party in a transaction in
which such third party offers to purchase all the outstanding shares not held by
PNC or its affiliates at a price per share not less than the price per share
offered to PNC. If PNC takes action under (ii) or (iii) above, all awards under
the program will vest and be immediately payable and all stock options granted
under BlackRock's 1999 Stock Award and Incentive Plan will vest and be
exercisable.
BlackRock and PNC also further amended BlackRock's Amended and Restated
Stockholders Agreement with PNC. which provides that nothing contained in the
agreement will be deemed to prohibit PNC or its affiliates from effecting a
distribution (including, but not limited to, a spin-off or a split-off) of its
BlackRock common stock to the public shareholders of PNC if PNC should decide to
do so. The amendment also provides that the Amended and Restated Stockholders
Agreement will remain in effect in the event PNC ceases to own shares of class B
common stock of BlackRock as a result of such converting to class A common stock
of BlackRock in accordance with the terms of the Initial Public Offering
Agreement.
63
2001 VERSUS 2000
CONSOLIDATED INCOME STATEMENT REVIEW
SUMMARY RESULTS
Consolidated net income for 2001 was $377 million or $1.26 per diluted share.
Excluding the effect of adopting the new accounting standard for financial
derivatives, net income was $382 million or $1.28 per diluted share compared
with $1.279 billion or $4.31 per diluted share for 2000. Income from continuing
operations in 2001 was $377 million or $1.26 per diluted share compared with
$1.214 billion or $4.09 per diluted share in 2000. Income from discontinued
operations was $5 million or $.02 per diluted share in 2001 compared with $65
million or $.22 per diluted share in 2000. Results for 2001 reflect the actions
taken during the year to accelerate the repositioning of PNC's lending business
and other strategic initiatives. These charges, totaling $1.2 billion pretax,
reduced 2001 net income by $768 million or $2.65 per diluted share.
Return on average common shareholders' equity was 5.65% and return on
average assets was .53% for 2001 compared with 20.52% and 1.76%, respectively,
for 2000.
NET INTEREST INCOME
Taxable-equivalent net interest income of $2.278 billion for 2001 increased 4%
compared with 2000 net interest income of $2.182 billion. The increase was
primarily due to the impact of transaction deposit growth and a lower rate
environment that was partially offset by the impact of continued downsizing of
the loan portfolio. The net interest margin widened 20 basis points to 3.84% for
2001 compared with 3.64% for 2000. The increase was primarily due to the impact
of the lower rate environment, the benefit of growth in transaction deposits and
the downsizing of higher-cost, less valuable retail certificates and wholesale
deposits.
PROVISION FOR CREDIT LOSSES
The provision for credit losses was $903 million for 2001 which included $714
million associated with institutional lending repositioning initiatives in 2001.
The provision was $136 million in 2000.
NONINTEREST INCOME
Noninterest income was $2.652 billion for 2001 compared with $2.950 billion in
2000. Noninterest income in 2001 included charges of $259 million for valuation
adjustments on loans held for sale related to the institutional lending
repositioning and $17 million of charges for asset impairments associated with
other strategic initiatives. A $111 million increase in net securities gains
and growth in asset management, fund servicing, consumer services and other
revenue was more than offset by net losses of $179 million resulting from lower
valuations of equity management investments as well as reduced brokerage and
corporate services revenue as a result of lower capital markets activity.
Asset management fees of $848 million for 2001 increased $39 million or
5% primarily driven by new institutional business and strong fixed-income
performance at BlackRock which more than offset decreases at PNC Advisors
primarily due to the impact of declining equity markets. Consolidated assets
under management were $284 billion at December 31, 2001, a 12% increase compared
with December 31, 2000. Fund servicing fees were $833 million for 2001, a $120
million increase compared with 2000 primarily driven by new client growth.
Service charges on deposits increased 6% to $218 million for 2001 mainly due
to an increase in transaction deposit accounts. Brokerage fees were $206 million
for 2001 compared with $249 million for 2000 as increased fees from sales of
insurance products were more than offset by declines in other brokerage revenue
due to weak equity markets.
Consumer services revenue of $229 million for 2001 increased $20 million or
10% compared with 2000 mainly due to the expansion of PNC's ATM network and the
increase in transaction deposit accounts.
Corporate services revenue was $60 million for 2001 compared with $342
million for 2000. Revenue in 2001 was adversely impacted by valuation
adjustments on loans held for sale of $259 million. In addition, increases in
treasury management and commercial mortgage-backed securities servicing revenue
were more than offset by the comparative impact of losses resulting from lower
valuations of equity investments and lower capital markets fees in 2001.
Equity management (private equity activities) reflected net losses of $179
million for 2001 compared with net gains of $133 million in 2000. The decrease
primarily resulted from a decline in the estimated fair value of both limited
partnership and direct investments.
Net securities gains were $131 million for 2001 compared with $20 million
in 2000.
Other noninterest income was $306 million for 2001 compared with $269
million for 2000. Excluding $12 million of asset write-downs in the fourth
quarter of 2001, other noninterest income increased 18% primarily due to higher
revenue from trading activities and gains on the sale of residential mortgage
loans. Net trading income included in other noninterest income was $142 million
in 2001 compared with $84 million in 2000.
64
NONINTEREST EXPENSE
Noninterest expense was $3.414 billion for 2001 compared with $3.103 billion for
2000. Costs to exit the vehicle leasing business, including the impairment of
goodwill associated with a prior acquisition and employee severance costs, and
additions to reserves related to insured residual value exposures totaled $135
million and are included in 2001 noninterest expense. In addition, $56 million
of integration and severance costs related to other strategic initiatives were
incurred in 2001. Excluding these items, noninterest expense increased 4%
compared with 2000. The increase was primarily in businesses that have shown
higher revenue growth including Regional Community Banking, BlackRock and PFPC.
Average full-time equivalent employees totaled approximately 24,500 and 24,100
for 2001 and 2000, respectively. The increase was mainly in asset management and
processing businesses.
CONSOLIDATED BALANCE SHEET REVIEW
LOANS
Loans were $38.0 billion at December 31, 2001, a decrease of $12.6 billion from
year end 2000 primarily due to residential mortgage securitizations and runoff,
transfers to held for sale and the managed reduction of institutional loans.
Loans at December 31, 2001 included $1.9 billion of vehicle leases and $200
million of commercial loans that have been designated for exit.
LOANS HELD FOR SALE
Loans held for sale were $4.2 billion at December 31, 2001 compared with $1.7
billion at December 31, 2000. In the fourth quarter of 2001, PNC designated for
exit $3.1 billion of loans and $7.9 billion of institutional credit exposure. Of
these amounts, $2.3 billion, net of $.6 billion of related charges, with total
credit exposure of $4.6 billion were transferred to loans held for sale.
Approximately $276 million of loans held at December 31, 2001 by companies
formed with AIG are classified in the consolidated financial statements as loans
held for sale.
SECURITIES
Total securities at December 31, 2001 were $13.9 billion compared with $5.9
billion at December 31, 2000. Total securities represented 20% of total assets
at December 31, 2001 compared with 8% at December 31, 2000. The increase was
primarily due to purchases of mortgage-backed and asset-backed securities during
2001 and the retention of interests from the securitization of residential
mortgage loans as loans declined and were replaced with securities. At December
31, 2001, the securities available for sale balance included a net unrealized
loss of $132 million, which represented the difference between fair value and
amortized cost. The comparable amount at December 31, 2000 was a net unrealized
loss of $54 million. The expected weighted-average life of securities available
for sale was 4 years at December 31, 2001 compared with 4 years and 5 months at
December 31, 2000.
The expected weighted-average life of securities held to maturity was
18 years and 11 months at December 31, 2001. PNC had no securities held for
maturity at December 31, 2000. The securities classified as held to maturity are
carried at amortized cost and are owned by companies formed with AIG in 2001
that are consolidated in PNC's financial statements.
FUNDING SOURCES
Total funding sources were $59.4 billion at December 31, 2001 and 2000. The
change in the composition of borrowed funds reflected a shift within categories
to manage overall funding costs.
Total deposits were $47.3 billion at December 31, 2001 compared with $47.7
billion at December 31, 2000. Demand and money market deposits increased due to
ongoing strategic marketing efforts to retain customers, as higher-cost, less
valuable retail certificates of deposit were de-emphasized.
ASSET QUALITY
Nonperforming assets were $391 million at December 31, 2001 compared with $372
million at December 31, 2000. The ratio of nonperforming assets to total loans,
loans held for sale and foreclosed assets was .93% at December 31, 2001 compared
with .71% at December 31, 2000. The allowance for credit losses was $560 million
and represented 1.47% of total loans and 265% of nonperforming loans at December
31, 2001. The comparable amounts were $598 million, 1.18% and 185%,
respectively, at December 31, 2000.
CAPITAL
Shareholders' equity totaled $5.8 billion at December 31, 2001 compared with
$6.7 billion at December 31, 2000. The payment of dividends, the impact of share
buybacks, the retirement of preferred stock and lower earnings in 2001 accounted
for the decline. During 2001, PNC repurchased 9.5 million shares of common stock
through open market or privately negotiated transactions and purchased or
redeemed preferred stock for $301 million. The regulatory capital ratios were
6.8% for leverage, 7.8% for tier I risk-based and 11.8% for total risk-based
capital at December 31, 2001 compared with 8.0% for leverage, 8.6% for tier I
risk-based and 12.6% for total risk-based capital at December 31, 2000.
65
FORWARD-LOOKING STATEMENTS
This report contains, and other statements that the Corporation may make may
contain, forward-looking statements with respect to the Corporation's outlook or
expectations for earnings, revenues, expenses, capital levels, asset quality or
other future financial or business performance, strategies and expectations and
the impact of legal, regulatory and supervisory matters on the Corporation's
business operations and performance. Forward-looking statements are typically
identified by words or phrases such as "believe," "feel," "expect,"
"anticipate," "intend," "outlook," "estimate," "forecast," "project,"
"position," "target," "assume," "achievable," "potential," "strategy," "goal,"
"objective," "plan," "aspiration," "outcome," "continue," "remain," "maintain,"
"seek," "strive," "trend," and variations of such words and similar expressions,
or future or conditional verbs such as "will," "would," "should," "could,"
"might," "can," "may" or similar expressions.
The Corporation cautions that forward-looking statements are subject to
numerous assumptions, risks and uncertainties, which change over time.
Forward-looking statements speak only as of the date they are made, and the
Corporation assumes no duty and does not undertake to update forward-looking
statements. Actual results could differ materially from those anticipated in
forward-looking statements and future results could differ materially from
historical performance.
The factors discussed elsewhere in this report or previously disclosed in
the Corporation's SEC reports (accessible on PNC's website at www.pnc.com and on
the SEC's website at www.sec.gov) and the following factors, among others, could
cause actual results to differ materially from those anticipated in
forward-looking statements or from historical performance:
(1) changes in political, economic or industry conditions, the interest rate
environment or financial and capital markets, which could result in: a
deterioration in credit quality, increased credit losses, and increased
funding of unfunded loan commitments and letters of credit; an adverse
effect on the allowances for credit losses and unfunded loan commitments
and letters of credit; a reduction in demand for credit or fee-based
products and services; a reduction in net interest income, value of assets
under management and assets serviced, value of private equity investments
and of other debt and equity investments, value of loans held for sale or
value of other on-balance-sheet and off-balance-sheet assets; or changes in
the availability and terms of funding necessary to meet PNC's liquidity
needs;
(2) relative and absolute investment performance of assets under management;
(3) the introduction, withdrawal, success and timing of business initiatives
and strategies, decisions regarding further reductions in balance sheet
leverage, the timing and pricing of any sales of loans held for sale, and
PNC's inability to realize cost savings or revenue enhancements, or to
implement integration plans relating to or resulting from mergers,
acquisitions, restructurings and divestitures;
(4) customer borrowing, repayment, investment and deposit practices and their
acceptance of PNC's products and services;
(5) the impact of increased competition;
(6) how PNC chooses to redeploy available capital, including the extent and
timing of any share repurchases and investments in PNC businesses;
(7) the inability to manage risks inherent in PNC's business;
(8) the unfavorable resolution of legal proceedings or government inquiries;
the impact of increased litigation risk from recent regulatory
developments; and the impact of reputational risk created by recent
regulatory developments on such matters as business generation and
retention, the ability to attract and retain management, liquidity and
funding;
(9) the denial of insurance coverage for claims made by PNC;
(10) an increase in the number of customer or counterparty delinquencies,
bankruptcies or defaults that could result in, among other things,
increased credit and asset quality risk, a higher provision for credit
losses and reduced profitability;
(11) the impact, extent and timing of technological changes, the adequacy of
intellectual property protection and costs associated with obtaining rights
in intellectual property claimed by others;
(12) actions of the Federal Reserve Board;
(13) the impact of legislative and regulatory reforms and changes in accounting
policies and principles;
(14) the impact of the regulatory examination process, the Corporation's failure
to satisfy the requirements of written agreements with regulatory agencies,
and regulators' future use of supervisory and enforcement tools; and
(15) terrorist activities and international hostilities, including the
situations surrounding Iraq and North Korea, which may adversely affect the
general economy, financial and capital markets, specific industries, and
the Corporation.
Some of the above factors are described in more detail in the Risk Factors
section of this Financial Review and factors relating to interest rate risk,
operational risk, trading activities, financial and other derivatives and
off-balance sheet activities are discussed in the Risk Management section of
this Financial Review. Factors relating to credit risk and liquidity are
discussed in the Consolidated Balance Sheet Review section of this Financial
Review. Other factors are described elsewhere in this report.
66
REPORTS ON CONSOLIDATED FINANCIAL STATEMENTS
THE PNC FINANCIAL SERVICES GROUP, INC.
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING
The management of The PNC Financial Services Group, Inc. is responsible for the
preparation, integrity and fair presentation of its published consolidated
financial statements. The accompanying consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in the
United States of America and, as such, include judgments and estimates of
management. The PNC Financial Services Group, Inc. also prepared the other
information included in the Annual Report and is responsible for its accuracy
and consistency with the consolidated financial statements.
Management is responsible for establishing and maintaining effective
internal controls over financial reporting and disclosure controls and
procedures. The internal control system is augmented by written policies and
procedures and by audits performed by an internal audit staff, which reports to
the Audit Committee of the Board of Directors. Internal auditors test the
operation of the internal control system and report findings to management and
the Audit Committee, and corrective actions are taken to address identified
control deficiencies and other opportunities for improving the system. The Audit
Committee, composed solely of independent directors, provides oversight to
management's conduct of the financial reporting process.
There are inherent limitations in the effectiveness of any system of
internal control, including the possibility of human error and circumvention or
overriding of controls. Accordingly, even effective internal control can provide
only reasonable assurance with respect to financial statement preparation.
Further, because of changes in conditions, the effectiveness of internal control
may vary over time.
Management assessed The PNC Financial Services Group, Inc.'s internal
controls over financial reporting and disclosure controls and procedures as of
December 31, 2002. This assessment was based on criteria for effective internal
controls over financial reporting described in "Internal Control-Integrated
Framework" issued by the Committee of Sponsoring Organizations of the Treadway
Commission and on requirements for disclosure controls and procedures arising
from the Sarbanes-Oxley Act of 2002. Based on this assessment, management
believes that The PNC Financial Services Group, Inc. maintained effective
internal controls over financial reporting and disclosure controls and
procedures as of December 31, 2002.
/s/ James E. Rohr /s/ William S. Demchak
James E. Rohr William S. Demchak
Chairman and Vice Chairman and
Chief Executive Officer Chief Financial Officer
REPORT OF DELOITTE & TOUCHE LLP,
INDEPENDENT AUDITORS
To the Board of Directors and Shareholders of
The PNC Financial Services Group, Inc.
We have audited the accompanying consolidated balance sheet of The PNC Financial
Services Group, Inc. and subsidiaries as of December 31, 2002, and the related
consolidated statements of income, shareholders' equity, and cash flows for the
year then ended. These financial statements are the responsibility of The PNC
Financial Services Group, Inc.'s management. Our responsibility is to express an
opinion on these financial statements based on our audit. The financial
statements of The PNC Financial Services Group, Inc. for the years ended
December 31, 2001 and 2000 were audited by other auditors whose report, dated
March 1, 2002, expressed an unqualified opinion on those statements.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of The PNC Financial Services
Group, Inc. and subsidiaries as of December 31, 2002, and the consolidated
results of their operations and their cash flows for the year then ended in
conformity with accounting principles generally accepted in the United States of
America.
As discussed in Note 14 to the consolidated financial statements, in 2002
The PNC Financial Services Group, Inc. changed its method of accounting for
goodwill and other intangible assets to conform with Statement of Financial
Accounting Standards No. 142.
/s/ Deloitte & Touche LLP
Pittsburgh, Pennsylvania
February 17, 2003
67
CONSOLIDATED STATEMENT OF INCOME
THE PNC FINANCIAL SERVICES GROUP, INC.
Year ended December 31
----------------------------------------------------
In millions, except per share data 2002 2001 2000
======================================================================================== ================================
INTEREST INCOME
Loans and fees on loans $2,294 $3,279 $4,045
Securities 616 625 386
Loans held for sale 135 119 204
Other 127 114 97
- ---------------------------------------------------------------------------------------- --------------------------------
Total interest income 3,172 4,137 4,732
INTEREST EXPENSE
Deposits 659 1,229 1,653
Borrowed funds 316 646 915
- ---------------------------------------------------------------------------------------- --------------------------------
Total interest expense 975 1,875 2,568
- ---------------------------------------------------------------------------------------- --------------------------------
Net interest income 2,197 2,262 2,164
Provision for credit losses 309 903 136
- ---------------------------------------------------------------------------------------- --------------------------------
Net interest income less provision for credit losses 1,888 1,359 2,028
======================================================================================== ================================
NONINTEREST INCOME
Asset management 853 848 809
Fund servicing 816 833 713
Service charges on deposits 227 218 206
Brokerage 195 206 249
Consumer services 239 229 209
Corporate services 526 60 342
Equity management (51) (179) 133
Net securities gains 89 131 20
Other 303 306 269
- ---------------------------------------------------------------------------------------- --------------------------------
Total noninterest income 3,197 2,652 2,950
======================================================================================== =================================
NONINTEREST EXPENSE
Staff expense 1,701 1,667 1,616
Net occupancy 243 220 203
Equipment 271 255 224
Marketing 51 57 70
Distributions on capital securities 58 63 67
Other 903 1,152 923
- ---------------------------------------------------------------------------------------- --------------------------------
Total noninterest expense 3,227 3,414 3,103
======================================================================================== ================================
Income from continuing operations before minority interest and
income taxes 1,858 597 1,875
Minority interest in income of consolidated entities 37 33 27
Income taxes 621 187 634
- ---------------------------------------------------------------------------------------- --------------------------------
Income from continuing operations 1,200 377 1,214
Income (loss) from discontinued operations
(less applicable income tax benefit of $9 and income tax expense
of $0 and $44) (16) 5 65
- ---------------------------------------------------------------------------------------- --------------------------------
Income before cumulative effect of accounting change 1,184 382 1,279
Cumulative effect of accounting change (less applicable income
tax benefit of $2) (5)
- ---------------------------------------------------------------------------------------- --------------------------------
Net income $1,184 $377 $1,279
======================================================================================== ================================
EARNINGS PER COMMON SHARE
FROM CONTINUING OPERATIONS
Basic $4.23 $1.27 $4.12
Diluted $4.20 $1.26 $4.09
FROM NET INCOME
Basic $4.18 $1.27 $4.35
Diluted $4.15 $1.26 $4.31
AVERAGE COMMON SHARES OUTSTANDING
Basic 283 287 290
Diluted 285 290 293
======================================================================================== ================================
See accompanying Notes To Consolidated Financial Statements.
68
CONSOLIDATED BALANCE SHEET
THE PNC FINANCIAL SERVICES GROUP, INC.
December 31
----------------------------------
In millions, except par value 2002 2001
======================================================================================================== ===============
ASSETS
Cash and due from banks $3,201 $4,327
Short-term investments 3,658 1,335
Loans held for sale 1,607 4,189
Securities 13,763 13,908
Loans, net of unearned income of $1,075 and $1,164 35,450 37,974
Allowance for credit losses (673) (560)
- -------------------------------------------------------------------------------------------------------- ---------------
Net loans 34,777 37,414
Goodwill 2,313 2,036
Other intangible assets 333 337
Other 6,725 6,092
- -------------------------------------------------------------------------------------------------------- ---------------
Total assets $66,377 $69,638
======================================================================================================== ===============
LIABILITIES
Deposits
Noninterest-bearing $9,538 $10,124
Interest-bearing 35,444 37,180
- -------------------------------------------------------------------------------------------------------- ---------------
Total deposits 44,982 47,304
Borrowed funds
Federal funds purchased 38 167
Repurchase agreements 814 954
Bank notes and senior debt 4,400 6,362
Federal Home Loan Bank borrowings 1,256 2,047
Subordinated debt 2,423 2,298
Other borrowed funds 185 262
- -------------------------------------------------------------------------------------------------------- ---------------
Total borrowed funds 9,116 12,090
Allowance for unfunded loan commitments and letters of credit 84 70
Accrued expenses 2,046 1,684
Other 2,172 1,649
- -------------------------------------------------------------------------------------------------------- ---------------
Total liabilities 58,400 62,797
======================================================================================================== ===============
Minority interest 270 170
Mandatorily redeemable capital securities of subsidiary trusts 848 848
SHAREHOLDERS' EQUITY
Preferred stock 1
Common stock - $5 par value
Authorized 800 shares
Issued 353 shares 1,764 1,764
Capital surplus 1,101 1,077
Retained earnings 7,187 6,549
Deferred benefit expense (9) (16)
Accumulated other comprehensive income 321 5
Common stock held in treasury at cost: 68 and 70 shares (3,505) (3,557)
- -------------------------------------------------------------------------------------------------------- ---------------
Total shareholders' equity 6,859 5,823
- -------------------------------------------------------------------------------------------------------- ---------------
Total liabilities, minority interest, capital securities and shareholders' equity $66,377 $69,638
====================================================================================================== ===============
See accompanying Notes To Consolidated Financial Statements.
69
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
THE PNC FINANCIAL SERVICES GROUP, INC.
