THE PNC FINANCIAL SERVICES GROUP, INC. Quarterly Report on Form 10-Q For the quarterly period ended June 30, 2001 Page 1 represents a portion of the second quarter 2001 Financial Review which is not required by the Form 10-Q report and is not "filed" as part of the Form 10-Q. The Quarterly Report on Form 10-Q and cross reference index is on page 41. CONSOLIDATED FINANCIAL HIGHLIGHTS THE PNC FINANCIAL SERVICES GROUP, INC.
Three months ended June 30 Six months ended June 30 ------------------------------ ---------------------------- Dollars in millions, except per share data 2001 2000 2001 2000 - ------------------------------------------------------------------------------------------------------------------------ FINANCIAL PERFORMANCE Revenue Net interest income (taxable-equivalent basis) $569 $550 $1,128 $1,110 Noninterest income 720 728 1,421 1,456 ------------------------------ ---------------------------- Total revenue 1,289 1,278 2,549 2,566 Income from continuing operations 295 299 560 601 Discontinued operations 16 40 22 ------------------------------ ---------------------------- Income before cumulative effect of accounting change 295 315 600 623 Cumulative effect of accounting change (5) ------------------------------ ---------------------------- Net income $295 $315 $595 $623 ============================== ============================ CASH EARNINGS (a) Continuing operations $324 $328 $619 $659 Discontinued operations 16 40 22 ------------------------------ ---------------------------- Before cumulative effect of accounting change 324 344 659 681 Cumulative effect of accounting change (5) ------------------------------ ---------------------------- Net income from cash earnings $324 $344 $654 $681 ============================== ============================ Per common share DILUTED EARNINGS Continuing operations $1.00 $1.01 $1.89 $2.02 Discontinued operations .05 .14 .07 ------------------------------ ---------------------------- Before cumulative effect of accounting change 1.00 1.06 2.03 2.09 Cumulative effect of accounting change (.02) ------------------------------ ---------------------------- Net income $1.00 $1.06 $2.01 $2.09 ============================== ============================ DILUTED CASH EARNINGS (a) Continuing operations $1.10 $1.10 $2.10 $2.21 Discontinued operations .06 .14 .08 ------------------------------ ---------------------------- Before cumulative effect of accounting change 1.10 1.16 2.24 2.29 Cumulative effect of accounting change (.02) ------------------------------ ---------------------------- Net income from cash earnings $1.10 $1.16 $2.22 $2.29 ============================== ============================ Cash dividends declared $.48 $.45 $.96 $.90 - ------------------------------------------------------------------------------------------------------------------------ SELECTED RATIOS FROM CONTINUING OPERATIONS Return on Average common shareholders' equity 18.13% 20.77% 17.36% 21.03% Average assets 1.67 1.74 1.58 1.75 Net interest margin 3.76 3.63 3.70 3.65 Noninterest income to total revenue 55.86 56.96 55.75 56.74 Efficiency (b) 57.65 57.29 57.78 57.57 FROM NET INCOME Return on Average common shareholders' equity 18.13% 21.91% 18.47% 21.81% Average assets 1.67 1.68 1.65 1.67 Net interest margin 3.76 3.41 3.64 3.43 Noninterest income to total revenue 55.86 58.92 56.51 58.60 Efficiency (c) 57.65 55.70 56.87 56.53 ========================================================================================================================
(a) Excludes amortization of goodwill and does not reflect the implementation of SFAS No. 142. (b) Excludes amortization and distributions on capital securities. (c) Excludes amortization, distributions on capital securities and residential mortgage banking risk management activities. 1
June 30 December 31 June 30 Dollars in millions, except per share data 2001 2000 2000 - ------------------------------------------------------------------------------------------------------- BALANCE SHEET DATA Assets $70,013 $69,844 $68,885 Earning assets 58,326 59,373 59,334 Loans, net of unearned income 44,167 50,601 50,281 Securities available for sale 11,258 5,902 5,315 Loans held for sale 1,613 1,655 2,305 Deposits 45,826 47,664 46,381 Borrowed funds 12,119 11,718 13,028 Shareholders' equity 6,748 6,656 6,157 Common shareholders' equity 6,532 6,344 5,844 Book value per common share 22.60 21.88 20.22 Loans to deposits 96% 106% 108% CAPITAL RATIOS Leverage 8.1% 8.0% 6.7% Common shareholders' equity to total assets 9.33 9.08 8.48 ASSET QUALITY RATIOS Nonperforming assets to total loans, loans held for sale and foreclosed assets .85% .71% .67% Allowance for credit losses to total loans 1.53 1.33 1.34 Allowance for credit losses to nonaccrual loans 180.48 208.98 217.04 Net charge-offs to average loans (For the three months ended) .40 .32 .27 =======================================================================================================