Accumulated Other
Comprehensive
Shares Outstanding Income (Loss) from
------------------- ------------------
Deferred
Preferred Common Preferred Common Capital Retained Benefit Continuing Discontinued
In millions Stock Stock Stock Stock Surplus Earnings Expense Operations Operations
============================== ========= ======== ======= ======= ======= ========= ======== ========== ==========
Balance at January 1, 2000 7 293 $7 $1,764 $1,276 $6,006 $(17) $(132) $(135)
Net income 1,279
Net unrealized securities
gains 86 90
Minimum pension liability
adjustment 1
Other 2
- ------------------------------ ------- --------- ------ -------- --------- -------- -------- ------- --------
Comprehensive income
- ------------------------------ ------- --------- ------ -------- --------- -------- -------- ------- --------
Cash dividends declared
Common (530)
Preferred (19)
Treasury stock activity (3) 6
Tax benefit of stock option
plans 20
Subsidiary stock transactions 1
Deferred benefit expense (8)
- ------------------------------ ------- --------- ------ -------- --------- -------- -------- ------- --------
Balance at December 31, 2000 7 290 7 1,764 1,303 6,736 (25) (43) (45)
============================== ======= ========= ====== ======== ========= ======== ======== ======= ========
Net income 377
Net unrealized securities
(losses) gains (51) 45
Net unrealized gains on cash
flow hedge derivatives 98
Minimum pension liability
adjustment (1)
Other 2
- ------------------------------ ------- --------- ------ -------- --------- -------- -------- ------- --------
Comprehensive income
- ------------------------------ ------- --------- ------ -------- --------- -------- -------- ------- --------
Cash dividends declared
Common (552)
Preferred (12)
Treasury stock activity (7) 26
Tax benefit of stock option
plans 40
Subsidiary stock transactions 3
Series F preferred stock
tender offer/redemption (6) (6) (295)
Deferred benefit expense 9
- ------------------------------ ------- --------- ------ -------- --------- -------- -------- ------- --------
Balance at December 31, 2001 1 283 1 1,764 1,077 6,549 (16) 5
============================== ======= ========= ====== ======== ========= ======== ======== ======= ========
Net income 1,184
Net unrealized securities
gains 265
Net unrealized gains on cash
flow hedge derivatives 37
Minimum pension liability
adjustment (2)
Other 16
- ------------------------------ ------- --------- ------ -------- --------- -------- -------- ------- --------
Comprehensive income
- ------------------------------ ------- --------- ------ -------- --------- -------- -------- ------- --------
Cash dividends declared
Common (545)
Preferred (1)
Treasury stock activity (1) 2 (1) 13
Tax benefit of stock option
plans 9
Subsidiary stock transactions 2
Deferred benefit expense 7
- ------------------------------ ------- --------- ------ -------- --------- -------- -------- ------- --------
BALANCE AT DECEMBER 31, 2002 285 $1,764 $1,101 $7,187 $(9) $321
============================== ======= ========= ====== ======== ========= ======== ======== ======= =======
Treasury
In millions Stock Total
============================== ======== ========
Balance at January 1, 2000 $(2,823) $5,946
Net income 1,279
Net unrealized securities
gains 176
Minimum pension liability
adjustment 1
Other 2
- ------------------------------ -------- --------
Comprehensive income 1,458
- ------------------------------ -------- --------
Cash dividends declared
Common (530)
Preferred (19)
Treasury stock activity (218) (212)
Tax benefit of stock option
plans 20
Subsidiary stock transactions 1
Deferred benefit expense (8)
- ------------------------------ -------- --------
Balance at December 31, 2000 (3,041) 6,656
============================== ======== ========
Net income 377
Net unrealized securities
(losses) gains (6)
Net unrealized gains on cash
flow hedge derivatives 98
Minimum pension liability
adjustment (1)
Other 2
- ------------------------------ -------- --------
Comprehensive income 470
- ------------------------------ -------- --------
Cash dividends declared
Common (552)
Preferred (12)
Treasury stock activity (516) (490)
Tax benefit of stock option
plans 40
Subsidiary stock transactions 3
Series F preferred stock
tender offer/redemption (301)
Deferred benefit expense 9
- ------------------------------ -------- --------
Balance at December 31, 2001 (3,557) 5,823
============================== ======== ========
Net income 1,184
Net unrealized securities
gains 265
Net unrealized gains on cash
flow hedge derivatives 37
Minimum pension liability
adjustment (2)
Other 16
- ------------------------------ -------- --------
Comprehensive income 1,500
- ------------------------------ -------- --------
Cash dividends declared
Common (545)
Preferred (1)
Treasury stock activity 52 64
Tax benefit of stock option
plans 9
Subsidiary stock transactions 2
Deferred benefit expense 7
- ------------------------------ -------- --------
BALANCE AT DECEMBER 31, 2002 $(3,505) $6,859
============================== ======== ========
See accompanying Notes To Consolidated Financial Statements.
70
CONSOLIDATED STATEMENT OF CASH FLOWS
THE PNC FINANCIAL SERVICES GROUP, INC.
Year ended December 31
-------------------------------------------------------
In millions 2002 2001 2000
======================================================================= ================ ================ =================
OPERATING ACTIVITIES
Net income $1,184 $377 $1,279
Loss (income) from discontinued operations 16 (5) (65)
Cumulative effect of accounting change 5
- ----------------------------------------------------------------------- ---------------- ---------------- -----------------
Income from continuing operations 1,200 377 1,214
Adjustments to reconcile income from continuing operations
to net cash provided by operating activities
Provision for credit losses 309 903 136
Depreciation, amortization and accretion 242 309 283
Deferred income taxes 487 (48) 376
Securities transactions (89) (128) (29)
Valuation adjustments 2 265 27
Change in
Loans held for sale 2,907 (92) 1,652
Short-term investments (2,323) (184) (51)
Other (82) (135) (560)
- ----------------------------------------------------------------------- ---------------- ---------------- -----------------
Net cash provided by operating activities 2,653 1,267 3,048
======================================================================= ================ ================ =================
INVESTING ACTIVITIES
Net change in loans 1,073 4,099 (2,215)
Repayment of securities 3,158 2,445 920
Sales
Securities 16,395 19,693 7,630
Loans 3,277 1,155 551
Foreclosed assets 11 15 24
Purchases
Securities (18,967) (26,147) (7,640)
Loans (874) (758)
Net cash (paid) received for acquisitions/divestitures (1,676) 485 (30)
Other (193) (131) (301)
- ----------------------------------------------------------------------- ---------------- ---------------- -----------------
Net cash provided (used) by investing activities 2,204 856 (1,061)
======================================================================= ================ ================ =================
FINANCING ACTIVITIES
Net change in
Noninterest-bearing deposits (586) 1,634 329
Interest-bearing deposits (1,736) (1,994) 1,533
Federal funds purchased (129) (1,260) 164
Repurchase agreements (140) 347 205
Sales/issuances
Bank notes and senior debt 2,157 2,849
Federal Home Loan Bank borrowings 3,123 1,781
Subordinated debt (1) 100
Other borrowed funds 22,246 35,346 37,060
Common stock 131 184 189
Repayments/maturities
Bank notes and senior debt (2,047) (1,915) (3,715)
Federal Home Loan Bank borrowings (791) (1,576) (3,539)
Subordinated debt (200) (20)
Other borrowed funds (22,323) (35,752) (37,367)
Acquisition of treasury stock (62) (681) (428)
Series F preferred stock tender offer/redemption (301)
Cash dividends paid (546) (569) (546)
- ----------------------------------------------------------------------- ---------------- ---------------- -----------------
Net cash used by financing activities (5,983) (1,458) (1,405)
======================================================================= ================ ================ =================
INCREASE (DECREASE)IN CASH AND DUE FROM BANKS (1,126) 665 582
Cash and due from banks at beginning of year 4,327 3,662 3,080
- ----------------------------------------------------------------------- ---------------- ---------------- -----------------
Cash and due from banks at end of year $3,201 $4,327 $3,662
======================================================================= ================ ================ =================
CASH PAID FOR
Interest $997 $1,813 $2,598
Income taxes 189 215 289
NON-CASH ITEMS
Transfer of mortgage loans to securities 4,341 710
Transfer from (to) loans to (from) loans held for sale, net 263 2,707 (143)
Transfer from loans to other assets 14 11 23
======================================================================= ============= =========== =================
See accompanying Notes To Consolidated Financial Statements.
71
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THE PNC FINANCIAL SERVICES GROUP, INC.
BUSINESS
The PNC Financial Services Group, Inc. ("Corporation" or "PNC") is one of the
largest diversified financial services companies in the United States, operating
businesses engaged in regional community banking; wholesale banking, including
corporate banking, real estate finance and asset-based lending; wealth
management; asset management and global fund processing services. The
Corporation provides certain products and services nationally and others in
PNC's primary geographic markets in Pennsylvania, New Jersey, Delaware, Ohio and
Kentucky. The Corporation also provides certain banking, asset management and
global fund processing services internationally. PNC is subject to intense
competition from other financial services companies and is subject to regulation
by various domestic and international authorities.
NOTE 1 ACCOUNTING POLICIES
BASIS OF FINANCIAL STATEMENT PRESENTATION
The consolidated financial statements include the accounts of PNC and its
subsidiaries, most of which are wholly owned, and certain general partnership
interests. Such statements have been prepared in accordance with accounting
principles generally accepted in the United States of America ("generally
accepted accounting principles"). All significant intercompany accounts and
transactions have been eliminated. Certain prior-period amounts have been
reclassified to conform with the current period presentation. These
reclassifications did not impact the Corporation's consolidated financial
condition or results of operations. The consolidated financial statements and
notes to consolidated financial statements reflect the residential mortgage
banking business, which was sold on January 31, 2001, in discontinued
operations, unless otherwise noted.
INVESTMENTS
PNC has interests in various types of investments. The accounting for these
investments is dependent on a number of factors including, but not limited to,
items such as marketability of the investment, ownership interest, PNC's intent
and the nature of the investment.
Venture capital investments, which include both direct investments in
companies and interests in limited partnerships, are reported at estimated fair
values. These estimates are based upon available information and may not
necessarily represent amounts that will ultimately be realized through
distribution, sale or liquidation of the investment. The valuation procedures
applied to direct investments include valuation techniques such as multiples of
earnings before interest, taxes, depreciation and amortization of the entity,
independent appraisals of the entity or the pricing used to value the entity in
a recent financing transaction. Limited partnership investments are valued based
on the financial statements received from the general partner, an independent
third party. All venture capital investments are included in the consolidated
balance sheet under other assets. Changes in the fair value of these assets are
recognized in noninterest income.
Equity investments other than venture capital investments are accounted for
under one of the following methods:
- - Marketable equity securities are accounted for at fair value based on the
securities' quoted market price from a national securities exchange. Those
purchased with the intention of recognizing short-term profits are placed
in the trading account, carried at market value and classified as
short-term investments. Gains and losses on trading securities are included
in noninterest income. Marketable equity securities not classified as
trading are designated as securities available for sale and are carried at
fair value with unrealized gains and losses, net of income taxes, reflected
in accumulated other comprehensive income or loss.
- - Investments in nonmarketable equity securities are recorded using the cost
or equity methods of accounting. The cost method is used for those
investments in which PNC does not have significant influence over the
investee. Under this method, there is no change to the cost basis unless
there is an other than temporary decline in value, which results in an
impairment charge. Dividends received on cost investments are included in
noninterest income. The equity method is used for those investments in
which PNC can have significant influence over the operations of the
investee. Under the equity method, PNC records its equity ownership share
of the net income or loss of the investee in noninterest income. PNC
records its nonmarketable equity securities in other assets.
- - Additionally, investments in limited partnerships are accounted for under
either the cost method or the equity method as described above for
nonmarketable equity securities. The equity method is used if the limited
partner's ownership interest in the partnership is greater than 3% to 5%.
For the remaining limited partnership investments, the cost method is used.
Limited partnership investments are included in other assets.
Debt securities are classified as securities and carried at amortized cost
if management has the positive intent and ability to hold the securities to
maturity. Debt securities purchased with the intention of recognizing short-term
profits
72
are placed in the trading account, carried at market value and classified as
short-term investments. Gains and losses on these securities are included in
noninterest income. Debt securities not classified as held to maturity or
trading are designated as securities available for sale and carried at fair
value with unrealized gains and losses, net of income taxes, reflected in
accumulated other comprehensive income or loss.
Interest on debt securities, including amortization of premiums and
accretion of discounts using the interest method, is included in interest
income. Gains and losses realized on the sale of debt securities available for
sale are computed on a specific security basis and included in noninterest
income.
SPECIAL PURPOSE ENTITIES
Special Purpose Entities ("SPEs") are broadly defined as legal entities
structured for a particular purpose. PNC utilizes SPEs in various legal forms to
conduct normal business activities including the sale or transfer of assets to
third parties. SPEs that meet the criteria for a Qualifying Special Purpose
Entity ("QSPE") as defined in Statement of Financial Accounting Standards
("SFAS") No. 140, "Accounting for Transfers and Servicing of Financial Assets
and Extinguishments of Liabilities," are not required to be consolidated. SPEs
that are not QSPEs are reviewed for consolidation based on each SPE's individual
structure and operations. General factors to be considered in making this
determination include whether the majority owner (or owners) of the SPE is
independent of PNC, has made a substantive capital investment in the SPE, has
control of the SPE, or possesses the substantive risks and rewards of ownership
of the SPE.
In response to demands to strengthen existing accounting guidance regarding
the consolidation of SPEs and other off-balance sheet entities, in January 2003
the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No.
("FIN") 46, "Consolidation of Variable Interest Entities".
In general, a variable interest entity ("VIE") is a corporation,
partnership, limited liability corporation, trust, grantor trust or any other
legal structure used to conduct activities or hold assets that either does not
have equity investors with voting rights that can directly or indirectly make
decisions about the entity's activities through those voting rights or similar
rights or has equity investors that do not provide sufficient financial
resources for the entity to support its activities. A VIE often holds financial
assets, including loans or receivables, real estate or other property.
FIN 46 requires a VIE to be consolidated if the company is subject to a
majority of the risk of loss from the VIE's activities, is entitled to receive a
majority of the entity's residual returns or both. A company that consolidates
the VIE is called the primary beneficiary. Upon consolidation, the primary
beneficiary generally must record all of the VIE's assets, liabilities and
noncontrolling interests at fair value. FIN 46 also requires disclosures about
VIEs that the company is not required to consolidate but in which it has a
significant variable interest.
The consolidation requirements of FIN 46 apply immediately to VIEs created
after January 31, 2003. The consolidation requirements apply to VIEs that
existed prior to that date in the first fiscal year or interim period beginning
after June 15, 2003.
Based on a preliminary review of the provisions of FIN 46, it is reasonably
possible that PNC and/or BlackRock will hold a significant variable interest in
certain existing VIEs that would require the Corporation to consolidate these
entities in the third quarter of 2003. A description of these existing VIEs
follows:
- - PNC Bank, N.A. ("PNC Bank") provides credit enhancement, liquidity
facilities and certain administrative services to Market Street Funding
Corporation ("Market Street"), a multi-seller asset-backed commercial paper
conduit that is independently owned and managed. The activities of Market
Street are limited to the purchase of, or making of, loans secured by
interests primarily in pools of receivables from U.S. corporations that
desire access to the commercial paper market. Market Street funds the
purchases by issuing commercial paper. Market Street's commercial paper has
been rated A1/P1 by Standard & Poor's and Moody's. Market Street had total
assets of $3.0 billion and total liabilities of $3.0 billion at December
31, 2002. PNC Bank provides certain administrative services, a portion of
the program-level credit enhancement and the majority of liquidity
facilities to Market Street in exchange for fees negotiated based on market
rates. Credit enhancement is provided in part by PNC Bank in the form of a
cash collateral account which is funded by a credit loan facility with a
five-year term expiring on December 31, 2004. At December 31, 2002,
approximately $96 million was outstanding on this facility. An additional
$287 million was provided by a major insurer. Also at December 31, 2002,
Market Street had liquidity facilities available supporting individual
pools of receivables totaling $3.9 billion, of which $3.2 billion was
provided by PNC Bank. As Market Street's program administrator, PNC
received fees of $13.9 million for the year ended December 31, 2002.
Commitment fees related to PNC's portion of the liquidity facilities
amounted to $7.5 million for 2002. PNC holds no ownership interest in
Market Street.
73
- - BlackRock Inc. ("BlackRock"), a majority-owned subsidiary of PNC, acts as
collateral asset manager for four collaterialized bond obligation funds
("CBOs") and one collaterialized loan obligation fund ("CLO") organized as
corporations or limited liability companies. The funds invest in high yield
securities and offer opportunity for high return and are subject to greater
risk than traditional investment products. These funds are structured to
take advantage of the yield differential between their assets and
liabilities and have terms to maturity from eight to twelve years. At
December 31, 2002, aggregate assets and debt in the CBOs and CLO was
approximately $2.1 billion and $2.1 billion, respectively. BlackRock's
equity ownership was approximately $10.4 million at December 31, 2002.
- - PNC Real Estate Finance makes equity investments in various limited
partnerships that sponsor affordable housing projects utilizing the Low
Income Housing Tax Credit ("LIHTC") pursuant to Section 42 of the Internal
Revenue Code. The purpose of these investments is to achieve a satisfactory
return on capital, to facilitate the sale of additional affordable housing
product offerings and to assist PNC in achieving goals associated with the
Community Reinvestment Act. The activities of the limited partnerships
include the identification, development and operation of multi-family
housing that is leased to qualifying residential tenants generally within
the PNC footprint. The investments are funded through a combination of debt
and equity with equity typically comprising 30 - 60% of the total project
capital. At December 31, 2002, PNC's maximum exposure to loss resulting
from those LIHTC investments in which PNC owns a 50% or greater interest
and which may be subject to the provisions of FIN 46 was $142 million. This
represents the combination of a recorded basis of $119 million and unfunded
commitments of $23 million.
- - Within the PNC Advisors' business segment, PNC GPI, Inc., ("GPI") a wholly
owned subsidiary of the Corporation, is the general partner and in some
cases the commodity pool operator for, and PNC Bank is the investment
manager for, a number of private investment funds organized as limited
partnerships. In addition, PNC Bank is the investment manager for, and GPI
is the commodity pool operator for, two private investment funds organized
as offshore corporations. On December 31, 2002, the aggregate value of the
assets of these funds was $725 million, and the value of PNC GPI's
ownership was $2.4 million.
- - As part of its equity management activities, the Corporation has
subsidiaries that invest in and act as the investment manager for a private
equity fund that is organized as a limited partnership. The fund invests in
private equity investments for the purpose of generating capital
appreciation and profits. At December 31, 2002, aggregate assets and equity
in the fund were approximately $37.3 million and $37.2 million,
respectively. PNC's ownership in the fund was valued at approximately $9.6
million at December 31, 2002.
As currently organized, the following entities would be considered VIEs under
FIN 46. However, management has identified, and intends to implement, certain
changes to the equity ownership and/or control structure of these entities that
management believes would remove them from the scope of FIN 46. As a result,
these entities would not be required to be consolidated in the third quarter of
2003.
- - BlackRock serves as investment manager for two fixed income hedge funds
that engage in trading of fixed income securities through both a limited
liability company ("LLC") and a corporate entity. These funds invest in the
global bond markets on a more leveraged basis and/or concentrated basis
than BlackRock's traditional fixed income products with diversification of
risk exposure in each portfolio. BlackRock serves as the managing member of
the LLC and the investment manager of the corporate entity which had
combined assets and liabilities of approximately $37.9 billion and $36.4
billion, respectively, at December 31, 2002. BlackRock's equity ownership
was approximately $7.5 million at December 31, 2002.
- - On November 4, 2002, BlackRock purchased certain assets and liabilities of
Cyllenius Partners GP, LLC and Cyllenius Capital Management LP and now
serves as the managing member of two LLCs and the investment manager for a
corporation (the "Cyllenius Funds") which engage in the trading of equity
securities both long and short. At December 31, 2002, the Cyllenius Funds
had total assets and liabilities of approximately $168.2 million and $44.8
million, respectively. BlackRock holds no ownership interest in the
Cyllenius Funds.
If PNC and/or BlackRock are required to consolidate existing VIEs under the
provisions of FIN 46, this change could have a significant impact on PNC's
consolidated balance sheet, regulatory capital, and asset quality and related
ratios. PNC management will continue to assess this interpretation's final
impact on the Corporation's consolidated financial statements. In addition, the
FASB is discussing implementation guidelines associated with FIN 46 which could
change management's current assessment of its impact. Therefore, additional
entities may be subject to consolidation upon PNC's implementation of FIN 46.
74
USE OF ESTIMATES
In preparing the consolidated financial statements, management is required to
make estimates and assumptions that affect the amounts reported. Actual results
will differ from such estimates and the differences may be material to the
consolidated financial statements.
BUSINESS COMBINATIONS
In business combinations accounted for using the purchase method of accounting,
the net assets of the companies acquired are recorded at their estimated fair
value at the date of acquisition and include the results of operations of the
acquired business from the date of acquisition. The excess of the purchase price
over the estimated fair value of the net assets acquired is recognized as
goodwill.
LOANS HELD FOR SALE
Loans are designated as held for sale when the Corporation has a positive intent
to sell them. Loans are transferred at the lower of cost or market to the loans
held for sale category. At the time of transfer, related write-downs on the
loans are recorded as charge-offs. A new cost basis of the loan is established
and any subsequent adjustment as a result of lower of cost or market analysis is
recognized as a valuation allowance with changes included in noninterest income.
The lower of cost or market analysis on pools of homogeneous loans is
applied on a net aggregate basis. Such analysis on non-homogeneous loans is
applied on an individual loan basis.
Interest income with respect to loans held for sale is accrued on the
principal amount outstanding.
LOANS AND LEASES
Loans are stated at the principal amounts outstanding, net of unearned income.
Interest income with respect to loans other than nonaccrual loans is accrued on
the principal amount outstanding and credited to interest income as earned using
the interest method. Significant loan fees are deferred and accreted to interest
income over the respective lives of the loans.
The Corporation also provides financing for various types of equipment,
aircraft, energy and power systems and rolling stock through a variety of lease
arrangements. Direct financing leases are carried at the aggregate of lease
payments plus estimated residual value of the leased property, less unearned
income. Lease financing income is recognized over the term of the lease using
methods that approximate the level yield method. Gains or losses on the sale of
leased assets or valuation adjustments on lease residuals are included in
noninterest income.
LOAN SECURITIZATIONS AND RETAINED INTERESTS
The Corporation sells mortgage and other loans through secondary market
securitizations. In certain cases, the Corporation will retain a portion of the
securities issued, interest-only strips, one or more subordinated tranches,
servicing rights and/or cash reserve accounts, all of which are associated with
the securitized asset. Any gain or loss recognized on the sale of the loans
depends on the allocation between the loans sold and the retained interests,
based on their relative fair market values at the date of transfer. The
Corporation generally estimates fair value based on the present value of future
expected cash flows using assumptions as to discount rates, prepayment speeds,
credit losses and servicing costs, if applicable.
Servicing rights are maintained at the lower of carrying value or fair
market value and are amortized in proportion to estimated net servicing income.
Retained interests in loan securitizations are carried at fair market value and
included in other assets. For retained interests classified as securities
available for sale, adjustments to fair market value are recognized through
accumulated other comprehensive income or loss. Fair market value adjustments
for all other retained interests are recorded in noninterest income. For
servicing rights retained, the Corporation generally receives a fee for
servicing the securitized loans.
For purposes of measuring impairment, the Corporation stratifies the pools
of assets underlying servicing rights by product type and/or geographic region
of the borrower. A valuation allowance is recorded when the carrying amount of
specific asset strata exceeds its fair value.
NONPERFORMING ASSETS
Nonperforming assets include nonaccrual loans, troubled debt restructurings,
nonaccrual loans held for sale and foreclosed assets. Generally, loans other
than consumer are classified as nonaccrual when it is determined that the
collection of interest or principal is doubtful or when a default of interest or
principal has existed for 90 days or more, unless the loans are well secured and
in the process of collection. When interest accrual is discontinued, accrued but
uncollected interest credited to income in the current year is reversed and
unpaid interest accrued in the prior year, if any, is charged against the
allowance for credit losses. Consumer loans are generally charged-off in the
month they become 120 days past due. Home equity loans and home equity lines of
credit are classified as nonaccrual at 120 days and 180 days past due,
respectively, and are recorded at the lower of cost or market value, less
liquidation costs, unless the loans are well secured and in the process of
collection.
75
A loan is categorized as a troubled debt restructuring in the year of
restructuring if a significant concession is granted to the borrower due to
deterioration in the financial condition of the borrower.
Nonperforming loans are generally not returned to performing status until
the obligation is brought current and has performed in accordance with the
contractual terms for a reasonable period of time and collection of the
contractual principal and interest is no longer doubtful.
Impaired loans consist of nonaccrual commercial and commercial real estate
loans and troubled debt restructurings. Interest collected on these loans is
recognized on the cash basis or cost recovery method.
Loans held for sale, which are carried at lower of cost or market value,
are considered nonaccrual when it is determined that the collection of interest
or principal is doubtful or when a default of interest or principal has existed
for 90 days or more, unless the loans are well secured and in the process of
collection. Nonaccrual loans held for sale are reported as other nonperforming
assets.
Foreclosed assets are comprised of property acquired through a foreclosure
proceeding or acceptance of a deed-in-lieu of foreclosure. These assets are
recorded on the date acquired at the lower of the related loan balance or market
value of the collateral less estimated disposition costs. Market values are
estimated primarily based on appraisals. Subsequently, foreclosed assets are
valued at the lower of the amount recorded at acquisition date or the current
market value less estimated disposition costs. Gains or losses realized from
disposition of such property are reflected in noninterest expense.
ALLOWANCE FOR CREDIT LOSSES
The allowance for credit losses is maintained at a level believed by management
to be sufficient to absorb estimated probable credit losses inherent in the loan
portfolio. The allowance is increased by the provision for credit losses, which
is charged against operating results and decreased by the amount of charge-offs,
net of recoveries. Management's determination of the adequacy of the allowance
is based on periodic evaluations of the credit portfolio and other relevant
factors. This evaluation is inherently subjective as it requires material
estimates, including, among others, expected default probabilities, loss given
default, exposure at default, the amounts and timing of expected future cash
flows on impaired loans, estimated losses on consumer loans and residential
mortgages, and general amounts for historical loss experience, economic
conditions, uncertainties in estimating losses and inherent risks in the various
credit portfolios, all of which may be susceptible to significant change.
In determining the adequacy of the allowance for credit losses, the
Corporation makes specific allocations to impaired loans, to pools of watchlist
and nonwatchlist loans, to consumer and residential mortgage loans, and to
unallocated reserves. While allocations are made to specific loans and pools of
loans, the total reserve is available for all credit losses.
Specific allocations are made to significant impaired loans and are
determined in accordance with SFAS No. 114, "Accounting by Creditors for
Impairments of a Loan," with impairment measured generally based on the present
value of the loan's expected cash flows, the loan's observable market price or
the fair value of the loan's collateral. A minimum specific allowance is
established on all impaired loans at the applicable pool reserve allocation rate
for similar loans.
Allocations to loan pools are developed by business segment and risk rating
and are based on historical loss trends and management's judgment concerning
those trends and other relevant factors. These factors may include, among
others, actual versus estimated losses, regional and national economic
conditions, business segment and portfolio concentrations, industry competition
and consolidation, and the impact of government regulations. Loss factors are
based on historical experience and may be adjusted for significant factors that,
based on management's judgment, impact the collectibility of the portfolio as of
the balance sheet date. Consumer and residential mortgage loan allocations are
made at a total portfolio level based on historical loss experience adjusted for
portfolio activity and economic conditions.
While PNC's pool reserve methodologies strive to reflect all risk factors,
there continues to be a certain element of risk associated with, but not limited
to, potential estimation or judgmental errors. Unallocated reserves are designed
to provide coverage for probable losses attributable to such risks. In addition,
unallocated reserves also include factors which may not be directly measured in
the determination of specific or pooled reserves. These factors include general
economic and business conditions affecting key lending areas of the Corporation,
credit quality trends, recent loss experience in particular segments of the
portfolio, duration of the current economic cycle, and bank regulatory
examination results.
ALLOWANCE FOR UNFUNDED LOAN COMMITMENTS AND LETTERS OF CREDIT
The allowance for unfunded loan commitments and letters of credit is maintained
at a level believed by management to be sufficient to absorb estimated probable
losses related to these unfunded credit facilities. The determination of the
adequacy of the allowance is based on periodic evaluations of the unfunded
credit facilities including an assessment of the probability of commitment
usage, credit risk factors for loans outstanding to these same customers, and
the terms and expiration dates of the unfunded credit facilities.
76
Net adjustments to the allowance for unfunded loan commitments and letters
of credit are included in the provision for credit losses.
COMMERCIAL MORTGAGE SERVICING RIGHTS
PNC provides servicing under various commercial loan servicing contracts. These
contracts are either purchased in the market place or retained as part of a
commercial mortgage loan securitization. If a contract is purchased, it is
recorded at cost. If a contract is retained, the servicing right is recorded
based on its relative fair value to all of the assets securitized. Fair value is
based on the present value of the future cash flows, including assumptions as to
prepayment speeds, discount rate, interest rates, cost to service and other
factors. The asset is amortized over its estimated life in proportion to
estimated net servicing income. On a quarterly basis, the asset is tested for
impairment. If the estimated fair value of the asset is less than the carrying
value, an impairment loss is recognized. The asset is recorded as an Other
Intangible Asset. Servicing fees are recognized as they are earned and are
reported in Corporate Services as part of noninterest income. The related
amortization expense is also classified in Corporate Services.
GOODWILL AND OTHER INTANGIBLE ASSETS
With the adoption of SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS
142"), on January 1, 2002, goodwill is no longer amortized to expense, but
rather is tested for impairment periodically. Certain other intangible assets
are amortized to expense using accelerated or straight-line methods over their
respective estimated useful lives. At least annually, management reviews
goodwill and other intangible assets and evaluates events or changes in
circumstances that may indicate impairment in the carrying amount of such
assets. If the sum of the expected undiscounted future cash flows, excluding
interest charges, is less than the carrying amount of the asset, an impairment
loss is recognized. Impairment, if any, is measured on a discounted future cash
flow basis.
DEPRECIATION AND AMORTIZATION
For financial reporting purposes, premises and equipment are depreciated
principally using the straight-line method over their estimated useful lives.
The estimated useful lives used for furniture and equipment range from one
to 10 years, while buildings are depreciated over an estimated useful life of 39
years. Leasehold improvements are amortized over their estimated useful lives of
up to 10 years, or the respective lease terms, whichever is shorter.
REPURCHASE AND RESALE AGREEMENTS
Repurchase and resale agreements are treated as collateralized financing
transactions and are carried at the amounts at which the securities will be
subsequently reacquired or resold, including accrued interest, as specified in
the respective agreements. The Corporation's policy is to take possession of
securities purchased under agreements to resell. The market value of securities
to be repurchased and resold is monitored, and additional collateral may be
obtained where considered appropriate to protect against credit exposure.
TREASURY STOCK
The Corporation records common stock purchased for treasury at cost. At the date
of subsequent reissue, the treasury stock account is reduced by the cost of such
stock on the first-in, first-out basis.
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
The Corporation uses a variety of financial derivatives as part of the overall
asset and liability risk management process to manage interest rate, market and
credit risk inherent in the Corporation's business activities. Substantially all
such instruments are used to manage risk related to changes in interest rates.
Interest rate and total rate of return swaps, purchased interest rate caps and
floors and futures contracts are the primary instruments used by the Corporation
for interest rate risk management.
Interest rate swaps are agreements with a counterparty to exchange periodic
fixed and floating interest payments calculated on a notional amount. The
floating rate is based on a money market index, primarily short-term LIBOR.
Total rate of return swaps are agreements with a counterparty to exchange an
interest rate payment for the total rate of return on a specified reference
index calculated on a notional amount. Purchased interest rate caps and floors
are agreements where, for a fee, the counterparty agrees to pay the Corporation
the amount, if any, by which a specified market interest rate exceeds or is less
than a defined rate applied to a notional amount, respectively. Interest rate
futures contracts are exchange-traded agreements to make or take delivery of a
financial instrument at an agreed upon price and are settled in cash daily.
Financial derivatives involve, to varying degrees, interest rate, market
and credit risk. The Corporation manages these risks as part of its asset and
liability management process and through credit policies and procedures. The
Corporation seeks to minimize counterparty credit risk by entering into
transactions with only a select number of high-quality institutions,
establishing credit limits, and generally requiring bilateral netting and
collateral agreements.
77
As required, effective January 1, 2001, the Corporation implemented SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities," as
amended. The statement requires the Corporation to recognize all derivative
instruments at fair value as either assets or liabilities. Financial derivatives
are reported at fair value in other assets or other liabilities. The accounting
for changes in the fair value of a derivative instrument depends on whether it
has been designated and qualifies as part of a hedging relationship. For
derivatives not designated as hedges, the gain or loss is recognized in current
earnings.
For those derivative instruments that are designated and qualify as hedging
instruments, the Corporation must designate the hedging instrument, based on the
exposure being hedged, as either a fair value hedge, a cash flow hedge or a
hedge of a net investment in a foreign operation. The Corporation has no
derivatives that hedge the net investment in a foreign operation.
For derivatives that are designated as fair value hedges (i.e., hedging the
exposure to changes in the fair value of an asset or a liability attributable to
a particular risk), the gain or loss on derivatives as well as the loss or gain
on the hedged items are recognized in current earnings. An adjustment to the
hedged item for the change in its fair value pertaining to the hedged risk is
included in its carrying value. For derivatives designated as cash flow hedges
(i.e., hedging the exposure to variability in expected future cash flows), the
effective portions of the gain or loss on derivatives are reported as a
component of accumulated other comprehensive income and recognized in earnings
in the same period or periods during which the hedged transaction affects
earnings. Any remaining gain or loss on these derivatives is recognized in
current earnings. The Corporation will discontinue hedge accounting
prospectively when it determines that the derivative is no longer an effective
hedge, the derivative expires or is sold, or management discontinues the
derivative's hedge designation. In those circumstances, amounts included in
accumulated other comprehensive income regarding a cash flow hedge are
recognized in earnings to match the earnings recognition pattern of the hedged
item (e.g., level yield amortization if hedging an interest-bearing instrument).
The Corporation terminated no cash flow hedges in 2002 or 2001 due to a
determination that a forecasted transaction was no longer likely to occur.
FAIR VALUE HEDGING STRATEGIES
The Corporation enters into interest rate and total rate of return swaps, caps,
floors and interest rate futures derivative contracts to hedge designated
commercial mortgage loans held for sale, securities available for sale,
commercial loans, bank notes, senior debt and subordinated debt for changes in
fair value primarily due to changes in interest rates. Adjustments related to
the ineffective portion of fair value hedging instruments are recorded in
interest income, interest expense or noninterest income depending on the hedged
item.
CASH FLOW HEDGING STRATEGY
The Corporation enters into interest rate swap contracts to modify the interest
rate characteristics of designated commercial loans from variable to fixed in
order to reduce the impact of interest rate changes on future interest income.
The fair value of these derivatives is reported in other assets or other
liabilities and offset in accumulated other comprehensive income for the
effective portion of the derivatives. When the hedged transaction culminates,
any unrealized gains or losses related to these swap contracts are removed from
accumulated other comprehensive income and are included in interest income.
Ineffectiveness of the strategy, as defined under SFAS No. 133, if any, is
reported in interest income.
CUSTOMER AND OTHER DERIVATIVES
To accommodate customer needs, PNC also enters into financial derivative
transactions primarily consisting of interest rate swaps, caps, floors and
foreign exchange contracts. Market risk exposure from customer positions is
managed through transactions with other dealers. The credit risk associated with
derivatives executed with 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. Additionally, the
Corporation enters into other derivative transactions for risk management
purposes that are not designated as accounting hedges, including credit default
swaps which are used to mitigate credit risk and lower the required regulatory
capital associated with commercial lending activities. The positions of customer
and other derivatives are recorded at fair value and changes in value are
included in noninterest income.
78
DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES - PRE-SFAS NO. 133
Prior to January 1, 2001, interest rate swaps, caps and floors that modified the
interest rate characteristics (such as from fixed to variable, variable to
fixed, or one variable index to another) of designated interest-bearing assets
or liabilities were accounted for under the accrual method. The net amount
payable or receivable from the derivative contract was accrued as an adjustment
to interest income or interest expense of the designated instrument. Premiums on
contracts were deferred and amortized over the life of the agreement as an
adjustment to interest income or interest expense of the designated instruments.
Unamortized premiums were included in other assets.
Changes in the fair value of financial derivatives accounted for under the
accrual method were not reflected in results of operations. Realized gains and
losses, except losses on terminated interest rate caps and floors, were deferred
as an adjustment to the carrying amount of the designated instruments and
amortized over the shorter of the remaining original life of the agreements or
the designated instruments. Losses on terminated interest rate caps and floors
were recognized immediately in results of operations. If the designated
instruments were disposed of, the fair value of the associated derivative
contracts and any unamortized deferred gains or losses were included in the
determination of gain or loss on the disposition of such instruments. Contracts
not qualifying for accrual accounting were marked to market with gains or losses
included in noninterest income.
For credit default swaps that qualified for hedge accounting treatment, the
premium paid to enter into the credit default swaps was recorded in other assets
and deferred and amortized to noninterest expense over the life of the
agreement. Changes in the fair value of credit default swaps qualifying for
hedge accounting treatment were not reflected in the Corporation's financial
position and had no impact on results of operations.
If the credit default swap did not qualify for hedge accounting treatment
or if the Corporation was the seller of credit protection, the credit default
swap was marked to market with gains or losses included in noninterest income.
ASSET MANAGEMENT AND FUND SERVICING FEES
Asset management and fund servicing fees are recognized primarily as the
services are performed. Asset management fees are primarily based on a
percentage of the fair value of the assets under management and performance fees
based on a percentage of the returns on such assets. Fund servicing fees are
primarily based on a percentage of the fair value of the assets, and the number
of shareholder accounts, administered by the Corporation.
INCOME TAXES
Income taxes are accounted for under the liability method. Deferred tax assets
and liabilities are determined based on differences between the financial
reporting and tax bases of assets and liabilities and are measured using the
enacted tax rates and laws that are expected to be in effect when the
differences are expected to reverse.
EARNINGS PER COMMON SHARE
Basic earnings per common share is calculated by dividing net income adjusted
for preferred stock dividends declared by the weighted-average number of shares
of common stock outstanding.
Diluted earnings per common share is based on net income adjusted for
dividends declared on nonconvertible preferred stock. The weighted-average
number of shares of common stock outstanding is increased by the assumed
conversion of outstanding convertible preferred stock and debentures from the
beginning of the year or date of issuance, if later, and the number of shares of
common stock that would be issued assuming the exercise of stock options and the
issuance of incentive shares. Such adjustments to net income and the
weighted-average number of shares of common stock outstanding are made only when
such adjustments are expected to dilute earnings per common share.
79
STOCK-BASED COMPENSATION
At December 31, 2002, the Corporation has stock-based employee compensation
plans, which are described more fully in Note 22 Stock-Based Compensation Plans.
PNC accounts for these plans under APB Opinion No. 25, "Accounting for Stock
Issued to Employees," and related interpretations. No stock-based employee
compensation expense has been reflected in net income for the Employee Stock
Purchase Plan ("ESPP") and stock options as all rights and options to purchase
PNC stock granted under these plans had an exercise price equal to the market
value of the underlying stock on the date of grant. The following table
illustrates the income from continuing operations and earnings per share as if
the Corporation had applied the fair value recognition provisions of SFAS No.
123, "Accounting for Stock-Based Compensation," as amended, to stock-based
employee compensation plans.
PRO FORMA INCOME FROM CONTINUING OPERATIONS
AND EARNINGS PER SHARE
Year Ended December 31
In millions, except per
share data 2002 2001 2000
========================= =========== =========== ============
Income from continuing
operations, as
reported $1,200 $377 $1,214
Less: Total stock-
based employee
compensation expense
determined under the
fair value method for
all awards, net of
related tax effects (47) (33) (18)
- ------------------------- ----------- ----------- ------------
Pro forma income from
continuing operations $1,153 $344 $1,196
- ------------------------- ----------- ----------- ------------
Earnings per share
from continuing
operations
Basic-as reported $4.23 $1.27 $4.12
Basic-pro forma 4.06 1.15 4.06
Diluted-as reported 4.20 1.26 4.09
Diluted-pro forma 4.04 1.14 4.02
========================= =========== =========== ============
RECENT ACCOUNTING PRONOUNCEMENTS
In July 2001, the FASB issued SFAS No. 142 which changed the accounting from
amortizing goodwill to an impairment-only approach. The amortization of
goodwill, including goodwill recognized relating to past business combinations,
ceased upon adoption of the new standard. Impairment testing for goodwill at a
reporting unit level is required on at least an annual basis. The standard also
addresses other accounting matters, disclosure requirements and financial
statement presentation issues relating to goodwill and other intangible assets.
The Corporation adopted SFAS No. 142 on January 1, 2002. As a result, during
2002 goodwill amortization decreased by approximately $117 million and net
income increased by approximately $93 million. Refer to "Goodwill And Other
Intangible Assets" herein and to Note 14 Goodwill And Other Intangible Assets
for additional information.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets," which replaces SFAS No. 121. This
statement primarily defines one accounting model for long-lived assets to be
disposed of by sale, including discontinued operations, and addresses
implementation issues regarding the impairment of long-lived assets. The
standard was effective January 1, 2002 and did not have a material impact on the
Corporation's consolidated financial statements.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," which replaces Emerging Issues
Task Force Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." SFAS No. 146 addresses the accounting and
reporting for one-time employee termination benefits, certain contract
termination costs, and other costs associated with exit or disposal activities
such as facility closings or consolidations and employee relocations. The
standard is effective for exit or disposal activities initiated after December
31, 2002. The Corporation adopted SFAS No. 146 prospectively as of January 1,
2003.
80
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions." This statement clarified that, only if certain criteria
are met, an acquisition of a less-than-whole financial institution (such as a
branch acquisition) should be accounted for as a business combination. In
addition, SFAS No. 147 amends SFAS No. 144 to include in its scope long-term
customer-relationship intangible assets of financial institutions such as
depositor- and borrower-relationship intangible assets. As a result, those
intangible assets are subject to the same undiscounted cash flow recoverability
test and impairment loss recognition and measurement provisions that SFAS No.
144 requires for other long-lived assets that are held and used by a company.
SFAS No. 147 became effective October 1, 2002 and did not have a material impact
on the Corporation's consolidated financial statements.
In November 2002, the FASB issued FIN 45, "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others." FIN 45 elaborates on the existing disclosure
requirements for most guarantees, including loan guarantees such as standby
letters of credit and indemnifications. It also clarifies that at the time a
company issues a guarantee, the company must recognize an initial liability for
the fair or market value of the obligations it assumes under that guarantee and
must disclose that information in its interim and annual financial statements.
The provisions related to recognizing a liability at inception of the guarantee
for the fair value of the guarantor's obligations would not apply to guarantees
accounted for as derivatives. The initial recognition and measurement provisions
apply on a prospective basis to guarantees issued or modified after December 31,
2002. See Note 29 Commitments And Guarantees for the disclosures currently
required under FIN 45.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation--Transition and Disclosure." This statement amends SFAS No. 123, to
provide alternative methods of transition for a voluntary change to the fair
value based method of accounting for stock-based employee compensation. In
addition, this statement amends the disclosure requirements of SFAS No. 123 to
require disclosures in both annual and interim financial statements regarding
the method of accounting for stock-based employee compensation and the effect of
the method used on reported results. See "Stock-Based Compensation" herein and
Note 22 Stock-Based Compensation Plans for additional information.
In January 2003, the FASB issued FIN 46, "Consolidation of Variable
Interest Entities." See "Special Purpose Entities" herein for further
information.
NOTE 2 NBOC ACQUISITION
In January 2002, PNC Business Credit acquired a portion of National Bank of
Canada's ("NBOC") U.S. asset-based lending business in a purchase business
combination. With this acquisition, PNC Business Credit established six new
marketing offices. The transaction was designed to allow PNC to acquire the
higher-quality portion of the portfolio, and provide NBOC a means for the
orderly liquidation and exit of the remaining portfolio.
PNC acquired 245 lending customer relationships representing approximately
$2.6 billion of credit exposure including $1.5 billion of loans outstanding with
the balance representing unfunded loan commitments. PNC also acquired certain
other assets and assumed liabilities resulting in a total acquisition cost of
approximately $1.8 billion that was paid primarily in cash. Goodwill recorded
was approximately $277 million, of which approximately $101 million is
non-deductible for federal income tax purposes. The results of the acquired
business have been included in results of operations for PNC Business Credit
since the acquisition date.
NBOC retained a portfolio ("Serviced Portfolio") totaling approximately
$662 million of credit exposure, including $463 million of outstandings, which
is being serviced by PNC for an 18-month term unless a different date is
mutually agreed upon. In June 2002, NBOC and PNC reached final agreement as to
the Serviced Portfolio's financial information. As such, certain financial data
previously disclosed with regard to the NBOC Serviced Portfolio has been
modified to reflect the terms of this revised agreement. The Serviced Portfolio
retained by NBOC primarily represents the portion of NBOC's U.S. asset-based
loan portfolio with the highest risk. The loans are either to borrowers with
deteriorating trends or with identified weaknesses which if not corrected could
jeopardize full satisfaction of the loans or in industries to which PNC Business
Credit wants to limit its exposure. Approximately $138 million of the Serviced
Portfolio outstandings were nonperforming on the acquisition date. At the end of
the servicing term, NBOC has the right to transfer the then remaining Serviced
Portfolio to PNC ("Put Option"). NBOC's and PNC's strategy is to aggressively
liquidate the Serviced Portfolio during the servicing term. PNC may sell or
otherwise liquidate any remaining loans in the event NBOC puts them to PNC at
the end of the servicing term.
NBOC retains significant risks and rewards of owning the Serviced
Portfolio, including realized credit losses, during the servicing term as
described below. NBOC assigned $24 million of specific reserves to certain of
the loans in the Serviced Portfolio. Additionally, NBOC absorbs realized credit
losses on the Serviced Portfolio in addition to the specific reserves on
individual identified loans. If during the
81
servicing term the realized credit losses in the Serviced Portfolio exceed $50
million plus the specific reserves, then PNC Business Credit will advance cash
to NBOC for these excess losses net of recoveries ("Excess Loss Payments"). PNC
is to be reimbursed by NBOC for any Excess Loss Payments if the Put Option is
not exercised. If the Put Option is exercised, the Put Option purchase price
will be reduced by the amount of any Excess Loss Payments.
As part of the allocation of the purchase price for the business acquired,
PNC Business Credit established a liability of $112 million to reflect its
obligation under the Put Option. An independent third party valuation firm
valued the Put Option by estimating the difference between the anticipated fair
value of loans from the Serviced Portfolio expected to be outstanding at the put
date and the anticipated Put Option purchase price. The Put Option liability is
revalued on a quarterly basis by the independent valuation firm with changes in
the value included in earnings. At December 31, 2002 the Put Option liability
was approximately $57 million. A $28 million reduction from the acquisition date
amount was recognized in earnings in 2002 as other noninterest income. In
addition, $27 million has been paid to NBOC as Excess Loss Payments.
If the Put Option is exercised, then PNC would record the loans acquired as
loans held for sale at the purchase price less the balance of the Put Option
liability at that date, which should approximate fair value. The Put Option
purchase price will be NBOC's outstanding principal balance for the loans
remaining in the Serviced Portfolio adjusted for the realized credit losses
during the servicing term and Excess Loss Payments. As the realized credit
losses have exceeded $50 million plus the specific reserves used, the Excess
Loss Payments made by PNC Business Credit to NBOC will be deducted from NBOC's
outstanding principal balance in determining the Put Option purchase price.
At December 31, 2002, the independent valuation firm estimated that loans
outstanding in the Serviced Portfolio at the put date would be $175 million. The
total credit losses over the 18-month term of the servicing agreement are
estimated to be $87 million. Using these and other assumptions, if the Put were
exercised at the end of the servicing term, PNC would record the acquired loans
at $114 million. Actual results may differ materially from these assumptions.
See Note 29 Commitments And Guarantees.
Prior to closing of the acquisition, PNC Business Credit transferred $49
million of nonperforming loans to NBOC in a transaction accounted for as a
financing. Those loans are subject to the terms of the servicing agreement and
are included in the Serviced Portfolio amounts set forth above. The loans were
transferred to loans held for sale on PNC's balance sheet reflecting a loss of
$9.9 million, which was recognized as a charge-off in the first quarter of 2002.
The carrying amount of those loans held for sale was $5 million at December 31,
2002 and is included in PNC's nonperforming assets. Excluding these loans, the
Serviced Portfolio in January 2002 was $608 million of credit exposure including
$414 million of outstandings of which $88 million was nonperforming. At December
31, 2002, comparable amounts were $249 million, $183 million and $53 million,
respectively.
NOTE 3 REGULATORY MATTERS
The Corporation is subject to the regulations of certain federal and state
agencies and undergoes periodic examinations by such regulatory authorities.
In July 2002, the Corporation announced that in order to settle an inquiry
by the Securities and Exchange Commission ("SEC") in connection with three 2001
transactions that gave rise to a financial statement restatement announced by
the Corporation on January 29, 2002, PNC had consented to an SEC cease and
desist order. The Corporation did not admit or deny the SEC's findings. At the
same time, the Corporation announced that it had entered into a written
agreement with the Federal Reserve Bank of Cleveland ("Federal Reserve") and
that its principal subsidiary, PNC Bank, had entered into a written agreement
with the Office of the Comptroller of the Currency ("OCC"). These agreements
address such issues as risk, management and financial controls. The Corporation
and PNC Bank also entered into agreements with the Federal Reserve and the OCC,
respectively, requiring the Corporation and PNC Bank to provide a plan for PNC
Bank to meet the "well capitalized" and "well managed" criteria within a 180-day
period.