2 FINANCIAL REVIEW THE PNC FINANCIAL SERVICES GROUP, INC. This Financial Review should be read in conjunction with The PNC Financial Services Group, Inc. ("Corporation" or "PNC") unaudited Consolidated Financial Statements and Statistical Information included herein and the Financial Review and audited Consolidated Financial Statements included in the Corporation's 2000 Annual Report. For information regarding certain business risks, see the Risk Management and Risk Factors 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. 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, corporate banking, real estate finance, asset-based lending, wealth management, asset management and global fund 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 asset management and global fund services internationally. Financial services organizations today are challenged to demonstrate that they can generate high-quality earnings growth in an increasingly competitive and weakened economic environment, one with slower growth rates, asset quality concerns and weaker equity markets. As a result, PNC has been aggressively pursuing strategies to create a more diverse and valuable business mix by increasing the contribution from more highly-valued businesses such as asset management, processing and treasury management and decreasing the contribution from lending-based traditional banking businesses. Earnings from asset management and processing businesses represented 26% of total business earnings for the first six months of 2001 and noninterest income was 57% of total revenue. At the same time, PNC sold its residential mortgage banking business and has been downsizing certain institutional lending portfolios resulting in a reduction of the loan to deposit ratio to 96% at June 30, 2001. On January 31, 2001, PNC closed the sale of its residential mortgage banking business. The gain on sale and earnings from operations included in the first six months of 2001 totaled $40 million or $.14 per diluted share. These earnings were partially offset by a $32 million or $.11 per diluted share charge in the first quarter of 2001 related to the charge-off of loans in the communications and energy, metals and mining portfolios that PNC has designated for downsizing and severance costs. Certain closing date adjustments are currently in dispute between PNC and the buyer. The disputed matters will be resolved in accordance with procedures provided for in the purchase agreement. The ultimate financial impact of the sale will not be determined until final settlement is completed. SUMMARY FINANCIAL RESULTS Consolidated net income for the first six months of 2001 was $595 million or $2.01 per diluted share. Excluding the effect of adopting the new accounting standard for financial derivatives, net income was $600 million or $2.03 per diluted share compared with $623 million or $2.09 per diluted share for the first six months of 2000. These results include the negative impact of a $49 million or $.17 per diluted share net loss from venture capital activities. Excluding this loss and the effect of the accounting change, results for the first six months of 2001 were $649 million or $2.20 per diluted share. Return on average common shareholders' equity was 18.47% and return on average assets was 1.65% for the first six months of 2001 compared with 21.81% and 1.67%, respectively, for the first six months of 2000. The residential mortgage banking business is reflected in discontinued operations throughout the Corporation's consolidated financial statements. Accordingly, the earnings and net assets of the residential mortgage banking business are shown separately on one line in the income statement and balance sheet, respectively, for all periods presented. The remainder of the discussion and information in this Financial Review reflects continuing operations, unless otherwise noted. Income from continuing operations for the first six months of 2001 was $560 million or $1.89 per diluted share. Excluding the $49 million net loss from venture capital activities and a $32 million charge in the first quarter of 2001 related to loans designated for downsizing and severance costs, income from continuing operations increased 7% to $641 million or $2.17 per diluted share for the first six months of 2001 compared with the same period a year ago. Taxable-equivalent net interest income of $1.128 billion for the first six months of 2001 increased 2% compared with the first six months of 2000. The net interest margin was 3.70% for the first six months of 2001 compared with 3.65% for the first six months of 2000. The increases were primarily due to the positive impact of transaction deposit growth and a lower rate environment that was partially offset by the impact of continued downsizing of the loan portfolio. 