As of December 19, 2002, the Federal Reserve and the OCC notified the
Corporation and PNC Bank, respectively, that PNC Bank now met both the "well
capitalized" and "well managed" criteria. This removed the limitations placed in
July 2002 on the Corporation's engaging in new activities or making new
investments and on PNC Bank's financial subsidiary activities. However, the
written agreements remain in place, and the Corporation and PNC Bank in certain
circumstances must continue to obtain prior approval from the Federal Reserve or
the OCC, respectively, before making acquisitions or engaging in new activities.
In addition, under applicable regulations, as long as the Corporation remains
subject to the written agreement with the Federal Reserve, the Corporation must
obtain prior regulatory approval to repurchase its common stock in amounts that
exceed 10 percent of consolidated net worth in any 12-month period. The
Corporation has incurred, and may continue to incur, additional operating costs
in connection with compliance with these agreements including, among others,
incremental staff and continued higher legal and consulting expenses. Further,
the reputational risk created by the SEC cease and desist order and the written
agreements with the Federal Reserve and the OCC could still have an impact on
such matters as business generation and retention, the ability to attract and
retain management, liquidity and funding.
82
The following table sets forth regulatory capital ratios for PNC and its
only significant bank subsidiary, PNC Bank:
REGULATORY CAPITAL
Amount Ratios
December 31 ------------------- ------------------
Dollars in millions 2002 2001 2002 2001
======================= ========== ======== ======== =========
Risk-based capital
Tier I
PNC $5,121 $4,599 8.8% 7.8%
PNC Bank, N.A. 5,160 4,704 9.8 8.7
Total
PNC 7,233 6,958 12.5 11.8
PNC Bank, N.A. 6,877 6,581 13.0 12.1
Leverage
PNC 5,121 4,599 8.1 6.8
PNC Bank, N.A. 5,160 4,704 9.0 7.6
======================= ========== ======== ======== =========
The access to and cost of funding new business initiatives including
acquisitions, the ability to pay dividends, the level of deposit insurance
costs, and the level and nature of regulatory oversight depend, in large part,
on a financial institution's capital strength. The minimum regulatory capital
ratios are 4% for Tier I risk-based, 8% for total risk-based and 3% for
leverage. However, regulators may require higher capital levels when particular
circumstances warrant. To qualify as "well capitalized," regulators require
banks to maintain capital ratios of at least 6% for Tier I risk-based, 10% for
total risk-based and 5% for leverage. At December 31, 2002, each bank subsidiary
of the Corporation met the "well capitalized" capital ratio requirements.
The principal source of parent company revenue and cash flow is the
dividends it receives from PNC Bank. PNC Bank's dividend level may be impacted
by its capital needs, supervisory policies, corporate policies, contractual
restrictions and other factors. Also, there are statutory limitations on the
ability of national banks to pay dividends or make other capital distributions.
Without regulatory approval, the amount available for payment of dividends by
PNC Bank was $460 million at December 31, 2002. Management expects that the
parent company will have sufficient liquidity available to pay dividends at
current rates through 2003.
Under federal law, bank subsidiaries generally may not extend credit to the
parent company or its nonbank subsidiaries on terms and under circumstances that
are not substantially the same as comparable extensions of credit to
nonaffiliates. No extension of credit may be made to the parent company or a
nonbank subsidiary which is in excess of 10% of the capital stock and surplus of
such bank subsidiary or in excess of 20% of the capital and surplus of such bank
subsidiary as to aggregate extensions of credit to the parent company and its
subsidiaries. Such extensions of credit, with limited exceptions, must be fully
collateralized by certain specified assets. In certain circumstances, federal
regulatory authorities may impose more restrictive limitations.
Federal Reserve Board regulations require depository institutions to
maintain cash reserves with the Federal Reserve Bank. During 2002, subsidiary
banks maintained reserves which averaged $112 million.
NOTE 4 DISCONTINUED OPERATIONS
In the first quarter of 2001, PNC closed the sale of its residential mortgage
banking business. In January 2003, PNC and the buyer, Washington Mutual Bank,
FA, agreed to a settlement of all issues in dispute between them in connection
with the sale. The settlement has been reported in PNC's fourth quarter 2002
results in discontinued operations. The results of the residential mortgage
banking business, which are presented on one line in the Consolidated Statement
Of Income, are as follows:
INCOME (LOSS) FROM DISCONTINUED OPERATIONS
Year ended December 31 - in millions 2002 2001 2000
====================================== ======= ======== =======
Income from operations, after tax $15 $65
Net loss on sale of business, after
tax $(16) (10)
- -------------------------------------- ------- -------- -------
Total income (loss) from
discontinued operations $(16) $5 $65
====================================== ======= ======== =======
There were no net assets of the residential mortgage banking business remaining
at either December 31, 2002 or December 31, 2001.
NOTE 5 FOURTH QUARTER 2001 ACTIONS
In the fourth quarter of 2001, PNC took several actions to accelerate the
strategic repositioning of its lending businesses that began in 1998. The
Corporation decided to exit approximately $7.9 billion of credit exposure
including $3.1 billion of loan outstandings in the institutional lending
portfolios. Of these amounts, approximately $5.2 billion of credit exposure and
$2.9 billion of loans, respectively, were transferred to loans held for sale in
2001. In connection with the transfer to held for sale, $653 million of
charge-offs and valuation adjustments were recognized in the fourth quarter of
2001. In addition, $90 million in charge-offs were taken against the allowance
for credit losses specifically allocated to these loans in the fourth quarter of
2001. During 2002, actions were begun to liquidate the institutional held for
sale portfolio resulting in net gains in excess of valuation adjustments
totaling $147 million. Approximately $626 million of exposure and $298 million
of loans remained to be liquidated at December 31, 2002.
Also in the fourth quarter of 2001, PNC decided to discontinue its vehicle
leasing business due to continued depressed market conditions and the increased
difficulty and cost of obtaining residual value insurance protection. The
vehicle leasing business had assets of $1.4 billion and $1.9
83
billion at December 31, 2002 and December 31, 2001, respectively, that were
designated for exit and will mature over a period of approximately four years.
Costs incurred in 2001 to exit this business, including the impairment of
goodwill associated with a prior acquisition and employee severance costs and
additions to reserves related to insured residual value exposures, totaled $135
million and were charged to noninterest expense in 2001.
The Corporation also recorded charges of $65 million in the fourth quarter
of 2001 for certain integration, severance and other costs related to other
strategic initiatives. During 2002, the Corporation recognized a $19 million
reduction of these charges that related to a PFPC facilities consolidation
strategy that has been modified, as certain originally contemplated relocations
will not occur.
NOTE 6 SALE OF SUBSIDIARY STOCK
PNC recognizes as income the gain from the sale of stock by its subsidiaries.
The gain is the difference between PNC's basis in the stock and the proceeds per
share received. PNC provides applicable taxes on the gain. Gains from the sale
of stock by PNC's subsidiaries are recorded in other noninterest income in the
Consolidated Statement Of Income and were not material for 2002, 2001 or 2000.
NOTE 7 CASH FLOWS
For the consolidated statement of cash flows, cash and cash equivalents are
defined as cash and due from banks.
The following table sets forth information pertaining to acquisitions and
divestitures that affected cash flows:
CASH FLOWS
Year ended December 31 - in
millions 2002 2001 2000
================================= ========== ======== =========
Assets (acquired) divested $(1,736) $7,252 $(4)
Liabilities (acquired) divested (60) 6,852 (4)
Cash paid 1,676 18 31
Cash and due from banks received 503 1
================================= ========== ======== =========
NOTE 8 TRADING ACTIVITIES
Most of PNC's trading activities are designed to provide capital markets
services to customers and not to position the Corporation's portfolio for gains
from market movements. PNC participates in derivatives and foreign exchange
trading as well as underwriting and "market making" in equity securities as an
accommodation to customers. PNC also engages in trading activities as part of
risk management strategies.
Net trading income in 2002, 2001 and 2000 included in noninterest income
was as follows:
DETAILS OF TRADING ACTIVITIES
Year ended December 31 - in
millions 2002 2001 2000
================================= ======== ========= ========
Corporate services $1 $5 $7
Other noninterest income
Securities underwriting and
trading 55 55 42
Derivatives trading 11 61 20
Foreign exchange 25 26 22
- --------------------------------- -------- --------- --------
Net trading income $92 $147 $91
================================= ======== ========= ========
84
NOTE 9 SECURITIES
Unrealized
Amortized -------------------------------------- Fair
In millions Cost Gains Losses Value
=================================================== =============== =================== ================== =============
DECEMBER 31, 2002
SECURITIES AVAILABLE FOR SALE
Debt securities
U.S. Treasury and government agencies $813 $13 $826
Mortgage-backed 8,916 189 $(2) 9,103
Asset-backed 2,699 83 (2) 2,780
State and municipal 61 2 63
Other debt 58 3 61
- --------------------------------------------------- --------------- ------------------- ------------------ -------------
Total debt securities 12,547 290 (4) 12,833
Corporate stocks and other 597 1 (13) 585
- --------------------------------------------------- --------------- ------------------- ------------------ -------------
Total securities available for sale $13,144 $291 $(17) $13,418
=================================================== =============== =================== ================== =============
SECURITIES HELD TO MATURITY
Debt securities
U.S. Treasury and government agencies $276 $33 $309
Asset-backed 8 8
Other debt 61 61
- --------------------------------------------------- --------------- ------------------- ------------------ -------------
Total debt securities 345 33 378
- --------------------------------------------------- --------------- ------------------- ------------------ -------------
Total securities held to maturity $345 $33 $378
=================================================== =============== =================== ================== =============
December 31, 2001
SECURITIES AVAILABLE FOR SALE
Debt securities
U.S. Treasury and government agencies $808 $3 $(4) $807
Mortgage-backed 9,669 37 (128) 9,578
Asset-backed 2,799 8 (31) 2,776
State and municipal 62 2 64
Other debt 75 1 (1) 75
- --------------------------------------------------- --------------- ------------------- ------------------ -------------
Total debt securities 13,413 51 (164) 13,300
Corporate stocks and other 264 (19) 245
- --------------------------------------------------- --------------- ------------------- ------------------ -------------
Total securities available for sale $13,677 $51 $(183) $13,545
=================================================== =============== =================== ================== =============
SECURITIES HELD TO MATURITY
Debt securities
U.S. Treasury and government agencies $260 $(3) $257
Asset-backed 8 8
Other debt 95 95
- --------------------------------------------------- --------------- ------------------- ------------------ -------------
Total debt securities 363 (3) 360
- --------------------------------------------------- --------------- ------------------- ------------------ -------------
Total securities held to maturity $363 $(3) $360
=================================================== =============== =================== ================== =============
December 31, 2000
SECURITIES AVAILABLE FOR SALE
Debt securities
U.S. Treasury and government agencies $313 $1 $(1) $313
Mortgage-backed 4,197 14 (48) 4,163
Asset-backed 742 (10) 732
State and municipal 94 2 96
Other debt 73 1 (1) 73
- --------------------------------------------------- --------------- ------------------- ------------------ -------------
Total debt securities 5,419 18 (60) 5,377
Corporate stocks and other 537 2 (14) 525
- --------------------------------------------------- --------------- ------------------- ------------------ -------------
Total securities available for sale $5,956 $20 $(74) $5,902
=================================================== =============== =================== ================== =============
Total securities at December 31, 2002 were $13.8 billion compared with $13.9
billion at December 31, 2001 and $5.9 billion at December 31, 2000. Securities
represented 21% of total assets at December 31, 2002 compared with 20% at
December 31, 2001 and 8% at December 31, 2000.
The expected weighted-average life of securities available for sale was 2
years and 8 months at December 31, 2002 compared with 4 years at December 31,
2001 and 4 years and 5 months at December 31, 2000.
85
The securities classified as held to maturity are carried at amortized cost
and were owned by companies formed with American International Group, Inc.
("AIG") in 2001 that were consolidated in PNC's financial statements. In January
2003, these securities were sold and these companies were liquidated. See Note
32 Subsequent Events.
The expected weighted-average life of securities held to maturity was 20
years and 2 months at December 31, 2002 and 18 years and 11 months at December
31, 2001. PNC had no securities held for maturity at December 31, 2000.
At December 31, 2002, the securities available for sale balance included a
net unrealized gain of $274 million, which represented the difference between
fair value and amortized cost. The comparable amounts at December 31, 2001 and
December 31, 2000 were net unrealized losses of $132 million and $54 million,
respectively. Net unrealized gains and losses in the securities available for
sale portfolio are included in shareholders' equity as accumulated other
comprehensive income or loss, net of tax or, for the portion attributable to
changes in a hedged risk as part of a fair value hedge strategy, in net income.
Net securities gains were $89 million in 2002, $128 million in 2001 and $29
million in 2000. Net securities gains for 2001 and 2000 included $3 million of
net securities losses and $9 million of net securities gains, respectively,
related to commercial mortgage banking activities that were reported in
corporate services revenue. There were no comparable amounts in 2002.
Information relating to securities sold is set forth in the following
table.
SECURITIES SOLD
Year ended
December 31 Gross Gross Net
In millions Proceeds Gains Losses Gains Taxes
================ ========= ======= ========= ========= =======
2002 $16,395 $106 $17 $89 $31
2001 19,693 144 16 128 45
2000 7,630 37 8 29 10
================ ========= ======= ========= ========= =======
The carrying value of securities pledged to secure public and trust deposits and
repurchase agreements and for other purposes was $9.5 billion and $6.2 billion
at December 31, 2002 and December 31, 2001, respectively. The fair value of
securities accepted as collateral that the Corporation is permitted by contract
or custom to sell or repledge was $582 million at December 31, 2002, and is
included in short-term investments on the Consolidated Balance Sheet. Of this
amount, $524 million was repledged to others.
The following table presents the amortized cost, fair value and
weighted-average yield of debt securities at December 31, 2002, by remaining
contractual maturity.
CONTRACTUAL MATURITY OF DEBT SECURITIES
December 31, 2002 Within 1 to 5 to After 10
Dollars in millions 1 Year 5 Years 10 Years Years Total
========================================= ============== =============== ================ ================ ================
SECURITIES AVAILABLE FOR SALE
U.S. Treasury and government agencies $193 $606 $9 $5 $813
Mortgage-backed 38 555 8,323 8,916
Asset-backed 1,128 237 1,334 2,699
State and municipal 4 18 33 6 61
Other debt 4 28 23 3 58
- ----------------------------------------- -------------- --------------- ---------------- ---------------- ----------------
Total securities available for sale $201 $1,818 $857 $9,671 $12,547
========================================= ============== =============== ================ ================ ================
Fair value $202 $1,908 $876 $9,847 $12,833
Weighted-average yield 1.35% 5.34% 4.22% 4.65% 4.67%
- ----------------------------------------- -------------- --------------- ---------------- ---------------- ----------------
SECURITIES HELD TO MATURITY
U.S. Treasury and government agencies $276 $276
Asset-backed $8 8
Other debt $33 22 $6 61
- ----------------------------------------- -------------- --------------- ---------------- ---------------- ----------------
Total securities held to maturity $33 $30 $6 $276 $345
========================================= ============== =============== ================ ================ ================
Fair value $33 $30 $6 $309 $378
Weighted-average yield 1.48% 1.57% 5.88% 5.77% 4.99%
========================================= ============== =============== ================ ================ ================
Based on current interest rates and expected prepayment speeds, the total
weighted-average expected maturity of mortgage-backed securities was 2 years and
11 months and of asset-backed securities was 2 years and 2 months at December
31, 2002. Weighted-average yields are based on historical cost with effective
yields weighted for the contractual maturity of each security.
86
NOTE 10 LOANS AND COMMITMENTS TO EXTEND CREDIT
Loans outstanding were as follows:
December 31 - in millions 2002 2001 2000 1999 1998
=========================================== ================ =============== ================= =============== =================
Commercial $14,987 $15,205 $21,207 $21,468 $25,177
Commercial real estate 2,267 2,372 2,583 2,730 3,449
Consumer 9,854 9,164 9,133 9,348 10,980
Residential mortgage 3,921 6,395 13,264 12,506 12,253
Lease financing 5,081 5,557 4,845 3,663 2,978
Credit card 2,958
Other 415 445 568 682 392
- ------------------------------------------- ---------------- --------------- ----------------- --------------- -----------------
Total loans 36,525 39,138 51,600 50,397 58,187
Unearned income (1,075) (1,164) (999) (724) (554)
- ------------------------------------------- ---------------- --------------- ----------------- --------------- -----------------
Total loans, net of unearned income $35,450 $37,974 $50,601 $49,673 $57,633
=========================================== ================ =============== ================= =============== =================
Loans outstanding and related unfunded commitments are concentrated in PNC's
primary geographic markets. At December 31, 2002, no specific industry
concentration exceeded 7.5 % of total commercial loans outstanding and unfunded
commitments.
NET UNFUNDED COMMITMENTS
December 31 - in millions 2002 2001
================================= =============== ============
Commercial $19,525 $20,233
Commercial real estate 718 711
Consumer 5,372 4,977
Lease financing 103 146
Other 125 139
Institutional lending
repositioning 1,015 4,837
- --------------------------------- --------------- ------------
Total $26,858 $31,043
================================= =============== ============
Commitments to extend credit represent arrangements to lend funds subject to
specified contractual conditions. At December 31, 2002, commercial commitments
are reported net of $6.2 billion of participations, assignments and
syndications, primarily to financial institutions. The comparable amount was
$7.1 billion at December 31, 2001. Commitments generally have fixed expiration
dates, may require payment of a fee, and contain termination clauses in the
event the customer's credit quality deteriorates. Based on the Corporation's
historical experience, most commitments expire unfunded, and therefore cash
requirements are substantially less than the total commitment.
Net outstanding letters of credit totaled $3.7 billion at December 31, 2002
and $4.0 billion at December 31, 2001 and consisted primarily of standby letters
of credit that commit the Corporation to make payments on behalf of customers if
certain specified future events occur. Such instruments are typically issued to
support industrial revenue bonds, commercial paper, and bid-or-performance
related contracts. At year-end 2002, the largest industry concentration within
standby letters of credit was for real estate projects, which accounted for
approximately 8% of the total. Maturities for standby letters of credit ranged
from 2003 to 2010. See Note 29 Commitments And Guarantees.
At December 31, 2002, $11.6 billion of loans were pledged to secure
borrowings and for other purposes.
Certain directors and executive officers of the Corporation and its
subsidiaries, as well as certain affiliated companies of these directors and
officers, were customers of and had loans with subsidiary banks in the ordinary
course of business. All such loans were on substantially the same terms,
including interest rates and collateral, as those prevailing at the time for
comparable transactions with other customers and did not involve more than a
normal risk of collectibility or present other unfavorable features. The
aggregate principal amounts of these loans were $18 million and $24 million at
December 31, 2002 and 2001, respectively. During 2002, new loans of $52 million
were funded and repayments totaled $58 million.
87
NOTE 11 NONPERFORMING ASSETS
The following table sets forth nonperforming assets and related information:
December 31 - dollars in millions 2002 2001 2000 1999 1998
===================================================== ============== ================ ============= ============= ================
Nonaccrual loans $308 $211 $323 $291 $286
Troubled debt restructured loan 1
-------------- ---------------- ------------- ------------- ----------------
Total nonperforming loans 309 211 323 291 286
-------------- ---------------- ------------- ------------- ----------------
Nonperforming loans held for sale (a) 97 169 33 17
Foreclosed assets 12 11 16 17 33
- ----------------------------------------------------- -------------- ---------------- ------------- ------------- ----------------
Total nonperforming assets (b) $418 $391 $372 $325 $319
===================================================== ============== ================ ============= ============= ================
Nonperforming loans to total loans .87% .56% .64% .59% .50%
Nonperforming assets to total loans, loans held for
sale and foreclosed assets 1.13 .93 .71 .61 .55
Nonperforming assets to total assets .63 .56 .53 .47 .45
===================================================== ============== ================ ============= ============= ================
Interest on nonperforming loans
Computed on original terms $23 $27 $42 $28 $25
Recognized 10 10 10 11 6
===================================================== ============== ================ ============= ============= ================
Past due loans
Accruing loans past due 90 days or more $130 $159 $113 $86 $263
As a percentage of total loans .37% .42% .22% .17% .46%
Past due loans held for sale
Accruing loans held for sale past due 90 days or
more $32 $33 $16 $24
As a percentage of total loans held for sale 1.99% .79% .97% .69%
===================================================== ============== ================ ============= ============= ================
(a) Includes $17 million and $6 million of troubled debt restructured loans
held for sale at December 31, 2002 and 2001, respectively.
(b) Excludes $40 million (including $12 million of troubled debt restructured
assets), $18 million, $18 million and $13 million of equity management
assets at December 31, 2002, 2001, 2000 and 1999, respectively, that are
carried at estimated fair value.
88
NOTE 12 ALLOWANCES FOR CREDIT LOSSES AND UNFUNDED LOAN COMMITMENTS AND LETTERS
OF CREDIT
Changes in the allowance for credit losses were as follows:
--------- --------- -----------
In millions 2002 2001 2000
============================= ========= ========= ===========
January 1 $560 $598 $600
Charge-offs (267) (985) (186)
Recoveries 44 37 51
- ----------------------------- --------- --------- -----------
Net charge-offs (223) (948) (135)
Provision for credit losses 309 903 136
Acquired allowance
(NBOC acquisition) 41
- ----------------------------- --------- --------- -----------
Net change in allowance for
unfunded loan commitments
and letters of credit (14) 7 (3)
- ----------------------------- --------- --------- -----------
December 31 $673 $560 $598
============================= ========= ========= ===========
Changes in the allowance for unfunded loan commitments and letters of credit
were as follows:
--------- --------- -----------
In millions 2002 2001 2000
============================= ========= ========= ===========
Allowance at January 1 $70 $77 $74
Net change in allowance for
unfunded loan commitments
and letters of credit 14 (7) 3
- ----------------------------- --------- --------- -----------
December 31 $84 $70 $77
============================= ========= ========= ===========
Impaired loans totaling $234 million and $192 million at December 31, 2002 and
2001, respectively, had a corresponding specific allowance for credit losses of
$80 million and $28 million. The average balance of impaired loans was $242
million in 2002, $319 million in 2001 and $277 million in 2000. There was no
interest income recognized on impaired loans in 2002, 2001 or 2000.
NOTE 13 PREMISES, EQUIPMENT AND LEASEHOLD IMPROVEMENTS
Premises, equipment and leasehold improvements, stated at cost less accumulated
depreciation and amortization, were as follows:
----------- -----------
December 31 - in millions 2002 2001
===================================== =========== ===========
Land $88 $87
Buildings 452 448
Equipment 1,542 1,413
Leasehold improvements 398 321
- ------------------------------------- ----------- -----------
Total 2,480 2,269
Accumulated depreciation and
amortization (1,238) (1,141)
- ------------------------------------- ----------- -----------
Net book value $1,242 $1,128
===================================== =========== ===========
Depreciation and amortization expense on premises, equipment and leasehold
improvements totaled $183 million in 2002, $168 million in 2001 and $149 million
in 2000.
Certain facilities and equipment are leased under agreements expiring at
various dates through the year 2071. Substantially all such leases are accounted
for as operating leases. Rental expense on such leases amounted to $180 million
in 2002, $165 million in 2001 and $148 million in 2000.
At December 31, 2002 and 2001, required minimum annual rentals due on
noncancelable leases having initial or remaining terms in excess of one year
aggregated $1.0 billion and $908 million, respectively. Minimum annual rentals
for each of the years 2003 through 2007 are $154 million, $137 million, $126
million, $106 million and $93 million, respectively.
In the fourth quarter of 2001, management of PFPC initiated a plan to
consolidate certain facilities as a follow-up to the integration of the Investor
Services Group acquisition. In connection with this initiative and other
strategic actions, pretax charges to noninterest expense of $36 million were
recognized in the fourth quarter of 2001. During 2002, these reserves were
reduced by $19 million as the facilities strategy has been modified and certain
originally contemplated relocations will not occur.
NOTE 14 GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, the Corporation implemented SFAS No. 142 which
changed the accounting for goodwill from the amortization of goodwill to an
impairment-only approach. The amortization of goodwill, including goodwill
recognized relating to past business combinations, ceased upon adoption of the
new standard. Impairment testing for goodwill at a reporting unit level will be
required on at least an annual basis.
In accordance with SFAS No. 142, the Corporation identified its reporting
unit structure for goodwill impairment testing purposes as of January 1, 2002.
Management performed the first step of the transitional goodwill impairment test
on its reporting units during the first quarter of 2002. During the fourth
quarter of 2002, the Corporation performed the first step of its annual goodwill
impairment test on its reporting units, using data as of September 30, 2002.
Barring any adverse triggering events in the interim, the Corporation will
perform its annual test during the fourth quarter of each year. The results of
these tests during 2002 indicated no impairment loss as the fair value of the
reporting units exceeded the carrying amount of the net assets (including
goodwill) in all cases. Fair value was determined by using discounted cash flow
and market comparability methodologies. As a result of adopting this statement,
the Corporation reassessed the useful lives and the classification of
identifiable intangible assets and determined that they continue to be
appropriate.
89
A summary of the changes in goodwill by business during 2002 follows:
GOODWILL
In millions January 1 Goodwill Adjust- Dec. 31
2002 Acquired ments 2002
=============================================================
Regional Community Banking $438 $438
Corporate Banking 39 39
PNC Real Estate Finance 298 $4 302
PNC Business Credit 23 $277 (2) 298
PNC Advisors 151 1 152
BlackRock 175 175
PFPC 912 (3) 909
- -------------------------------------------------------------
Total $2,036 $277 $2,313
=============================================================
The gross carrying amount, accumulated amortization and net carrying amount of
other intangible assets by major category consisted of the following:
OTHER INTANGIBLE ASSETS
December 31 - in millions 2002 2001
=============================================================
Customer-related intangibles
Gross carrying amount $199 $185
Accumulated amortization (67) (47)
- -------------------------------------------------------------
Net carrying amount $132 $138
- -------------------------------------------------------------
Mortgage and other loan
servicing rights
Gross carrying amount $313 $286
Accumulated amortization (112) (87)
- -------------------------------------------------------------
Net carrying amount $201 $199
- -------------------------------------------------------------
Total $333 $337
=============================================================
The majority of the Corporation's other intangible assets have finite lives and
are amortized primarily on a straight-line basis or, in the case of mortgage and
other loan servicing rights, on an accelerated basis. For customer-related
intangibles, the estimated remaining useful lives range from one to fifteen
years, with a weighted-average remaining useful life of approximately seven
years. The Corporation's mortgage and other loan servicing rights are amortized
primarily over a period of seven to ten years using the net present value of the
cash flows received from servicing the related loans.
The changes in the carrying amount of goodwill and net other intangible
assets during 2002 follows:
CHANGES IN GOODWILL AND OTHER INTANGIBLES
Customer Servicing
In millions Goodwill -Related Rights
================================ ======== ========= =========
Balance at December 31, 2001 $2,036 $138 $199
Additions/adjustments 277 14 27
Amortization (20) (25)
- -------------------------------- -------- --------- ---------
BALANCE AT DECEMBER 31, 2002 $2,313 $132 $201
================================ ======== ========= =========
In conjunction with the 2002 NBOC acquisition, PNC Business Credit recorded a
customer-based intangible of $12.4 million that will be amortized over seven
years. Goodwill recorded in connection with the NBOC acquisition was
approximately $277 million.
Amortization expense on intangible assets for 2002 was approximately $45
million. Amortization expense on existing intangible assets for 2003, 2004,
2005, 2006 and 2007 is estimated to be $44 million, $43 million, $39 million,
$36 million and $34 million, respectively.
The following table sets forth reported and pro forma net income and basic
and diluted earnings per share as if the nonamortization provisions of SFAS No.
142 had been applied in the previous periods.
PRO FORMA EFFECTS
Year ended December 31
In millions, except per share
data 2002 2001 2000
================================= ======== ======== ==========
Reported net income $1,184 $377 $1,279
Goodwill amortization,
net of taxes 93 93
- --------------------------------- -------- -------- ----------
Pro forma net income $1,184 $470 $1,372
- --------------------------------- -------- -------- ----------
Basic earnings per share
Reported, from net income $4.18 $1.27 $4.35
Goodwill amortization,
net of taxes .33 .32
- --------------------------------- -------- -------- ----------
Pro forma basic earnings
per share $4.18 $1.60 $4.67
- --------------------------------- -------- -------- ----------
Diluted earnings per share
Reported, from net income $4.15 $1.26 $4.31
Goodwill amortization,
net of taxes .32 .32
- --------------------------------- -------- -------- ----------
Pro forma diluted earnings
per share $4.15 $1.58 $4.63
================================= ======== ======== ==========
NOTE 15 SECURITIZATIONS
During 2002, PNC sold commercial mortgage loans totaling $239 million and other
loans totaling $38 million in secondary market securitizations. These
securitization transactions resulted in pretax gains of $4 million and $2
million, respectively, for the year ended December 31, 2002.
During 2001, the Corporation sold residential mortgage loans, commercial
mortgage loans and other loans totaling $1.0 billion, $374 million, and $82
million, respectively, in secondary market securitization transactions. These
securitization transactions resulted in pretax gains of $9.6 million, $1
million, and $2 million, respectively, for the year ended December 31, 2001.
In addition to the sale of loans discussed above, in March 2001 PNC
securitized $3.8 billion of residential mortgage loans by selling the loans into
a trust with PNC retaining 99%, or $3.7 billion, of the certificates. PNC also
securitized $175 million of commercial mortgage loans by selling the loans into
a trust with PNC retaining 99%, or $173 million, of the certificates. In each
case, the 1% interest in the trust was purchased by a publicly-traded entity
managed by a subsidiary of PNC. A substantial portion of the entity's purchase
price was financed by PNC. The reclassification of these loans to
90
securities increased the liquidity of the assets and was consistent with PNC's
on-going balance sheet restructuring.
At the time of the residential mortgage securitization, gains of $25.9
million were deferred and were recognized when principal payments were received
or the securities sold to third parties. At December 31, 2001, these securities
had been reduced to $1.3 billion through sales and principal payments and the
remaining deferred gains were $7.8 million. In the first quarter of 2002, the
remaining securities were sold. The deferred gain remaining at the time of sale
of $6.0 million was recognized as other noninterest income.
No gain was recognized at the time of the commercial mortgage loan
securitization and none of the securities retained at the time of the
securitization remained on the balance sheet at December 31, 2001.
In addition to the securities discussed above, the Corporation retained
certain interest-only strips and servicing rights that were created in the sale
of certain loans and securities. Additional information on these items is
contained below.
Key economic assumptions used in measuring the fair value of the
interest-only strips and servicing rights at the date of the securitization
resulting from securitizations completed during the year and related information
were as follows:
KEY ECONOMIC ASSUMPTIONS
Weighted Prepayment
Dollars in Fair Average Life Speed
millions Value (Years) (CPR)(a) Discount Rate
================= ======= =========== ========== =============
During 2002
Residential
mortgage $7 1.2 - 1.5 60.0% 7.50%
Commercial
mortgage 3 30.0 10.0 10.00 - 12.00
Other 2 2.4 (b) 4.14
- --------------- --------- ----------- ---------- -------------
During 2001
Residential
mortgage $38 1.2 - 1.7 36.0% 10.00%
Commercial
mortgage 5 9.4 10.0 10.00
Other 2 1.9 (b) 4.14
=============== ========= =========== ========== =============
(a) Constant Prepayment Rate ("CPR").
(b) Historically, there have been no prepayments on these loans, which are
guaranteed by an agency of the U. S. Government.
Quantitative information about managed securitized loan portfolios in which the
Corporation had interest-only strips outstanding at December 31, 2002 and
related delinquencies follows:
INTEREST-ONLY STRIPS
Managed Delinquencies
December 31 - in -------------------- -------------------
millions 2002 2001 2002 2001
====================== ========== ========= ========= =========
Residential loans $650 $1,058 $22 $24
Student loans 338 453 39 49
- ---------------------- ---------- --------- --------- ---------
Total managed loans $988 $1,511 $61 $73
====================== ========== ========= ========= =========
Certain cash flows received from and paid to securitization trusts or other
entities in which the Corporation had retained interests outstanding during the
period follows:
SECURITIZATION CASH FLOWS
Year ended December 31 - in millions 2002 2001
=========================================== ========= =========
Proceeds from new securitizations $278 $1,040
Servicing revenue 5 8
Other cash flows received on retained
interests 12 16
=========================================== ========= =========
Proceeds from new securitizations are limited to cash proceeds received from
third parties. It excludes the value of securities generated as a result of the
recharacterization of loans to securities. During 2002 and 2001, there were no
purchases of delinquent or foreclosed assets, and servicing advances and
repayments of servicing advances related to these securitizations were not
significant.
Changes in the Corporation's commercial mortgage servicing assets are as
follows:
COMMERCIAL MORTGAGE SERVICING ASSET ACTIVITY
In millions 2002 2001
======================================= ============= =========
Balance at January 1 $199 $156
Additions 27 70
Amortization (25) (27)
- --------------------------------------- ------------- ---------
Balance at December 31 $201 $199
======================================= ============= =========
Assuming a prepayment speed of 10% and weighted average life of 10.7 years
discounted at 8.5%, the estimated fair value of commercial mortgage servicing
rights was $227 million at December 31, 2002. A 10% and 20% adverse change in
all assumptions used to determine fair value at December 31, 2002, results in a
$23 million and $46 million decrease in fair value, respectively. No valuation
allowance was necessary at December 31, 2002 or December 31, 2001.
At December 31, 2002, key economic assumptions and the sensitivity of the
current fair value of residual cash flows to an immediate 10% or 20% adverse
change in those assumptions are as follows:
91
FAIR VALUE ASSUMPTIONS
December 31, 2002 Residential Student
Dollars in millions Mortgages Loans Other
=============================== =========== ======== ========
Fair value of retained interest
(carrying value) $9 $65 $3
Weighted-average life (in years) 1.1 1.6 1.8
Residual cash flows discount
rate 7.50% 3.6 4.14%
Impact on fair value of 10%
adverse change $(.9)
Impact on fair value of 20%
adverse change $(.1) (1.7)
Prepayment speed assumption
(CPR) 60.0% 20.8% (a)
Impact on fair value of 10%
adverse change $(.8) $(.8) (a)
Impact on fair value of 20%
adverse change (1.4) (1.6) (a)
=============================== =========== ======== ========
(a) Historically, there have been no prepayments on these loans, which are
guaranteed by an agency of the U. S. Government.
These sensitivities are hypothetical and should be used with caution. As the
figures indicate, changes in fair value based on a 10% variation in assumptions
generally cannot be extrapolated because the relationship of the change in
assumption to the change in fair value may not be linear. Also, the effect of a
variation in a particular assumption on fair value is calculated independently
of variations in other assumptions, whereas a change in one factor may
realistically have an impact on another, which might magnify or counteract the
sensitivities.
NOTE 16 DEPOSITS
The aggregate amount of time deposits with a denomination greater than $100,000
was $2.7 billion and $4.0 billion at December 31, 2002 and 2001, respectively.
Remaining contractual maturities of time deposits for the years 2003 through
2007 and thereafter are $5.7 billion, $2.4 billion, $947 million, $473 million
and $1.1 billion, respectively.
NOTE 17 BORROWED FUNDS
Bank notes have interest rates ranging from 1.46% to 6.14% with approximately
60% maturing in 2003. Senior and subordinated notes consisted of the following:
December 31, 2002
Dollars in
millions Outstanding Stated Rate Maturity
================= ============== ================ =============
Senior $2,546 1.93% - 7.00% 2003 - 2006
Subordinated
Nonconvertible 2,423 6.13 - 8.25 2003 - 2009
-----------
Total $4,969
==================== =========== ================ =============
Borrowed funds have scheduled repayments for the years 2003 through 2007 and
thereafter of $3.1 billion, $2.1 billion, $1.1 billion, $1.2 billion and $1.6
billion, respectively. Included in borrowed funds are Federal Home Loan Bank
advances of $1.3 billion at December 31, 2002 which are collateralized by a
blanket lien.
Included in outstandings for the senior and subordinated notes in the table
above are basis adjustments of $93 million and $212 million, respectively,
related to SFAS No. 133.
NOTE 18 CAPITAL SECURITIES OF SUBSIDIARY TRUSTS
Mandatorily Redeemable Capital Securities of Subsidiary Trusts ("Capital
Securities") include nonvoting preferred beneficial interests in the assets of
PNC Institutional Capital Trust A, Trust B and Trust C. Trust A, formed in
December 1996, holds $350 million of 7.95% junior subordinated debentures, due
December 15, 2026, and redeemable after December 15, 2006, at a premium that
declines from 103.975% to par on or after December 15, 2016. Trust B, formed in
May 1997, holds $300 million of 8.315% junior subordinated debentures due May
15, 2027, and redeemable after May 15, 2007, at a premium that declines from
104.1575% to par on or after May 15, 2017. Trust C, formed in June 1998, holds
$200 million of junior subordinated debentures due June 1, 2028, bearing
interest at a floating rate per annum equal to 3-month LIBOR plus 57 basis
points. The rate in effect at December 31, 2002 was 1.99%. Trust C Capital
Securities are redeemable on or after June 1, 2008 at par.
Cash distributions on the Capital Securities are made to the extent
interest on the debentures is received by the Trusts. In the event of certain
changes or amendments to regulatory requirements or federal tax rules, the
Capital Securities are redeemable in whole.
Trust A is a wholly owned finance subsidiary of PNC Bank, N.A., PNC's
principal bank subsidiary, and Trusts B and C are wholly owned finance
subsidiaries of the Corporation.
The respective parents of the Trusts have, through the agreements governing
the Capital Securities, taken together, fully, irrevocably and unconditionally
guaranteed all of the obligations of the Trusts under the Capital Securities.
See Note 3 Regulatory Matters for a discussion of certain dividend restrictions.
NOTE 19 SHAREHOLDERS' EQUITY
Information related to preferred stock is as follows:
Preferred Shares
------------------------
December 31 Liquidation
Shares in thousands value per share 2002 2001
======================= ============= ============ ===========
Authorized
$1 par value 17,135 17,172
Issued and outstanding
Series A 40 9 10
Series B 40 3 3
Series C 20 187 204
Series D 20 273 293
- ----------------------- ------------- ------------ -----------
Total 472 510
======================= ============= ============ ===========
92
Series A through D are cumulative and, except for Series B, are redeemable at
the option of the Corporation. Annual dividends on Series A, B and D preferred
stock total $1.80 per share and on Series C preferred stock total $1.60 per
share. Holders of Series A through D preferred stock are entitled to a number of
votes equal to the number of full shares of common stock into which such
preferred stock is convertible. Series A through D preferred stock have the
following conversion privileges: (i) one share of Series A or Series B is
convertible into eight shares of common stock; and (ii) 2.4 shares of Series C
or Series D are convertible into four shares of common stock.
During 2000, the Board of Directors adopted a shareholder rights plan
providing for issuance of share purchase rights. Except as provided in the plan,
if a person or group becomes beneficial owner of 10% or more of PNC's
outstanding common stock, all holders of the rights, other than such person or
group, may purchase PNC common stock or equivalent preferred stock at half of
market value.
The Corporation has a dividend reinvestment and stock purchase plan.
Holders of preferred stock and common stock may participate in the plan, which
provides that additional shares of common stock may be purchased at market value
with reinvested dividends and voluntary cash payments. Common shares issued
pursuant to this plan were: 796,140 shares in 2002, 472,015 shares in 2001, and
649,334 shares in 2000.
At December 31, 2002, the Corporation had reserved approximately 30.7
million common shares to be issued in connection with certain stock plans and
the conversion of certain debt and equity securities.
In January 2002, the Board of Directors authorized the Corporation to
purchase up to 35 million shares of its common stock through February 29, 2004.
These shares may be purchased in the open market or in privately negotiated
transactions. This authorization terminated any prior authorization. During
2002, a total of 320,000 shares were repurchased under this program, all in the
first quarter. Under this program, the Corporation currently expects to purchase
between $250 million and $1 billion of its common stock during 2003. The extent
and timing of any future share repurchases will depend on a number of factors
including, among others, market and general economic conditions, regulatory
capital considerations, alternative uses of capital and the potential impact on
PNC's credit rating. Under applicable regulations, as long as PNC remains
subject to its written agreement with the Federal Reserve, it must obtain prior
regulatory approval to repurchase its common stock in amounts that exceed 10
percent of consolidated net worth in any 12-month period.
NOTE 20 FINANCIAL DERIVATIVES
Effective January 1, 2001, the Corporation implemented SFAS No. 133. As a result
of the adoption of this statement, the Corporation recognized, in the first
quarter of 2001, an after-tax loss from the cumulative effect of a change in
accounting principle of $5 million reported in the consolidated income statement
and an after-tax accumulated other comprehensive loss of $4 million. The impact
of the adoption of this standard related to the residential mortgage banking
business is reflected in the results of discontinued operations.
Earnings adjustments resulting from cash flow and fair value hedge
ineffectiveness were not significant to the results of operations of the
Corporation during 2002 or 2001.
During the next twelve months, the Corporation expects to reclassify to
earnings $138 million of pretax net gains, or $90 million after tax, on cash
flow hedge derivatives currently reported in accumulated other comprehensive
income. These net gains are anticipated to result from net cash flows on receive
fixed interest rate swaps and would mitigate reductions in interest income
recognized on the related floating rate commercial loans.
The Corporation generally has established agreements with its major
derivative dealer counterparties that provide for exchanges of marketable
securities or cash to collateralize either party's positions. At December 31,
2002 the Corporation held cash and U.S. government securities with a fair value
of $377 million and pledged mortgage-backed securities with a fair value of $149
million under these agreements.
NOTE 21 EMPLOYEE BENEFIT PLANS
PENSION AND POST-RETIREMENT PLANS
The Corporation has a noncontributory, qualified defined benefit pension plan
covering most employees. Retirement benefits are derived from a cash balance
formula based on compensation levels, age and length of service. Pension
contributions are based on an actuarially determined amount necessary to fund
total benefits payable to plan participants.
The Corporation also maintains nonqualified supplemental retirement plans
for certain employees. All retirement benefits provided under these plans are
unfunded and any payments to plan participants are made by the Corporation. The
Corporation also provides certain health care and life insurance benefits for
retired employees ("post-retirement benefits") through various plans.
93
A reconciliation of the changes in the benefit obligation for qualified and
nonqualified pension plans and post-retirement benefit plans as well as the
change in plan assets for the qualified pension plan is as follows:
Qualified Nonqualified Post-retirement
Pension Pension Benefits
------------------------- ----------------------- -------------------------
December 31 - in millions 2002 2001 2002 2001 2002 2001
=================================================== ============ ============ =========== =========== =========== =============
Benefit obligation at beginning of year $854 $798 $66 $58 $211 $203
Service cost 33 30 1 2 2 2
Interest cost 61 61 5 5 15 14
Actuarial loss 38 35 2 6 38 12
Participant contributions 5 4
Benefits paid (68) (70) (4) (5) (26) (24)
- --------------------------------------------------- ------------ ------------ ----------- ----------- ----------- -------------
Benefit obligation at end of year $918 $854 $70 $66 $245 $211
=================================================== ============ ============ =========== =========== =========== =============
Fair value of plan assets at beginning of year $928 $952
Actual loss on plan assets (104) (89)
Employer contribution 210 135 $5 $5
Benefits paid (68) (70) (5) (5)
- --------------------------------------------------- ------------ ------------ ----------- -----------
Fair value of plan assets at end of year $966 $928
=================================================== ============ ============ =========== ===========
Funded status $48 $73 $(70) $(65) $(245) $(211)
Unrecognized net actuarial loss 485 266 25 23 85 50
Unrecognized prior service cost (credit) (5) (6) 2 3 (48) (54)
- --------------------------------------------------- ------------ ------------ ----------- ----------- ----------- -------------
Net amount recognized on the balance sheet $528 $333 $(43) $(39) $(208) $(215)
=================================================== ============ ============ =========== =========== =========== =============
Prepaid pension cost $528 $333 $(43) $(39)
Additional minimum liability (23) (21)
Intangible asset 2 3
Accumulated other comprehensive loss 21 18
- --------------------------------------------------- ------------ ------------ ----------- -----------
Net amount recognized on the balance sheet $528 $333 $(43) $(39)
=================================================== ============ ============ =========== =========== =========== =============
Plan assets primarily consist of listed common stocks, U.S. government and
agency securities and various mutual funds managed by BlackRock from which
BlackRock and PFPC receive compensation for providing investment advisory,
custodial and transfer agency services. Plan assets are managed by BlackRock and
do not include common or preferred stock of the Corporation.
94
The components of net periodic pension and post-retirement benefit cost were as
follows:
----------------------------- ------------------------------- ------------------------------
Qualified Pension Plans Nonqualified Pension Plans Post-retirement Benefits
- ---------------------------------- ----------------------------- ------------------------------- ------------------------------
Year ended December 31 - in 2002 2001 2000 2002 2001 2000 2002 2001 2000
millions
- ---------------------------------- --------- --------- --------- ---------- --------- ---------- --------- --------- ----------
Service cost $33 $30 $31 $1 $2 $2 $2 $2 $2
Interest cost 61 61 60 5 5 5 15 14 14
Expected return on plan assets (97) (97) (93)
Transition amount amortization (5) 1
Curtailment gain (3)
Amortization of prior service
cost (1) (1) (1) (6) (6) (6)
Recognized net actuarial loss 19 2 2 (1) 2
Losses due to settlements 7
- ---------------------------------- --------- --------- --------- ---------- --------- ---------- --------- --------- ----------
Net periodic cost $15 $(7) $(8) $8 $9 $14 $13 $7 $10
================================== ========= ========= ========= ========== ========= ========== ========= ========= ==========
Weighted-average assumptions were as follows:
-----------------------------------
Qualified and Nonqualified Pensions
-----------------------------------
As of December 31 2002 2001 2000
========================== ========== ========== ==========
Discount rate 6.75% 7.25% 7.50%
Rate of compensation
increase 4.00 4.50 4.50
========================== ========== ========== ==========
The assumption for the expected long-term return on plan assets was 9.50% for
the determination of net periodic pension cost for the 2002, 2001 and 2000
fiscal years. The Corporation intends to change this assumption to 8.50% for
determining pension cost in fiscal 2003 to reflect a more conservative view of
long-term future trust returns.
-------------------------------
Post-retirement Benefits
-------------------------------
As of December 31 2002 2001 2000
=========================== ========== ========= ==========
Discount rate 6.75% 7.25% 7.50%
Expected health care cost
trend rate
Following year 11.00 7.75 7.75
Ultimate 5.25 5.50 5.00
Year to Reach Ultimate 2009 2005 2005
=========================== ========== ========= ==========
The health care cost trend rate declines until it stabilizes at 5.25% beginning
in 2009. A one-percentage-point change in assumed health care cost trend rates
would have the following effects:
--------- --------
Year ended December 31, 2002 - in Increase Decrease
millions
======================================== ========= ========
Effect on total service and interest cost $1 $(1)
Effect on post-retirement benefit
obligation 13 (11)
======================================== ========= ========
INCENTIVE SAVINGS PLAN
The Corporation sponsors an incentive savings plan that covers substantially all
employees. Under this plan, employee contributions up to 6% of biweekly
compensation as defined by the plan are matched, subject to Internal Revenue
Code limitations. Contributions to the plan for 2002 are matched primarily by
shares of PNC common stock held in treasury, except for participants who have
exercised their diversification election rights. Contributions to the Plan for
prior years were matched primarily by shares of PNC common stock held in
treasury, or by the Corporation's employee stock ownership plan ("ESOP"). The
Corporation also maintains a nonqualified supplemental savings plan for certain
employees.