3 The provision for credit losses was $125 million for the first six months of 2001 compared with $66 million for the same period in 2000. The increase was primarily related to loans in the communications and energy, metals and mining portfolios that PNC is downsizing. Noninterest income was $1.421 billion for the first six months of 2001 and included $69 million of equity management losses from venture capital activities. Excluding equity management gains and losses from both years, noninterest income increased 13% compared with the first six months of 2000 primarily due to growth in asset management and processing revenue. Noninterest expense was $1.564 billion for the first six months of 2001 compared with $1.572 billion for the first six months of 2000 and the efficiency ratio remained flat at 58% during both periods. The decrease in expense was primarily due to aggressive expense management. Total assets were $70.0 billion at June 30, 2001 compared with $69.8 billion at December 31, 2000. Average interest-earning assets were $60.7 billion for the first six months of 2001 compared with $60.3 billion for the first six months of 2000. A decline in loans and loans held for sale was offset by an increase in securities available for sale that are used for balance sheet and interest rate risk management activities. Shareholders' equity totaled $6.7 billion at June 30, 2001 and the regulatory capital ratios were 8.1% for leverage, 9.0% for tier I risk-based and 12.8% for total risk-based capital. During the first six months of 2001, PNC repurchased 3.4 million shares of common stock. Nonperforming assets were $390 million at June 30, 2001 compared with $372 million at December 31, 2000. The ratio of nonperforming assets to total loans, loans held for sale and foreclosed assets increased to .85% at June 30, 2001 compared with .71% at December 31, 2000 primarily due to the impact of downsizing the loan portfolio. The allowance for credit losses was $675 million and represented 1.53% of total loans and 180% of nonaccrual loans at June 30, 2001. The comparable amounts were $675 million, 1.33% and 209%, respectively, at December 31, 2000. The increase in the allowance as a percentage of total loans primarily resulted from the downsizing of the loan portfolio. Net charge-offs were $125 million or .53% of average loans for the first six months of 2001 compared with $65 million or .26% for the same period in 2000. The increase was primarily related to loans in institutional lending portfolios that PNC is downsizing. 4 FINANCIAL REVIEW THE PNC FINANCIAL SERVICES GROUP, INC. REVIEW OF BUSINESSES PNC operates seven major businesses engaged in regional community banking, corporate banking, real estate finance, asset-based lending, wealth management, asset management and global fund services. Business results 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 business results are not necessarily comparable with similar information for any other financial services institution. 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 change from time to time as management accounting practices are enhanced and businesses change. Securities available for sale 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. 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 primarily due to differences between management accounting practices and generally accepted accounting principles, loan portfolios and businesses that have been designated for downsizing during 2000 or earlier, equity management activities, minority interests, residual asset and liability management activities, eliminations and unassigned items, the impact of which is reflected in the "Other" category. The operating results and financial impact of the disposition of the residential mortgage banking business, previously PNC Mortgage, are included in discontinued operations. RESULTS OF BUSINESSES
Revenue Return on Earnings (taxable-equivalent basis) Assigned Capital Average Assets --------------------------------------------------------------------------------------- Six months ended June 30 - dollars in millions 2001 2000 2001 2000 2001 2000 2001 2000 - ---------------------------------------------------------------------------------------------------------------------------------- PNC Bank Regional Community Banking $339 $281 $1,100 $991 25% 22% $40,321 $38,182 Corporate Banking 66 120 384 420 11 20 16,612 16,110 - --------------------------------------------------------------------------------- ---------------------- Total PNC Bank 405 401 1,484 1,411 21 21 56,933 54,292 - --------------------------------------------------------------------------------- ---------------------- Secured Finance PNC Real Estate Finance 38 33 106 103 19 17 5,291 5,604 PNC Business Credit 30 26 71 57 38 36 2,429 2,173 - --------------------------------------------------------------------------------- ---------------------- Total Secured Finance 68 59 177 160 25 23 7,720 7,777 - --------------------------------------------------------------------------------- ---------------------- Total Banking 473 460 1,661 1,571 21 22 64,653 62,069 - --------------------------------------------------------------------------------- ---------------------- Asset Management and Processing PNC Advisors 83 86 389 398 30 31 3,420 3,577 BlackRock 52 40 269 221 26 27 571 434 PFPC 32 16 370 331 31 16 1,742 1,587 - --------------------------------------------------------------------------------- ---------------------- Total Asset Management and Processing 167 142 1,028 950 29 27 5,733 5,598 - --------------------------------------------------------------------------------- ---------------------- Total business results 640 602 2,689 2,521 23 23 70,386 67,667 Other (80) (1) (140) 45 861 833 - --------------------------------------------------------------------------------- ---------------------- Results from continuing operations 560 601 2,549 2,566 17 21 71,247 68,500 Discontinued operations 40 22 103 430 Cumulative effect of accounting change (5) - --------------------------------------------------------------------------------- ---------------------- Total Consolidated $595 $623 $2,549 $2,566 18 22 $71,350 $68,930 ==================================================================================================================================
5 REGIONAL COMMUNITY BANKING Six months ended June 30 - dollars in millions 2001 2000 - ----------------------------------------------------------------- INCOME STATEMENT Net interest income $718 $703 Other noninterest income 339 292 Net securities gains (losses) 43 (4) - ----------------------------------------------------------------- Total revenue 1,100 991 Provision for credit losses 20 22 Noninterest expense 551 534 - ----------------------------------------------------------------- Pretax earnings 529 435 Income taxes 190 154 - ----------------------------------------------------------------- Earnings $339 $281 - ----------------------------------------------------------------- AVERAGE BALANCE SHEET Loans Consumer Home equity $6,121 $5,311 Indirect 895 1,352 Other consumer 924 871 - ----------------------------------------------------------------- Total consumer 7,940 7,534 Commercial 3,624 3,711 Residential mortgage 9,603 11,599 Leasing 1,799 1,179 Other 136 172 - ----------------------------------------------------------------- Total loans 23,102 24,195 Securities available for sale 9,346 5,470 Loans held for sale 1,288 1,358 Assigned assets and other assets 6,585 7,159 - ----------------------------------------------------------------- Total assets $40,321 $38,182 - ----------------------------------------------------------------- Deposits Noninterest-bearing demand $4,488 $4,591 Interest-bearing demand 5,517 5,377 Money market 11,919 9,776 Savings 1,870 2,063 Certificates 12,741 13,524 - ----------------------------------------------------------------- Total deposits 36,535 35,331 Other liabilities 1,066 274 Assigned capital 2,720 2,577 Total funds $40,321 $38,182 - ----------------------------------------------------------------- PERFORMANCE RATIOS Return on assigned capital 25% 22% Noninterest income to total revenue 35 29 Efficiency 48 52 ================================================================= Regional Community Banking provides deposit, branch-based brokerage, electronic banking and credit products and services to retail customers as well as deposit, credit, treasury management and capital markets products and services to small businesses primarily within PNC's geographic region. Regional Community Banking's strategic focus is on driving sustainable revenue growth, aggressively managing the revenue/expense relationship and improving the risk/return dynamic of this business. Regional Community Banking utilizes knowledge-based marketing capabilities to analyze customer demographic information, transaction patterns and delivery preferences to develop customized banking packages focused on improving customer satisfaction and profitability. Regional Community Banking has also invested heavily in building a sales culture and infrastructure while improving efficiency. Capital investments have been strategically directed towards the expansion of multi-channel distribution, consistent with customer preferences, as well as the delivery of relevant customer information to all distribution channels. Regional Community Banking contributed 53% of total business earnings for the first six months of 2001 compared with 47% for the first six months of 2000. Earnings increased $58 million or 21% to $339 million for the first six months of 2001 primarily due to business growth and net securities gains. Excluding