Prior to 2002, the Corporation made annual contributions to the ESOP that
were at least equal to the debt service requirements on the ESOP's borrowings
less dividends received by the ESOP. All dividends received by the ESOP were
used to pay debt service. Dividends used for debt service totaled $8 million in
2001 and $9 million in 2000. To satisfy additional debt service requirements,
PNC contributed $1 million in 2001. No contributions were made in 2000. As of
December 31, 2001 the ESOP's borrowings were paid off and fully extinguished.
As the ESOP's borrowings were repaid, shares were allocated to employees
who made contributions during the year based on the proportion of annual debt
service to total debt service. The Corporation includes all ESOP shares as
common shares outstanding in the earnings per share computation.
95
COMPONENTS OF ESOP SHARES
As of or for the year ended
December 31
In thousands 2002 2001
===================================== ============ ============
Unallocated
Allocated 4,008 4,134
Released for allocation 364
Retired (490)
- ------------------------------------- ------------ ------------
Total 4,008 4,008
===================================== ============ ============
Compensation expense related to the portion of contributions matched with ESOP
shares is determined based on the number of ESOP shares allocated. Compensation
expense related to these plans was $47 million, $28 million and $30 million for
2002, 2001 and 2000, respectively.
NOTE 22 STOCK-BASED COMPENSATION PLANS
The Corporation has a long-term incentive award plan ("Incentive Plan") that
provides for the granting of incentive stock options, nonqualified stock
options, stock appreciation rights, performance units, restricted stock and
other incentive shares to executives and directors. In any given year, the
number of shares of common stock available for grant under the Incentive Plan
may range from 1.5% to 3% of total issued shares of common stock determined at
the end of the preceding calendar year. Of this amount, no more than 20% is
available for restricted stock and other incentive share awards.
As of December 31, 2002 no incentive stock options, stock appreciation
rights or performance unit awards were outstanding.
NONQUALIFIED STOCK OPTIONS
Options are granted at exercise prices not less than the market value of common
stock on the date of grant. Generally, options granted since 1999 become
exercisable in installments after the grant date. Options granted prior to 1999
are mainly exercisable twelve months after the grant date. Payment of the option
price may be in cash or previously owned shares of common stock at market value
on the exercise date.
A summary of stock option activity follows:
Per Option
------------------------------
Weighted-
Average
Exercise
Shares in thousands Exercise Price Price Shares
==================== ================= ============ ===========
January 1, 2000 $11.38 - $76.00 $44.83 11,075
Granted 42.19 - 66.22 44.20 4,171
Exercised 11.38 - 59.31 37.77 (2,952)
Terminated 31.13 - 61.75 48.10 (496)
-----------
December 31, 2000 21.63 - 76.00 46.25 11,798
Granted 53.74 - 74.70 73.14 3,996
Exercised 21.63 - 59.31 43.46 (2,737)
Terminated 42.19 - 74.59 53.22 (580)
-----------
December 31, 2001 21.75 - 76.00 55.15 12,477
Granted 37.42 - 60.65 54.91 4,514
Exercised 21.75 - 55.59 40.05 (495)
Terminated 27.56 - 74.59 58.98 (955)
-----------
December 31, 2002 21.75 - 76.00 55.33 15,541
==================== ================= ============ ===========
Information about stock options outstanding at December 31, 2002 follows:
-------------------------------------------------------------- -----------------------------------
Options Outstanding Options Exercisable
-------------------------------------------------------------- -----------------------------------
December 31, 2002
Shares in thousands Weighted-average Weighted-average remaining Shares Weighted-average
Range of exercise prices Shares exercise price contractual life (in years) exercise price
============================== ============== ================= ============================= ============== ====================
$21.75 - $32.99 681 $29.11 2.4 681 $29.11
33.00 - 49.99 3,618 42.24 7.0 1,888 42.85
50.00 - 76.00 11,242 61.12 7.5 5,341 58.85
-------------- -----------
Total 15,541 $55.33 7.1 7,910 $52.47
============================== ============== ================= ============================= ============== ====================
Options granted in 2002 and 2001 include options for 52,000 shares in each year
granted to non-employee directors.
The weighted-average grant-date fair value of options granted in 2002, 2001
and 2000 was $11.40, $15.87 and $9.86 per option, respectively. At December 31,
2001 and 2000 options for 5,279,000 and 5,834,898 shares of common stock,
respectively, were exercisable at a weighted-average price of $48.01 and $45.96,
respectively.
There were no options granted in excess of market value in 2002, 2001 or
2000. Shares of common stock available for the granting of options and other
awards under the Incentive Plan were 10,584,683 at December 31, 2002, 2001 and
2000.
96
INCENTIVE SHARE AND RESTRICTED STOCK AWARDS
In 1998, incentive share awards potentially representing 362,250 shares of
common stock were granted to certain senior executives pursuant to the Incentive
Plan. Issuance of restricted shares pursuant to these incentive awards was
subject to the market price of PNC's common stock equaling or exceeding
specified levels for defined periods. In 2001, 104,250 of these shares were
issued. The remaining shares expired and will not be issued under this award.
The restricted period ends July 1, 2003. During the restricted period, the
recipient receives dividends and can vote the shares. Generally, if the
recipient leaves the Corporation before the end of the restricted period, the
shares will be forfeited.
In 2000, 606,000 incentive shares of common stock were granted to certain
senior executives pursuant to the Incentive Plan. One-half of any shares of
restricted stock issued pursuant to these awards will vest after three years and
the remainder after four years if certain performance targets are met. Shares
awarded under this grant will be offset on a share-for-share basis by shares
received, if any, by the executive from the 1998 grant.
There were 239,250, 39,000 and 66,000 incentive shares forfeited during
2002, 2001 and 2000, respectively.
In addition, 52,000, 33,600 and 53,100 shares of restricted stock were
granted to certain key employees in 2002, 2001 and 2000, respectively. These
shares vest 25% after three years, 25% after four years and 50% after five
years. Shares forfeited were 6,800, 22,725, and 8,438 in 2002, 2001, and 2000,
respectively.
In 2002, a total of 109,138 shares of restricted stock were granted to
senior executives with vesting periods ranging from 24 months to 50 months. Of
these, 1,551 shares were forfeited in 2002.
There were 13,000 shares of restricted stock granted to non-employee
directors in 2001. One half of these shares vest after one year and the
remainder after two years. In 2002, 1,000 of these shares were forfeited. In
2000, 245,000 shares of restricted stock were granted to senior executives with
a three-year vesting period. Of these, 35,000 shares were forfeited in 2002.
Compensation expense recognized for incentive share and restricted stock
awards totaled ($1 million), $10 million and $8 million in 2002, 2001 and 2000,
respectively. The net credit to expense in 2002 was due to forfeitures and
adjustments of accruals related to performance-based awards under the Incentive
Plan.
EMPLOYEE STOCK PURCHASE PLAN
The Corporation's ESPP has approximately 2.2 million shares available for
issuance. Persons who have been continuously employed for at least one year are
eligible to participate. Participants purchase the Corporation's common stock at
85% of the lesser of fair market value on the first or last day of each offering
period. No charge to earnings is recorded with respect to the ESPP.
Shares issued pursuant to the ESPP were as follows:
Year ended December 31 Shares Price Per Share
======================= ================== ======================
2002 449,222 $47.81 and $35.87
2001 395,217 55.57 and 49.26
2000 504,988 42.82 and 45.53
======================= ================== ======================
PRO FORMA EFFECTS
A table that sets forth pro forma income from continuing operations and basic
and diluted earnings per share as if compensation expense was recognized under
SFAS 123 for stock options and the ESPP for 2002, 2001 and 2000 is included in
Note 1 Accounting Policies.
For purposes of computing pro forma results, PNC estimated the fair value
of stock options and ESPP shares using the Black-Scholes option pricing model.
The model requires the use of numerous assumptions, many of which are
highly subjective in nature. Therefore, the pro forma results are estimates of
results of operations as if compensation expense had been recognized for all
stock-based compensation plans and are not indicative of the impact on future
periods. The following assumptions were used in the option pricing model for
purposes of estimating pro forma results. The dividend yield represents average
yields over the previous three-year period. Volatility is measured using the
fluctuation in quarter-end closing stock prices over a five-year period.
OPTION PRICING ASSUMPTIONS
----------- ---------- ------------
Year ended December 31 2002 2001 2000
=========================== =========== ========== ============
Risk-free interest rate 4.4% 4.9% 6.6%
Dividend yield 3.5 3.2 3.1
Volatility 26.7 25.7 21.8
Expected life 5 yrs. 5 yrs. 5 yrs.
=========================== =========== ========== ============
97
NOTE 23 INCOME TAXES
The components of income taxes were as follows:
Year ended December 31
In millions 2002 2001 2000
=========================== ========== ========== =============
Current
Federal $86 $195 $226
State 48 40 32
- --------------------------- ---------- ---------- -------------
Total current 134 235 258
Deferred
Federal 463 (51) 363
State 24 3 13
- --------------------------- ---------- ---------- -------------
Total deferred 487 (48) 376
- --------------------------- ---------- ---------- -------------
Total $621 $187 $634
=========================== ========== ========== =============
Significant components of deferred tax assets and liabilities are as follows:
December 31 - in millions 2002 2001
==================================== ============ ===========
Deferred tax assets
Allowance for credit losses $297 $225
Compensation and benefits 31
Net unrealized securities losses 75
Loan valuations related to
institutional lending
repositioning 135 330
Other 171 163
- ------------------------------------ ------------ -----------
Total deferred tax assets 603 824
==================================== ============ ===========
Deferred tax liabilities
Leasing 1,372 1,182
Depreciation 66 53
Net unrealized securities gains 87
Compensation and benefits 26
Other 155 89
- ------------------------------------ ------------ -----------
Total deferred tax liabilities 1,706 1,324
- ------------------------------------ ------------ -----------
Net deferred tax liability $1,103 $500
==================================== ============ ===========
A reconciliation between the statutory and effective tax rates follows:
Year ended December 31 2002 2001 2000
=============================== ========= ======== ==========
Statutory tax rate 35.0% 35.0% 35.0%
Increases (decreases) resulting
from
State taxes 2.5 4.6 1.6
Tax-exempt interest (.4) (1.7) (.6)
Goodwill 2.9 .9
Life insurance (1.1) (3.3) (1.0)
Tax credits (2.4) (7.2) (1.8)
Other (.2) 1.0 (.3)
- ------------------------------- --------- -------- ----------
Effective tax rate 33.4% 31.3% 33.8%
=============================== ========= ======== ==========
At December 31, 2002 the Corporation had available $3.8 million of federal
income tax credit carryforwards which expire in 2022.
NOTE 24 LEGAL PROCEEDINGS
The several putative class action complaints filed during 2002 were consolidated
in a consolidated class action complaint brought on behalf of purchasers of the
Corporation's common stock between July 19, 2001 and July 18, 2002. The
consolidated class action complaint names the Corporation, the Chairman and
Chief Executive Officer, the former Chief Financial Officer, the Controller and
the Corporation's independent auditors for 2001 as defendants and seeks
unquantified damages, interest, attorneys' fees and other expenses. The
consolidated class action complaint alleges violations of federal securities
laws related to disclosures regarding the three 2001 transactions that gave rise
to a financial statement restatement announced by the Corporation on January 29,
2002 and related matters. The Corporation and all other defendants have filed a
motion to dismiss this lawsuit. Management believes there are substantial
defenses to this lawsuit and intends to defend it vigorously. The impact of the
final disposition of this lawsuit cannot be assessed at this time.
Also, in August 2002, the United States Department of Labor began a formal
investigation of the Administrative Committee of the Corporation's Incentive
Savings Plan ("Plan") in connection with the Committee's conduct relating to the
Corporation's common stock held by the Plan and the Corporation's restatement of
earnings for 2001. Both the Administrative Committee and the Corporation are
cooperating fully with the investigation. The impact of the final disposition of
this investigation cannot be assessed at this time.
The Corporation and persons to whom the Corporation may have
indemnification obligations, in the normal course of business, are subject to
various other pending and threatened legal proceedings in which claims for
monetary damages and other relief are asserted. Management does not anticipate
that the ultimate aggregate liability, if any, arising out of such other legal
proceedings will have a material adverse effect on the Corporation's financial
position, although at the present time, management is not in a position to
determine whether any pending or threatened legal proceedings will have a
material adverse effect on the Corporation's results of operations in any future
reporting period.
98
NOTE 25 EARNINGS PER SHARE
The following table sets forth basic and diluted earnings per share
calculations.
Year ended December 31 - in millions, except share and per share data 2002 2001 2000
================================================================================== ============= ============= ================
CALCULATION OF BASIC EARNINGS PER COMMON SHARE
Income from continuing operations $1,200 $377 $1,214
Less: Preferred dividends declared (a) 1 13 19
- ---------------------------------------------------------------------------------- ------------- ------------- ----------------
Income from continuing operations applicable to basic earnings per common share 1,199 364 1,195
Income (loss) from discontinued operations applicable to basic earnings per
common share (16) 5 65
Cumulative effect of accounting change applicable to basic earnings per common
share (5)
- ---------------------------------------------------------------------------------- ------------- ------------- ----------------
Net income applicable to basic earnings per common share $1,183 $364 $1,260
Basic weighted-average common shares outstanding (in thousands) 283,449 286,726 289,958
Basic earnings per common share from continuing operations $4.23 $1.27 $4.12
Basic earnings (loss) per common share from discontinued operations (.05) .02 .23
Basic earnings (loss) per common share from cumulative effect of accounting
change (.02)
- ---------------------------------------------------------------------------------- ------------- ------------- ----------------
Basic earnings per common share $4.18 $1.27 $4.35
================================================================================== ============= ============= ================
CALCULATION OF DILUTED EARNINGS PER COMMON SHARE
Income from continuing operations $1,200 $377 $1,214
Less: Dividends declared on nonconvertible Series F preferred stock (a) 1 13 18
- ---------------------------------------------------------------------------------- ------------- ------------- ----------------
Income from continuing operations applicable to diluted earnings per common share 1,199 364 1,196
Income (loss) from discontinued operations applicable to diluted earnings per
common share (16) 5 65
Cumulative effect of accounting change applicable to diluted earnings per common
share (5)
- ---------------------------------------------------------------------------------- ------------- ------------- ----------------
Net income applicable to diluted earnings per common share $1,183 $364 $1,261
Basic weighted-average common shares outstanding (in thousands) 283,449 286,726 289,958
Weighted-average common shares to be issued using average market price and
assuming:
Conversion of preferred stock Series A and B 98 106 118
Conversion of preferred stock Series C and D 795 870 986
Conversion of debentures 16 17 20
Exercise of stock options 496 1,661 1,531
Incentive share awards 299 368 173
- ---------------------------------------------------------------------------------- ------------- ------------- ----------------
Diluted weighted-average common shares outstanding (in thousands) 285,153 289,748 292,786
Diluted earnings per common share from continuing operations $4.20 $1.26 $4.09
Diluted earnings (loss) per common share from discontinued operations (.05) .02 .22
Diluted earnings (loss) per common share from cumulative effect of accounting
change (.02)
- ---------------------------------------------------------------------------------- ------------- ------------- ----------------
Diluted earnings per common share $4.15 $1.26 $4.31
================================================================================== ============= ============= ================
(a) Adjustment for year ended December 31, 2001 includes $1 million of cost
incurred due to tender offer of Series F preferred stock.
99
NOTE 26 SEGMENT REPORTING
PNC operates seven major businesses engaged in regional community banking;
wholesale banking, including corporate banking, real estate finance and
asset-based lending; wealth management; asset management and global fund
processing services. Assets, revenue and earnings attributable to foreign
activities were not material for the years ended December 31, 2002, 2001 or
2000.
Results of individual businesses are presented based on PNC's management
accounting practices and the Corporation's management structure. There is no
comprehensive, authoritative body of guidance for management accounting
equivalent to generally accepted accounting principles; therefore, PNC's results
of individual businesses are not necessarily comparable with similar information
for any other company. Financial results are presented, to the extent
practicable, as if each business operated on a stand-alone basis.
The management accounting process uses various balance sheet and income
statement assignments and transfers to measure performance of the businesses.
Methodologies are refined from time to time as management accounting practices
are enhanced and businesses change. There were no significant methodology
changes made during 2002 other than the impact of refinements to the
Corporation's reserve methodology related to loans and unfunded credit
facilities. Securities or borrowings and related net interest income are
assigned based on the net asset or liability position of each business. Capital
is assigned based on management's assessment of inherent risks and equity levels
at independent companies providing similar products and services. The allowance
for credit losses is allocated based on management's assessment of risk inherent
in the loan portfolios. The costs incurred by support areas not directly aligned
with the businesses are allocated primarily based on the utilization of
services.
Total business financial results differ from consolidated results from
continuing operations. This is primarily due to differences between management
accounting practices and generally accepted accounting principles, such as
economic capital assignments rather than legal entity shareholders' equity, unit
cost allocations rather than actual expense assignments, and policies that do
not fully allocate holding company expenses; minority interest in income of
consolidated entities; eliminations and other corporate items. The impact these
differences is reflected in the "Other" category. Other also includes equity
management activities and residual asset and liability management activities
which do not meet the criteria for disclosure as a separate reportable segment.
The impact of the institutional lending repositioning and other strategic
actions that occurred during 2001 and 2000 is reflected in the business results.
BUSINESS SEGMENT PRODUCTS AND SERVICES
Regional Community Banking provides deposit, lending, cash management and
investment services to two million consumer and small business customers within
PNC's geographic footprint.
Wholesale Banking includes the results for Corporate Banking, PNC Real
Estate Finance and PNC Business Credit.
Corporate Banking provides credit, equipment leasing, treasury management
and capital markets products and services to mid-sized corporations, government
entities and selectively to large corporations primarily within PNC's geographic
region. Treasury management activities, which include cash and investment
management, receivables management, disbursement services and global trade
services; capital markets products, which include foreign exchange, derivatives
trading and loan syndications; and equipment leasing products are offered
through Corporate Banking and sold by several businesses across the Corporation.
PNC Real Estate Finance specializes in financial solutions for the
acquisition, development, permanent financing and operation of commercial real
estate nationally. PNC Real Estate Finance offers treasury and investment
management, access to the capital markets, commercial mortgage loan servicing
and other products and services to clients that develop, own, manage or invest
in commercial real estate. PNC's commercial real estate financial services
platform provides processing services through Midland Loan Services, Inc., a
leading third-party provider of loan servicing and technology to the commercial
real estate finance industry. Columbia Housing Partners, LP is a national
syndicator of affordable housing.
PNC Business Credit provides asset-based lending, treasury management and
capital markets products and services to middle market customers nationally. PNC
Business Credit's lending services include loans secured by accounts receivable,
inventory, machinery and equipment, and other collateral, and its customers
include manufacturing, wholesale, distribution, retailing and service industry
companies.
PNC Advisors provides a full range of tailored investment, trust and
banking products and services to affluent individuals and families, including
full-service brokerage through J.J.B. Hilliard, W.L. Lyons, Inc. and investment
consulting and trust services to the ultra-affluent through Hawthorn. PNC
Advisors also serves as investment manager and trustee for employee benefit
plans and charitable and endowment assets and provides defined contribution plan
services and investment options through its Vested Interest(R) product.
BlackRock is one of the largest publicly traded investment management firms
in the United States with approximately $273 billion of assets under management
at December 31, 2002. BlackRock manages assets on behalf of institutions and
individuals worldwide through a variety of fixed income, liquidity and equity
mutual funds, separate accounts and alternative investment products. Mutual
funds include the flagship fund families, BlackRock Funds and BlackRock
Provident Institutional Funds. In addition, BlackRock provides risk management
and investment system services to institutional investors under the BlackRock
Solutions brand name.
PFPC is the largest full-service mutual fund transfer agent and second
largest provider of mutual fund accounting and administration services in the
United States, offering a wide range of fund services to the investment
management industry. PFPC also provides processing solutions to the
international marketplace through its Ireland and Luxembourg operations.
100
RESULTS OF BUSINESSES
- ------------------------------ --------- --------- ---------- ---------- ---------- ---------- ----------- ---------- ----------
PNC
Regional Real PNC
Year ended December 31 Community Corporate Estate Business PNC
In millions Banking Banking Finance Credit Advisors BlackRock PFPC Other Consolidated
============================== ========= ========= ========== ========== ========== ========== =========== ========== ==========
2002
INCOME STATEMENT
Net interest income $1,403 $344 $116 $134 $100 $9 $(71) $162 $2,197
Noninterest income 773 437 112 48 554 577 810 (114) 3,197
- ------------------------------ --------- --------- ---------- ---------- ---------- ---------- ----------- ---------- ----------
Total revenue 2,176 781 228 182 654 586 739 48 5,394
Provision for credit losses 52 203 (10) 64 4 (4) 309
Depreciation and amortization 35 11 7 1 10 20 12 73 169
Other noninterest expense 1,026 348 153 52 487 342 619 31 3,058
- ------------------------------ --------- --------- ---------- ---------- ---------- ---------- ----------- ---------- ----------
Earnings before minority
interest and income taxes 1,063 219 78 65 153 224 108 (52) 1,858
Minority interest in income
of consolidated entities (2) 39 37
Income taxes 366 69 (10) 25 56 91 43 (19) 621
- ------------------------------ --------- --------- ---------- ---------- ---------- ---------- ----------- ---------- ----------
Earnings $697 $150 $90 $40 $97 $133 $65 $(72) $1,200
============================== ========= ========= ========== ========== ========== ========== =========== ========== ==========
Inter-segment revenue $20 $7 $38 $16 $8 $(89)
============================== ========= ========= ========== ========== ========== ========== =========== ========== ==========
AVERAGE ASSETS $38,976 $13,807 $5,018 $3,837 $2,929 $864 $1,888 $(730) $66,589
============================== ========= ========= ========== ========== ========== ========== =========== ========== ==========
2001
INCOME STATEMENT
Net interest income $1,460 $501 $116 $104 $128 $11 $(66) $8 $2,262
Noninterest income 758 32 89 (8) 607 533 834 (193) 2,652
- ------------------------------ --------- --------- ---------- ---------- ---------- ---------- ----------- ---------- ----------
Total revenue 2,218 533 205 96 735 544 768 (185) 4,914
Provision for credit losses 50 733 44 29 2 45 903
Depreciation and amortization 71 13 22 2 17 26 45 77 273
Other noninterest expense 1,169 374 136 29 487 337 662 (53) 3,141
- ------------------------------ --------- --------- ---------- ---------- ---------- ---------- ----------- ---------- ----------
Earnings before minority
interest and income taxes 928 (587) 3 36 229 181 61 (254) 597
Minority interest in income
of consolidated entities 33 33
Income taxes 332 (212) (35) 14 86 74 25 (97) 187
- ------------------------------ --------- --------- ---------- ---------- ---------- ---------- ----------- ---------- ----------
Earnings $596 $(375) $38 $22 $143 $107 $36 $(190) $377
============================== ========= ========= ========== ========== ========== ========== =========== ========== ==========
Inter-segment revenue $11 $4 $61 $16 $6 $(98)
============================== ========= ========= ========== ========== ========== ========== =========== ========== ==========
AVERAGE ASSETS $40,285 $16,685 $5,290 $2,463 $3,330 $684 $1,771 $(74) $70,434
============================== ========= ========= ========== ========== ========== ========== =========== ========== ==========
2000
INCOME STATEMENT
Net interest income $1,408 $582 $118 $99 $136 $7 $(46) $(140) $2,164
Noninterest income 619 254 108 20 656 477 715 101 2,950
- ------------------------------ --------- --------- ---------- ---------- ---------- ---------- ----------- ---------- ----------
Total revenue 2,027 836 226 119 792 484 669 (39) 5,114
Provision for credit losses 45 79 (7) 12 5 2 136
Depreciation and amortization 71 13 20 2 14 20 49 70 259
Other noninterest expense 1,000 381 125 28 497 314 542 (43) 2,844
- ------------------------------ --------- --------- ---------- ---------- ---------- ---------- ----------- ---------- ----------
Earnings before minority
interest and income taxes 911 363 88 77 276 150 78 (68) 1,875
Minority interest in income
of consolidated entities 27 27
Income taxes 321 122 4 28 103 63 31 (38) 634
- ------------------------------ --------- --------- ---------- ---------- ---------- ---------- ----------- ---------- ----------
Earnings $590 $241 $84 $49 $173 $87 $47 $(57) $1,214
============================== ========= ========= ========== ========== ========== ========== =========== ========== ==========
Inter-segment revenue $3 $5 $79 $13 $5 $(105)
============================== ========= ========= ========== ========== ========== ========== =========== ========== ==========
AVERAGE ASSETS $38,958 $17,746 $5,889 $2,271 $3,500 $537 $1,578 $(1,913) $68,566
============================== ========= ========= ========== ========== ========== ========== =========== ========== ==========
Certain revenue and expense amounts shown above differ from amounts included in
the "Review of Business" section of the Financial Review portion of this Annual
Report due to classification differences and the presentation in the Financial
Review of business revenues on a taxable-equivalent basis (except for BlackRock
and PFPC).
101
NOTE 27 COMPREHENSIVE INCOME
The Corporation's other comprehensive income primarily consists of unrealized
gains or losses on securities available for sale and cash flow hedge derivatives
and minimum pension liability adjustments. The income effects allocated to each
component of other comprehensive income (loss) are as follows:
Year ended December 31 Pretax Tax Benefit After-tax
In millions Amount (Expense) Amount
============================ =========== ============ ==========
2002
Unrealized securities gains $349 $(121) $228
Less: Reclassification
adjustment for losses
realized in net income (57) 20 (37)
- ---------------------------- ----------- ------------ ----------
Net unrealized securities
gains 406 (141) 265
- ---------------------------- ----------- ------------ ----------
Unrealized gains on cash
flow hedge derivatives 136 (48) 88
Less: Reclassification
adjustment for gains
realized in net income 79 (28) 51
- ---------------------------- ----------- ------------ ----------
Net unrealized gains on
cash flow hedge
derivatives 57 (20) 37
Minimum pension liability
adjustment (3) 1 (2)
Other 24 (8) 16
- ------------------------------ --------- ------------ ----------
Other comprehensive income
from continuing operations $484 $(168) $316
============================ =========== ============ ==========
2001
Unrealized securities
losses $(86) $30 $(56)
Less: Reclassification
adjustment for losses
realized in net income (8) 3 (5)
- -------------------------- ------------- ------------ ----------
Net unrealized
securities losses (78) 27 (51)
- -------------------------- ------------- ------------ ----------
SFAS No. 133 transition
adjustment (6) 2 (4)
Unrealized gains on cash
flow hedge derivatives 102 (36) 66
Less: Reclassification
adjustment for losses
realized in net income (55) 19 (36)
- -------------------------- ------------- ------------ ----------
Net unrealized gains on
cash flow hedge
derivatives 151 (53) 98
Minimum pension
liability adjustment (2) 1 (1)
Other 3 (1) 2
- ------------------------------ --------- ------------ ----------
Other comprehensive income
from continuing operations $74 $(26) $48
============================ =========== ============ ==========
2000
Unrealized securities
gains $124 $(40) $84
Less: Reclassification
adjustment for losses
realized in net income (3) 1 (2)
- -------------------------- ------------- ------------ ----------
Net unrealized
securities gains 127 (41) 86
Minimum pension
liability adjustment 2 (1) 1
Other 3 (1) 2
- ------------------------------ --------- ------------ ----------
Other comprehensive income
from continuing operations $132 $(43) $89
============================== ========= ============ ==========
The accumulated balances related to each component of other comprehensive income
(loss) are as follows:
December 31 - in millions 2002 2001
======================================= ========== ========
Net unrealized securities gains
(losses) $179 $(86)
Net unrealized gains on cash flow
hedge derivatives 135 98
Minimum pension liability adjustment (14) (12)
Other 21 5
--------------------------------------- ---------- --------
Accumulated other comprehensive
income from continuing operations $321 $5
======================================= ========== ========
102
NOTE 28 FAIR VALUE OF FINANCIAL INSTRUMENTS
--------------------------------------------- --------------------------------------
2002 2001
--------------------------------------------- --------------------------------------
CARRYING FAIR Carrying Fair
December 31 - in millions AMOUNT VALUE Amount Value
============================================ ====================== ====================== =================== ==================
ASSETS
Cash and short-term assets $7,295 $7,295 $6,200 $6,200
Securities 13,763 13,796 13,908 13,905
Loans held for sale 1,607 1,607 4,189 4,189
Net loans (excludes leases) 30,766 31,718 33,011 33,588
Other assets 791 791 966 966
Commercial mortgage servicing rights 201 227 199 240
Financial derivatives
Interest rate risk management 519 519 278 278
Commercial mortgage banking risk
management 5 5
Customer/other derivatives 762 762 497 497
LIABILITIES
Demand, savings and money market deposits 34,363 34,363 34,531 34,531
Time deposits 10,619 10,946 12,773 12,942
Borrowed funds 9,383 9,544 12,390 12,579
Financial derivatives
Interest rate risk management 8 8 16 16
Commercial mortgage banking risk
management 16 16 4 4
Customer/other derivatives 766 766 476 476
OFF-BALANCE-SHEET
Unfunded loan commitments
and letters of credit (71) (85) (57) (71)
============================================ ====================== ====================== =================== ==================
103
Real and personal property, lease financing, loan customer relationships,
deposit customer intangibles, retail branch networks, fee-based businesses, such
as asset management and brokerage, trademarks and brand names are excluded from
the amounts set forth in the previous table. Accordingly, the aggregate fair
value amounts presented do not represent the underlying value of the
Corporation.
Fair value is defined as the estimated amount at which a financial
instrument could be exchanged in a current transaction between willing parties,
or other than in a forced or liquidation sale. However, it is not management's
intention to immediately dispose of a significant portion of such financial
instruments, and unrealized gains or losses should not be interpreted as a
forecast of future earnings and cash flows. The derived fair values are
subjective in nature, involve uncertainties and significant judgment and,
therefore, cannot be determined with precision. Changes in assumptions could
significantly impact the derived fair value estimates.
The following methods and assumptions were used in estimating fair value
amounts for financial instruments.
GENERAL
For short-term financial instruments realizable in three months or less, the
carrying amount reported in the consolidated balance sheet approximates fair
value. Unless otherwise stated, the rates used in discounted cash flow analyses
are based on market yield curves.
CASH AND SHORT-TERM ASSETS
The carrying amounts reported in the consolidated balance sheet for cash and
short-term investments approximate fair values primarily due to their short-term
nature. For purposes of this disclosure only, short-term assets include due from
banks, interest-earning deposits with banks, federal funds sold and resale
agreements, trading securities, customer's acceptance liability and accrued
interest receivable.
SECURITIES
The fair value of securities is based on quoted market prices, where available.
If quoted market prices are not available, fair value is estimated using the
quoted market prices of comparable instruments.
NET LOANS AND LOANS HELD FOR SALE
Fair values are estimated based on the discounted value of expected net cash
flows incorporating assumptions about prepayment rates, credit losses and
servicing fees and costs. For revolving home equity loans, this fair value does
not include any amount for new loans or the related fees that will be generated
from the existing customer relationships. In the case of nonaccrual loans,
scheduled cash flows exclude interest payments. The carrying value of loans held
for sale approximates fair value.
OTHER ASSETS Other Assets as shown in the accompanying table include
noncertificated interest only strips, Federal Home Loan Bank ("FHLB") and
Federal Reserve Bank ("FRB") stock, equity investments carried at cost, and
private equity investments. The fair value is estimated based on the discounted
value of expected net cash flows. The carrying amounts of the venture capital,
and private equity investments are recorded at fair value. The equity
investments carried at cost, including the FHLB and FRB stock, have a carrying
value which approximate fair value.
COMMERCIAL MORTGAGE SERVICING RIGHTS
Fair value is based on the present value of the future cash flows, including
assumptions as to prepayment speeds, discount rate, interest rates, cost to
service and other factors.
DEPOSITS
The carrying amounts of noninterest-bearing demand and interest-bearing money
market and savings deposits approximate fair values. For time deposits, which
include foreign deposits, fair values are estimated based on the discounted
value of expected net cash flows assuming current interest rates.
BORROWED FUNDS
The carrying amounts of federal funds purchased, commercial paper, acceptances
outstanding and accrued interest payable are considered to be their fair value
because of their short-term nature. For all other borrowed funds, fair values
are estimated based on the discounted value of expected net cash flows assuming
current interest rates.
UNFUNDED LOAN COMMITMENTS AND LETTERS OF CREDIT
The fair value of unfunded loan commitments and letters of credit is PNC's
estimate of the cost to terminate them. For purposes of this disclosure, this
fair value is the sum of the deferred fees currently recorded by PNC on these
facilities and the liability established on these facilities related to their
creditworthiness.
FINANCIAL AND OTHER DERIVATIVES
The fair value of derivatives is based on the discounted value of the expected
net cash flows. These fair values represent the amounts the Corporation would
receive or pay to terminate the contracts, assuming current interest rates.
NOTE 29 COMMITMENTS AND GUARANTEES
EQUITY FUNDING COMMITMENTS
The Corporation has commitments to make additional equity investments in certain
equity management entities and
104
affordable housing limited partnerships. These commitments totaled $273 million
at December 31, 2002.
STANDBY LETTERS OF CREDIT
PNC issues standby letters of credit and has risk participation in standby
letters of credit issued by other financial institutions, in each case to
support obligations of its customers to third parties. If the customer fails to
meet its financial or performance obligation to the third party under the terms
of the contract, then upon their request PNC would be obligated to make payment
to the guaranteed party. Standby letters of credit and risk participations in
standby letters of credit outstanding on December 31, 2002 had terms ranging
from less than 1 year to 8 years. The aggregate maximum amount of future
payments PNC could be required to make under outstanding standby letters of
credit and risk participations in standby letters of credit was $4.6 billion at
December 31, 2002. Assets valued, as of December 31, 2002, at approximately $1.3
billion secured certain specifically identified standby letters of credit and
letter of credit risk participations having aggregate future payments of
approximately $1.3 billion. In addition, a substantial portion of the remaining
standby letters of credit and letter of credit risk participations issued on
behalf of a specific customer are also secured by collateral or guarantees which
secure that customer's other obligations to PNC.
LIQUIDITY FACILITIES AND STANDBY BOND PURCHASE AGREEMENTS
PNC enters into liquidity facilities primarily to support individual pools of
receivables acquired by commercial paper conduits including Market Street. At
December 31, 2002, the aggregate commitments under these facilities was $3.6
billion, of which $3.2 billion was related to Market Street. Collateral or third
party insurance secures PNC's exposure under these facilities. PNC also enters
into Standby Bond Purchase Agreements to support municipal bond obligations. At
December 31, 2002, the aggregate of PNC's commitments under these facilities was
$299 million.
INDEMNIFICATIONS
PNC is a party to numerous acquisition or divestiture agreements, under which it
has purchased or sold, or agreed to purchase or sell, various types of assets.
These agreements can cover the purchase or sale of entire businesses, loan
portfolios, branch banks, partial interests in companies, or other types of
assets. They generally include indemnification provisions under which PNC
indemnifies the other parties to these agreements against a variety of risks to
the other parties as a result of the transaction in question; when PNC is the
seller, the indemnification provisions will generally also provide protection
relating to the quality of the assets being sold and the extent of any
liabilities being assumed. Due to the nature of these indemnification
provisions, it is not possible to quantify the aggregate exposure to PNC
resulting from them.
PNC provides indemnification in connection with securities offering
transactions in which it is involved. When PNC is the issuer of the securities,
it provides indemnification to the underwriter or placement agents analogous to
the indemnification provided purchasers of businesses from it, as described
above. When PNC is an underwriter or placement agent, it provides a limited
indemnification to the issuer related to its actions in connection with the
offering and, if there are other underwriters, indemnification to the other
underwriters intended to result in an appropriate sharing of the risk of
participating in the offering. Due to the nature of these indemnification
provisions, it is not possible to quantify the aggregate exposure to PNC
resulting from them.
PNC enters into certain types of agreements such as (i) agreements relating
to providing various servicing and processing functions to third parties, (ii)
agreements relating to the creation of trusts or other legal entities to
facilitate leasing transactions, CMBS transactions (loan securitizations) and
certain other off-balance sheet transactions, (iii) syndicated credit
agreements, as a syndicate member, and (iv) sales of individual loans, which
provide indemnification to third parties. Due to the nature of these
indemnification provisions, it is not possible to calculate potential exposure
under them.
PNC enters into certain types of agreements, such as leases with tenants,
in which PNC indemnifies third parties for acts by PNC's agents. While PNC does
not believe these indemnification liabilities are material, either individually
or in the aggregate, it is not possible to calculate potential exposure.
PNC enters into contracts for the delivery of technology service in which
PNC indemnifies the other party against claims of patent infringement by third
parties. Due to the nature of these indemnification provisions, it is not
possible to calculate potential exposure under this type of indemnification.
In the ordinary course of business PNC enters into contracts with third
parties pursuant to which the third parties provide services on behalf of PNC.
In many of the contracts PNC agrees to indemnify the third party service
provider under certain circumstances. The terms of the indemnity vary from
contract to contract and the amount of the indemnification liability, if any,
cannot be determined.
PNC is a general or limited partner in certain asset management and
investment limited partnerships, many of which contain indemnification
provisions which would require PNC to make payments in excess of its remaining
funding commitments. While in certain of these partnerships the maximum
liability to PNC is limited to the sum of PNC's unfunded commitments and
partnership distributions received by PNC, in the others the indemnification
liability is unlimited. As a result, it is not possible to determine the
aggregate potential exposure for these indemnifications.
105
Pursuant to their bylaws, the Corporation and its subsidiaries provide
indemnification to directors, officers and, in some cases, employees and agents
against certain liabilities incurred as a result of their service on behalf of
or at the request of the Corporation and its subsidiaries and also advance on
behalf of covered individuals costs incurred in defending against certain
claims, subject to written undertakings by each such individual to repay all
amounts so advanced if it is ultimately determined that the individual is not
entitled to indemnification. The Corporation advanced such defense costs on
behalf of several such individuals during 2002 with respect to pending
litigation or investigations. It is not possible to determine the aggregate
potential exposure resulting from the obligation to provide this indemnity or to
advance such costs.
In connection with the lending of securities held by its mutual fund
processing services business on behalf of certain of its customers, PNC provides
indemnification to those customers against the failure of the borrower to return
the securities. Each borrower's obligation to return the securities is fully
secured on a daily basis, and thus the exposure to the Corporation is limited to
temporary shortfalls in the collateral as a result of short-term fluctuations in
trading prices of the borrowed securities. At December 31, 2002, the aggregate
maximum potential exposure as a result of these indemnity obligations was $6.0
billion, although PNC held cash collateral at the time in excess of that amount.
CONTINGENT PAYMENTS IN CONNECTION WITH CERTAIN ACQUISITIONS
A number of the acquisition agreements to which PNC is a party and under which
it has purchased various types of assets, including the purchase of entire
businesses, partial interests in companies, or other types of assets, require
PNC to make additional payments in future years if certain predetermined goals,
such as revenue targets, are achieved or if other contingencies, such as
specified declines in the value of the consideration paid, occur within a
specified time. As certain of these provisions do not specify dollar
limitations, it is not possible to quantify the aggregate exposure to PNC
resulting from these agreements.
NBOC ACQUISITION PUT OPTION
See Note 2 NBOC Acquisition for a description of the Put Option, which
represents NBOC's right to transfer the then remaining Serviced Portfolio, as
defined, to PNC at the end of the loan servicing term. At December 31, 2002, the
Put Option liability was approximately $57 million. Based upon a third party
valuation, the estimated purchase price of the discontinued loan portfolio at
the Put Option exercise date is $175 million. While there is no recourse to
third parties for amounts that may be paid under this arrangement, the amount
paid under the Put Option is supported by a portfolio of loans which in turn are
supported by specific collateral. The loans would be liquidated in due course to
recover some or all of the amounts that may ultimately be paid in connection
with this Put Option.
NOTE 30 UNUSED LINE OF CREDIT
At December 31, 2002, the Corporation's parent company maintained a line of
credit in the amount of $460 million, none of which was drawn. This line is
available for general corporate purposes and expires in 2003.
NOTE 31 PARENT COMPANY
Summarized financial information of the parent company is as follows:
STATEMENT OF INCOME
Year ended December 31 - in
millions 2002 2001 2000
==================================== ======== ======== ========
OPERATING REVENUE
Dividends from:
Bank subsidiaries $525 $1,116 $690
Nonbank subsidiaries 71 60 55
Interest income 3 6 9
Noninterest income 1 2 1
- ------------------------------------ -------- -------- --------
Total operating revenue 600 1,184 755
==================================== ======== ======== ========
OPERATING EXPENSE
Interest expense 50 50 54
Other expense 77 6 (6)
- ------------------------------------ -------- -------- --------
Total operating expense 127 56 48
==================================== ======== ======== ========
Income before income taxes and
equity in undistributed net
income of subsidiaries 473 1,128 707
Income tax benefits (52) (17) (21)
- ------------------------------------ -------- -------- --------
Income before equity in
undistributed net income of
subsidiaries 525 1,145 728
Bank subsidiaries 631 (531) 386
Nonbank subsidiaries 28 (237) 165
- ------------------------------------ -------- -------- --------
Net income $1,184 $377 $1,279
==================================== ======== ======== ========
BALANCE SHEET
December 31 - in millions 2002 2001
========================================= ========== ==========
ASSETS
Cash and due from banks $1 $1
Securities available for sale 192 94
Investments in:
Bank subsidiaries 6,285 5,324
Nonbank subsidiaries 1,696 1,555
Other assets 160 152
- ----------------------------------------- ---------- ----------
Total assets $8,334 $7,126
========================================= ========== ==========
LIABILITIES
Nonbank affiliate borrowings $1,256 $1,086
Accrued expenses and other liabilities 219 217
- ----------------------------------------- ---------- ----------
Total liabilities 1,475 1,303
- ----------------------------------------- ---------- ----------
SHAREHOLDERS' EQUITY 6,859 5,823
- ----------------------------------------- ---------- ----------
Total liabilities and shareholders'
equity $8,334 $7,126
========================================= ========== ==========
Commercial paper and all other debt issued by PNC Funding Corp., a wholly owned
finance subsidiary, is fully and unconditionally guaranteed by the parent
company. In addition, in connection with certain affiliates' commercial mortgage
servicing operations, the parent company has committed to maintain such
affiliates' net worth above minimum requirements.
106
During 2002, 2001 and 2000, the parent company received net income tax
refunds of $36 million, $37 million and $36 million, respectively. Such refunds
represent the parent company's portion of consolidated income taxes. During
2002, 2001 and 2000, the parent company paid interest of $45 million, $49
million and $56 million, respectively.
STATEMENT OF CASH FLOWS
--------- -------- ---------
Year ended December 31 - in
millions 2002 2001 2000
================================= ========= ======== =========
OPERATING ACTIVITIES
Net income $1,184 $377 $1,279
Adjustments to reconcile net
income to net cash provided
(used) by operating activities:
Equity in undistributed net
earnings of subsidiaries (659) 768 (551)
Other 10 44 (24)
- --------------------------------- --------- -------- ---------
Net cash provided by operating
activities 535 1,189 704
================================= ========= ======== =========
INVESTING ACTIVITIES
Net change in short-term
investments with subsidiary
bank 16
Net capital (contributed to)
returned from subsidiaries (125) (237) 258
Securities available for sale
Sales and maturities 1,556 1,206 372
Purchases (1,655) (1,247) (425)
Other (1) (14) (13)
- --------------------------------- --------- -------- ---------
Net cash (used) provided by
investing activities (225) (292) 208
================================= ========= ======== =========
FINANCING ACTIVITIES
Borrowings from nonbank
subsidiary 393 763 314
Repayments on borrowings from
nonbank subsidiary (223) (190) (440)
Acquisition of treasury stock (62) (681) (428)
Cash dividends paid to
shareholders (546) (569) (546)
Issuance of stock 128 181 189
Series F preferred stock tender
offer/maturity (301)
Repayments on borrowings (100)
- --------------------------------- --------- -------- ---------
Net cash used by financing
activities (310) (897) (911)
================================= ========= ======== =========
Increase in cash and due from
banks 1
Cash and due from banks at
beginning of year 1 1
Cash and due from banks at end
of year $1 $1 $1
================================= ========= ======== =========
NOTE 32 SUBSEQUENT EVENT
In January 2003, PNC took actions to convert its preferred shares and
subsequently requested liquidation of the three companies formed in 2001 in
transactions with AIG. These companies had been consolidated into the financial
statements of PNC since 2001.
Prior to the distribution of assets, the companies sold debt securities
previously classified as held to maturity in their financial statements and
incurred liquidation costs as required by the operating agreements. Liquidating
distributions of cash and interests in subsidiaries of the three companies that
held loan and venture capital assets were made. These assets had been
transferred from PNC subsidiaries to the companies as part of the original
transactions in 2001. The net impact on PNC's consolidated financial condition
or results of operations was not material.
107
STATISTICAL INFORMATION (UNAUDITED)
THE PNC FINANCIAL SERVICES GROUP, INC.
SELECTED QUARTERLY FINANCIAL DATA
---------------------------------------------- -------------------------------------------
Dollars in millions,
except per share data 2002 2001(a)
---------------------------------------------- -------------------------------------------
Fourth Third Second First Fourth Third Second First
====================================== =========== ========= =========== ============ =========== ========= ========== ==========
SUMMARY OF OPERATIONS
Interest income $741 $769 $804 $858 $902 $984 $1,079 $1,172
Interest expense 217 241 249 268 324 419 514 618
- -------------------------------------- ----------- --------- ----------- ------------ ----------- --------- ---------- ----------
Net interest income 524 528 555 590 578 565 565 554
Provision for credit losses 65 73 89 82 668 110 45 80
Noninterest income before net
securities gains (losses) 765 703 854 786 446 646 729 700
Net securities gains(losses) 1 68 16 4 (3) 88 17 29
Noninterest expense 791 790 839 807 1,007 805 807 795
- -------------------------------------- ----------- --------- ----------- ------------ ----------- --------- ---------- ----------
Income (loss) from continuing
operations before minority interest
and income taxes 434 436 497 491 (654) 384 459 408
Minority interest in income of
consolidated entities 11 4 12 10 8 9 8 8
Income taxes 145 147 165 164 (232) 128 156 135
- -------------------------------------- ----------- --------- ----------- ------------ ----------- --------- ---------- ----------
Income (loss) from continuing
operations 278 285 320 317 (430) 247 295 265
(Loss) income from discontinued
operations (16) 5
- -------------------------------------- ----------- --------- ----------- ------------ ----------- --------- ---------- ----------
Income (loss) before cumulative
effect of accounting change 262 285 320 317 (430) 247 295 270
Cumulative effect of accounting change (5)
- -------------------------------------- ----------- --------- ----------- ------------ ----------- --------- ---------- ----------
Net income (loss) $262 $285 $320 $317 $(430) $247 $295 $265
====================================== =========== ========= =========== ============ =========== ========= ========== ==========
PER COMMON SHARE DATA
Book value $24.03 $23.62 $22.46 $21.02 $20.54 $23.09 $22.60 $22.39
Basic earnings (loss) (b)
Continuing operations .97 1.00 1.13 1.12 (1.52) .85 1.01 .90
Discontinued operations (.05) .02
- -------------------------------------- ----------- --------- ----------- ------------ ----------- --------- ---------- ----------
Before cumulative effect of
accounting change .92 1.00 1.13 1.12 (1.52) 85 1.01 .92
Cumulative effect of accounting
change (.02)
- -------------------------------------- ----------- --------- ----------- ------------ ----------- --------- ---------- ----------
Net income (loss) .92 1.00 1.13 1.12 (1.52) .85 1.01 .90
====================================== =========== ========= =========== ============ =========== ========= ========== ==========
Diluted earnings (loss) (c) (d)
Continuing operations .97 1.00 1.12 1.11 (1.52) .84 1.00 .89
Discontinued operations (.05) .02
- -------------------------------------- ----------- --------- ----------- ------------ ----------- --------- ---------- ----------
Before cumulative effect of
accounting change .92 1.00 1.12 1.11 (1.52) .84 1.00 .91
Cumulative effect of accounting
change (.02)
- -------------------------------------- ----------- --------- ----------- ------------ ----------- --------- ---------- ----------
Net income (loss) .92 1.00 1.12 1.11 (1.52) .84 1.00 .89
====================================== =========== ========= =========== ============ =========== ========= ========== ==========
(a) See Note 5 Fourth Quarter 2001 Actions for further information regarding
items impacting the comparability of fourth quarter 2001 amounts with other
quarterly data presented.
(b) The sum of the quarterly amounts for each year do not equal the respective
year's amount because the quarterly calculations are based on a changing
number of average shares.
(c) The sum of the quarterly amounts in 2001 does not equal the year's amount
because the quarterly calculations are based on a changing number of
average shares.
(d) Additional shares were excluded from fourth quarter 2001 EPS calculations
since they were antidilutive.
The Statistical Information (unaudited) presented on pages 108 through 113
reflects the residential mortgage business, which was sold on January 31, 2001,
in discontinued operations, unless otherwise noted.
108
ANALYSIS OF YEAR-TO-YEAR CHANGES IN NET INTEREST INCOME
------------------------------------------- -----------------------------------------------
2002/2001 2001/2000
------------------------------------------- -----------------------------------------------
INCREASE/(DECREASE) IN INCOME/EXPENSE Increase/(Decrease) in Income/Expense
DUE TO CHANGES IN: Due to Changes in:
Taxable-equivalent basis - in millions VOLUME RATE TOTAL Volume Rate Total
========================================= =========== ============ ============== =============== ============== ================
INTEREST-EARNING ASSETS
Loans held for sale $45 $(29) $16 $(35) $(50) $(85)
Securities
Securities available for sale
U.S. Treasury, government agencies
and corporations (34) (20) (54) 117 (5) 112
Other debt 76 (46) 30 181 (25) 156
State and municipal (1) (1) (3) (3)
Corporate stocks and other 5 5 (15) (18) (33)
-------------- ----------------
Total securities available for sale 48 (68) (20) 276 (44) 232
Securities held to maturity 13 (2) 11 6 6
-------------- ----------------
Total securities 62 (71) (9) 281 (43) 238
Loans, net of unearned income
Commercial (245) (221) (466) (162) (259) (421)
Commercial real estate (9) (46) (55) (9) (47) (56)
Consumer 34 (136) (102) (7) (52) (59)
Residential mortgage (281) (43) (324) (275) 10 (265)
Lease financing (3) (25) (28) 70 (12) 58
Other (4) (9) (13) (14) (11) (25)
-------------- ----------------
Total loans, net of unearned income (521) (467) (988) (399) (369) (768)
Other 81 (68) 13 24 (6) 18
-------------- ----------------
Total interest-earning assets $(265) $(703) $(968) $(42) $(555) $(597)
========================================= =========== ============ ============== =============== ============== ================
INTEREST-BEARING LIABILITIES
Interest-bearing deposits
Demand and money market $17 $(282) $(265) $82 $(234) $(152)
Savings 1 (9) (8) (2) (16) (18)
Retail certificates of deposit (91) (168) (259) (124) (68) (192)
Other time 4 (11) (7) (6) (6)
Deposits in foreign offices (12) (19) (31) (34) (22) (56)
-------------- ----------------
Total interest-bearing deposits (45) (525) (570) (27) (397) (424)
Borrowed funds
Federal funds purchased (44) (38) (82) (5) (39) (44)
Repurchase agreements (1) (18) (19) 11 (23) (12)
Bank notes and senior debt (16) (111) (127) (60) (106) (166)
Federal Home Loan Bank borrowings (19) (61) (80) 48 (33) 15
Subordinated debt (9) (28) (37) (3) (38) (41)
Other borrowed funds (9) 24 15 (36) 15 (21)
-------------- ----------------
Total borrowed funds (115) (215) (330) (18) (251) (269)
-------------- ----------------
Total interest-bearing liabilities (144) (756) (900) (43) (650) (693)
-------------- ----------------
Change in net interest income $(156) $88 $(68) $(20) $116 $96
========================================= =========== ============ ============== =============== ============== ================
Changes attributable to rate/volume are prorated into rate and volume
components.
109
AVERAGE CONSOLIDATED BALANCE SHEET AND NET INTEREST ANALYSIS
------------------------------------ -----------------------------------
2002 2001
------------------------------------ -----------------------------------
Dollars in millions Average Average Average Average
Taxable-equivalent basis Balances Interest Yields/Rates Balances Interest Yields/Rates
================================================== =========== ========= ============== =========== ========== ============
ASSETS
Interest-earning assets
Loans held for sale $2,897 $135 4.66% $2,021 $119 5.89%
Securities
Securities available for sale
U.S. Treasury and government agencies and
corporations 3,182 162 5.09 3,833 216 5.64
Other debt 7,916 420 5.31 6,549 390 5.96
State and municipal 61 5 8.20 74 6 8.11
Corporate stocks and other 488 14 2.87 319 9 2.82
- -------------------------------------------------- ----------- ---------- ----------- ----------
Total securities available for sale 11,647 601 5.16 10,775 621 5.76
Securities held to maturity 352 17 4.83 92 6 6.52
- -------------------------------------------------- ----------- ---------- ----------- ----------
Total securities 11,999 618 5.15 10,867 627 5.77
Loans, net of unearned income
Commercial 15,922 952 5.98 19,658 1,418 7.21
Commercial real estate 2,451 129 5.26 2,580 184 7.13
Consumer 9,545 630 6.60 9,099 732 8.04
Residential mortgage 4,639 311 6.70 8,801 635 7.22
Lease financing 4,173 265 6.35 4,223 293 6.94
Credit card
Other 393 17 4.33 460 30 6.52
- -------------------------------------------------- ----------- ---------- ----------- ----------
Total loans, net of unearned income 37,123 2,304 6.21 44,821 3,292 7.34
Other 3,326 128 3.85 1,632 115 7.05
- -------------------------------------------------- ----------- ---------- ----------- ----------
Total interest-earning assets/interest income 55,345 3,185 5.75 59,341 4,153 7.00
Noninterest-earning assets
Investment in discontinued operations 51
Allowance for credit losses (628) (614)
Cash and due from banks 2,729 2,939
Other assets 9,143 8,768
- -------------------------------------------------- ----------- -----------
Total assets $66,589 $70,485
================================================== =========== ===========
LIABILITIES, MINORITY INTEREST, CAPITAL
SECURITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities
Interest-bearing deposits
Demand and money market $22,086 241 1.09 $21,322 506 2.37
Savings 2,033 10 .49 1,928 18 .93
Retail certificates of deposit 10,361 375 3.62 12,313 634 5.15
Other time 596 27 4.53 522 34 6.51
Deposits in foreign offices 443 6 1.35 829 37 4.46
- -------------------------------------------------- ----------- ---------- ----------- ----------
Total interest-bearing deposits 35,519 659 1.86 36,914 1,229 3.33
Borrowed funds
Federal funds purchased 551 9 1.63 2,057 91 4.42
Repurchase agreements 956 14 1.46 980 33 3.37
Bank notes and senior debt 5,168 138 2.67 5,521 265 4.80
Federal Home Loan Bank borrowings 1,528 3 .20 2,178 83 3.81
Subordinated debt 2,210 101 4.57 2,362 138 5.84
Other borrowed funds 299 51 17.06 384 36 9.38
- -------------------------------------------------- ----------- ---------- ----------- ----------
Total borrowed funds 10,712 316 2.95 13,482 646 4.79
- -------------------------------------------------- ----------- ---------- ----------- ----------
Total interest-bearing liabilities/interest
expense 46,231 975 2.11 50,396 1,875 3.72
Noninterest-bearing liabilities, minority
interest, capital securities and shareholders'
equity
Demand and other noninterest-bearing deposits 8,599 8,297
Allowance for unfunded loan commitments and
letters of credit 80 79
Accrued expenses and other liabilities 4,326 4,096
Minority interest 212 136
Mandatorily redeemable capital securities of
subsidiary trusts 848 848
Shareholders' equity 6,293 6,633
- -------------------------------------------------- ----------- -----------
Total liabilities, minority interest, capital
securities and shareholders' equity $66,589 $70,485
- -------------------------------------------------- ----------- ---------- ------------- ----------- ---------- ------------
Interest rate spread 3.64 3.28
Impact of noninterest-bearing sources .35 .56
- -------------------------------------------------- ----------- ---------- ------------- ----------- ---------- ------------
Net interest income/margin $2,210 3.99% $2,278 3.84%
================================================== =========== ========== ============= =========== ========== ============
Nonaccrual loans are included in loans, net of unearned income. The impact of
financial derivatives used in interest rate risk management is included in the
interest and average yields/rates of the related assets and liabilities. Average
balances of securities available for sale are based on amortized historical cost
(excluding SFAS No. 115 adjustments to fair value).
110
- -------------------------------------- ------------------------------------------ ---------------------------------------------
2000 1999 1998
- -------------------------------------- ------------------------------------------ ---------------------------------------------
Average Average Average Average Average Average
Balances Interest Yields/Rates Balances Interest Yields/Rates Balances Interest Yields/Rates
============== ========== ============ ============== ============ ============== =============== ============ ================
$2,507 $204 8.14% $1,392 $104 7.47% $436 $31 7.11%
1,760 104 5.91 1,970 108 5.48 3,665 208 5.68
3,545 234 6.60 3,307 209 6.32 1,770 114 6.44
114 9 7.89 135 12 8.89 141 14 9.93
642 42 6.54 672 37 5.51 553 30 5.42
- -------------- ---------- -------------- ------------ --------------- ------------
6,061 389 6.42 6,084 366 6.02 6,129 366 5.97
- -------------- ---------- -------------- ------------ --------------- ------------
6,061 389 6.42 6,084 366 6.02 6,129 366 5.97
21,685 1,839 8.48 23,082 1,792 7.76 22,768 1,794 7.88
2,685 240 8.94 3,362 265 7.88 3,279 277 8.45
9,177 791 8.62 10,310 844 8.19 11,073 940 8.49
12,599 900 7.14 12,258 859 7.01 12,421 900 7.25
3,222 235 7.29 2,564 182 7.10 2,028 143 7.05
672 100 14.88 3,849 538 13.98
650 55 8.46 532 40 7.52 195 14 7.18
- -------------- ---------- -------------- ------------ --------------- ------------
50,018 4,060 8.12 52,780 4,082 7.73 55,613 4,606 8.28
1,289 97 7.53 1,045 53 5.07 899 47 5.23
- -------------- ---------- -------------- ------------ --------------- ------------
59,875 4,750 7.93 61,301 4,605 7.51 63,077 5,050 8.01
487 449 348
(608) (619) (772)
2,718 2,082 2,211
6,581 5,226 4,851
- -------------- -------------- ---------------
$69,053 $68,439 $69,715
============== ============== ===============
$18,735 658 3.51 $16,921 493 2.91 $14,285 439 3.07
2,050 36 1.76 2,390 39 1.63 2,620 51 1.95
14,642 826 5.64 14,220 708 4.98 15,420 826 5.36
621 40 6.44 1,515 85 5.61 1,786 103 5.77
1,473 93 6.31 872 44 5.05 935 52 5.56
- -------------- ---------- -------------- ------------ --------------- ------------
37,521 1,653 4.41 35,918 1,369 3.81 35,046 1,471 4.20
2,139 135 6.31 1,662 84 5.05 2,526 139 5.50
754 45 5.97 621 31 4.99 791 42 5.31
6,532 431 6.60 8,517 457 5.37 10,657 605 5.68
1,113 68 6.11 1,929 105 5.44 1,026 60 5.85
2,406 179 7.44 2,051 154 7.51 1,799 140 7.78
802 57 7.11 686 39 5.69 1,109 79 7.12
- -------------- ---------- -------------- ------------ --------------- ------------
13,746 915 6.66 15,466 870 5.63 17,908 1,065 5.95
- -------------- ---------- -------------- ------------ --------------- ------------
51,267 2,568 5.01 51,384 2,239 4.36 52,954 2,536 4.79
8,151 8,234 8,848
75 76 91
2,479 1,995 1,465
96 32 14
848 848 762
6,137 5,870 5,581
- -------------- -------------- ---------------
$69,053 $68,439 $69,715
- -------------- ---------- ------------ -------------- ------------ -------------- --------------- ------------ ----------------
2.92 3.15 3.22
.72 .71 .77
- -------------- ---------- ------------ -------------- ------------ -------------- --------------- ------------ ----------------
$2,182 3.64% $2,366 3.86% $2,514 3.99%
============== ========== ============ ============== ============ ============== =============== ============ ================
Loan fees for each of the years ended December 31, 2002, 2001, 2000, 1999 and
1998 were $106 million, $119 million, $115 million, $120 million and $107
million, respectively.
111
SUMMARY OF LOAN LOSS EXPERIENCE
------------- -------------- -------------- -------------- ---------------
Year ended December 31 - dollars in millions 2002 2001 2000 1999 1998
===================================================== ============= ============== ============== ============== ===============
Allowance at beginning of year $560 $598 $600 $678 $882
Charge-offs
Commercial (194) (876) (121) (72) (122)
Commercial real estate (3) (37) (3) (4) (8)
Consumer (40) (42) (46) (63) (83)
Residential mortgage (5) (2) (8) (8) (7)
Lease financing (25) (28) (8) (9) (7)
Credit card (60) (297)
- ----------------------------------------------------- ------------- -------------- -------------- -------------- ---------------
Total charge-offs (267) (985) (186) (216) (524)
===================================================== ============= ============== ============== ============== ===============
Recoveries
Commercial 26 17 21 22 20
Commercial real estate 1 1 4 4 3
Consumer 14 16 22 25 34
Residential mortgage 1 1 2 1 1
Lease financing 2 2 2 1 2
Credit card 2 17
- ----------------------------------------------------- ------------- -------------- -------------- -------------- ---------------
Total recoveries 44 37 51 55 77
===================================================== ============= ============== ============== ============== ===============
Net charge-offs (223) (948) (135) (161) (447)
Provision for credit losses 309 903 136 163 225
Acquisitions/(divestitures) 41 (81) 3
Net change in allowance for unfunded loan
commitments and letters of credit (14) 7 (3) 1 15
===================================================== ============= ============== ============== ============== ===============
Allowance at end of year $673 $560 $598 $600 $678
===================================================== ============= ============== ============== ============== ===============
Allowance as a percent of period-end
Loans 1.90% 1.47% 1.18% 1.21% 1.18%
Nonperforming loans 218 265 185 206 237
As a percent of average loans
Net charge-offs (a) .60 2.12 .27 .31 .80
Provision for credit losses (b) .83 2.01 .27 .31 .40
Allowance for credit losses 1.81 1.25 1.20 1.14 1.22
Allowance as a multiple of net charge-offs (a) 3.02X .59x 4.43x 3.73x 1.52x
===================================================== ============= ============= =============== ============== ===============
(a) Excluding $804 million of net charge-offs in 2001 related to the
institutional lending repositioning initiative, net charge-offs would be
.32% of average loans and the allowance as a multiple of net charge-offs
would be 3.89x.
(b) Excluding $714 million of provision in 2001 related to the institutional
lending repositioning initiative, provision for credit losses would be .42%
of average loans.
The following table presents the allocation of allowance for credit losses and
the categories of loans as a percentage of total loans. Changes in the
allocation over time reflect the changes in loan portfolio composition, risk
profile and refinements to reserve methodologies. For purposes of this
presentation, the unallocated portion of the allowance for credit losses has
been assigned to loan categories based on the relative specific and pool
allocation amounts. At December 31, 2002, the unallocated portion was $112
million.
ALLOCATION OF ALLOWANCE FOR CREDIT LOSSES
----------------------- -------------------- ------------------- ---------------------- ---------------------
2002 2001 2000 1999 1998
----------------------- -------------------- ------------------- ---------------------- ---------------------
December 31 Loans Loans Loans Loans Loans
to to to to to
Dollars in Total Total Total Total Total
millions Allowance Loans Allowance Loans Allowance Loans Allowance Loans Allowance Loans
================== =========== =========== ========= ========== ========= ========= ========== =========== ========== ==========
Commercial $504 42.3% $392 40.0% $467 41.9% $447 43.2% $393 43.7%
Commercial real
estate 52 6.4 63 6.3 44 5.1 52 5.5 50 6.0
Consumer 28 27.8 39 24.1 43 18.0 51 18.8 65 19.0
Residential
mortgage 10 11.0 8 16.8 9 26.2 11 25.2 9 21.3
Credit card 136 5.1
Lease financing
and other 79 12.5 58 12.8 35 8.8 39 7.3 25 4.9
- ------------------ ----------- ----------- --------- ---------- --------- --------- ---------- ----------- ---------- ----------
Total $673 100.0% $560 100.0% $598 100.0% $600 100.0% $678 100.0%
================== =========== =========== ========= ========== ========= ========= ========== =========== ========== ==========
112
SHORT-TERM BORROWINGS
Federal funds purchased include overnight borrowings and term federal funds,
which are payable on demand. Repurchase agreements generally have maturities of
18 months or less. Approximately 60% of the total bank notes of the Corporation
mature in 2003. Other short-term borrowings primarily consist of U.S. Treasury,
tax and loan borrowings, which are payable on demand and commercial paper, which
is issued in maturities not to exceed nine months. At December 31, 2002, 2001
and 2000, $2.4 billion, $2.4 billion and $3.4 billion, respectively, notional
value of interest rate swaps were designated to borrowed funds. The effect of
these swaps is included in the rates set forth in the following table.
SHORT-TERM BORROWINGS
--------------------------- ------------------------- ----------------------------
2002 2001 2000
--------------------------- ------------------------- ----------------------------
Dollars in millions Amount Rate Amount Rate Amount Rate
============================================== ============== ============ ============ ============ ============ ===============
Federal funds purchased
Year-end balance $38 1.06% $167 1.52% $1,445 4.89%
Average during year 551 1.63 2,057 4.42 2,139 6.31
Maximum month-end balance during year 3,563 2,817 2,778
Repurchase agreements
Year-end balance 814 1.28 954 1.56 607 5.77
Average during year 956 1.46 980 3.37 754 5.97
Maximum month-end balance during year 1,121 1,247 864
Bank notes
Year-end balance 1,854 1.63 3,600 2.68 5,512 6.74
Average during year 2,514 2.06 4,273 4.70 5,934 6.55
Maximum month-end balance during year 2,801 5,513 6,527
Other
Year-end balance 147 2.58 244 2.83 632 6.31
Average during year 311 1.42 362 4.34 784 6.87
Maximum month-end balance during year 876 1,131 1,368
============================================== ============== ============ ============ ============ ============ ===============
LOAN MATURITIES AND INTEREST SENSITIVITY
---------- --------- -------- ----------
December 31, 2002 1 Year Through After 5 Gross
In millions or Less 5 Years Years Loans
===================== ========== ========= ======== ==========
Commercial $6,807 $7,028 $1,152 $14,987
Real estate project 984 677 89 1,750
- --------------------- ---------- --------- -------- ----------
Total $7,791 $7,705 $1,241 $16,737
- --------------------- ---------- --------- -------- ----------
Loans with
Predetermined rate $672 $1,029 $484 $2,185
Floating rate 7,119 6,676 757 14,552
- --------------------- ---------- --------- -------- ----------
Total $7,791 $7,705 $1,241 $16,737
===================== ========== ========= ======== ==========
At December 31, 2002, $3.6 billion notional value of interest rate swaps, caps
and floors designated to commercial loans altered the interest rate
characteristics of such loans. The basis adjustment related to fair value hedges
for commercial loans is included in the above table.
TIME DEPOSITS OF $100,000 OR MORE
Time deposits in foreign offices totaled $463 million at December 31, 2002,
substantially all of which are in denominations of $100,000 or more. The
following table sets forth maturities of domestic time deposits of $100,000 or
more:
-----------------
December 31, 2002 - in millions Certificates
of Deposit
============================================ =================
Three months or less $525
Over three through six months 373
Over six through twelve months 227
Over twelve months 1,111
- -------------------------------------------- -----------------
Total $2,236
============================================ =================
COMMON STOCK PRICES/DIVIDENDS DECLARED
The table below sets forth by quarter the range of high and low sale and
quarter-end closing prices for The PNC Financial Services Group, Inc. common
stock and the cash dividends declared per common share.
---------------- --------- ------------ -----------
Cash
Dividends
High Low Close Declared
============== ============== ========== =========== ===========
2002 Quarter
First $62.800 $52.500 $61.490 $.48
Second 61.490 49.600 52.280 .48
Third 52.750 32.700 42.170 .48
Fourth 44.230 36.020 41.900 .48
- -------------- -------------- ---------- ----------- -----------
Total $1.92
============== ============== ========== =========== ===========
2001 Quarter
First $75.813 $56.000 $67.750 $.48
Second 71.110 62.400 65.790 .48
Third 70.390 51.140 57.250 .48
Fourth 60.110 52.300 56.200 .48
- -------------- -------------- ---------- ----------- -----------
Total $1.92
============== ============== ========== =========== ===========
113
CORPORATE INFORMATION
THE PNC FINANCIAL SERVICES GROUP, INC.
CORPORATE HEADQUARTERS
The PNC Financial Services Group, Inc.
One PNC Plaza
249 Fifth Avenue
Pittsburgh, Pennsylvania 15222-2707
(412) 762-2000
STOCK LISTING
The PNC Financial Services Group, Inc. common stock is listed on the New York
Stock Exchange under the symbol PNC. At the close of business on February 7,
2003, there were 51,948 common shareholders of record.
INTERNET INFORMATION
The PNC Financial Services Group, Inc.'s financial reports and information about
its products and services are available on the Internet at www.pnc.com.
FINANCIAL INFORMATION
The Annual Report on Form 10-K is filed with the Securities and Exchange
Commission ("SEC"). Copies of this document and other filings, including
exhibits thereto, may be obtained electronically at the SEC's home page at
www.sec.gov or at PNC's home page at www.pnc.com. Copies may also be obtained
without charge by contacting Shareholder Services at (800) 982-7652 or via email
at web.queries@computershare.com.
INQUIRIES
For financial services call 1-888-PNC-2265. Individual shareholders should
contact Shareholder Services at (800) 982-7652.
Analysts and institutional investors should contact William H. Callihan,
Director of Investor Services, at (412) 762-8257 or via e-mail at
investor.relations@pnc.com.
News media representatives and others seeking general information should
contact R. Jeep Bryant, Senior Vice President, Corporate Communications, at
(412) 762-4550 or via e-mail at corporate.communications@pnc.com.
TRUST PROXY VOTING
Reports of 2002 nonroutine proxy voting by the trust divisions of The PNC
Financial Services Group, Inc. are available by writing to Thomas R. Moore,
Corporate Secretary, at corporate headquarters.
ANNUAL SHAREHOLDERS MEETING
All shareholders are invited to attend The PNC Financial Services Group, Inc.
annual meeting on Tuesday, April 22, 2003, at 11 a.m., Eastern Daylight Time, at
One PNC Plaza, 249 Fifth Avenue, Pittsburgh, Pennsylvania 15222.
ADDITIONAL EXECUTIVE OFFICERS
(See also Executive Officers pictured on page 21)
Robert C. Barry, Jr.
Director of Finance
Michael J. Hannon
Chief Credit Policy Officer
Richard J. Johnson
Director of Finance
Samuel R. Patterson
Controller
DIVIDEND POLICY
Holders of The PNC Financial Services Group, Inc. common stock are entitled to
receive dividends when declared by the Board of Directors out of funds legally
available. The Board presently intends to continue the policy of paying
quarterly cash dividends. However, future dividends will depend on earnings, the
financial condition of The PNC Financial Services Group, Inc. and other factors,
including applicable government regulations and policies and contractual
restrictions.
DIVIDEND REINVESTMENT AND STOCK PURCHASE PLAN
The PNC Financial Services Group, Inc. Dividend Reinvestment and Stock Purchase
Plan enables holders of common and preferred stock to purchase additional shares
of common stock conveniently and without paying brokerage commissions or service
charges. A prospectus and enrollment form may be obtained by contacting
Shareholder Services at (800) 982-7652.
REGISTRAR AND TRANSFER AGENT
Computershare Investor Services, LLC
2 North LaSalle Street
Chicago, IL 60602
(800) 982-7652
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