net securities gains from the first six months of 2001 and net securities losses from the first six months of 2000, earnings increased 10% primarily driven by higher noninterest income, deposit growth and improved efficiency. Total revenue increased 11% to $1.1 billion for the first six months of 2001. Excluding net securities gains and losses from both periods, revenue increased 6% in the period-to-period comparison primarily due to higher consumer transaction activity in 2001 and residential mortgage loan securitization gains. The provision for credit losses for the first six months of 2001 decreased $2 million compared with the same period in 2000 primarily due to the impact of downsizing indirect lending. Total loans decreased in the comparison as the reduction of residential mortgage loans due to securitizations and the continued downsizing of the indirect automobile lending portfolio were partially offset by higher home equity loans and leases that resulted from strategic acquisitions. The decrease in residential mortgage loans was offset by an increase in securities available for sale. Total deposits grew 3% in the comparison driven by a $2.2 billion increase in transaction deposits. The increase in money market deposits resulted from targeted consumer marketing initiatives to add new accounts and retain existing customers as funds shifted from savings and certificates of deposit. 6 FINANCIAL REVIEW THE PNC FINANCIAL SERVICES GROUP, INC. CORPORATE BANKING Six months ended June 30 - dollars in millions 2001 2000 - ------------------------------------------------------------------ INCOME STATEMENT Credit-related revenue $205 $199 Noncredit revenue 179 221 - ------------------------------------------------------------------ Total revenue 384 420 Provision for credit losses 88 38 Noninterest expense 196 196 - ------------------------------------------------------------------ Pretax earnings 100 186 Income taxes 34 66 - ------------------------------------------------------------------ Earnings $66 $120 - ------------------------------------------------------------------ AVERAGE BALANCE SHEET Loans Middle market $5,943 $6,132 Large corporate 3,161 3,106 Energy, metals and mining 1,273 1,334 Communications 1,169 1,451 Leasing 2,216 1,734 Other 321 368 - ------------------------------------------------------------------ Total loans 14,083 14,125 Other assets 2,529 1,985 - ------------------------------------------------------------------ Total assets $16,612 $16,110 - ------------------------------------------------------------------ Deposits $4,862 $4,539 Assigned funds and other liabilities 10,504 10,363 Assigned capital 1,246 1,208 - ------------------------------------------------------------------ Total funds $16,612 $16,110 - ------------------------------------------------------------------ PERFORMANCE RATIOS Return on assigned capital 11% 20% Noncredit revenue to total revenue 47 53 Efficiency 51 46 ================================================================== Corporate Banking provides credit, equipment leasing, treasury management and capital markets products and services to large and mid-sized corporations, institutions and government entities primarily within PNC's geographic region. The strategic focus for Corporate Banking is on the middle market with an emphasis on higher-margin noncredit products and services, especially treasury management and capital markets. Approximately 35% of the loan portfolio represents syndicated loans. These credits are generally large commitments that are shared by a number of financial institutions to reduce exposure to any one client. During the first quarter of 2001, the Corporation announced the decision to downsize the communications portfolio and certain portions of the energy, metals and mining and large corporate portfolios. The designated loans are included in Corporate Banking business results in both periods presented. Management continues to evaluate opportunities to reduce lending exposure and improve the risk/return characteristics of this business. Corporate Banking contributed 10% of total business earnings for the first six months of 2001 compared with 20% for the first six months of 2000. Earnings declined to $66 million for the first six months of 2001 compared with $120 million for the first six months of 2000 primarily due to provision for credit losses in 2001 related to portfolios that PNC is downsizing. Total revenue of $384 million for the first six months of 2001 decreased $36 million compared with the same period in 2000. Credit-related revenue increased 3% compared with the first six months of 2000 as an increase in net interest margin was partially offset by a decrease in average loans. The decrease in average loans in the period-to-period comparison was primarily due to reductions in the energy, metals and mining, communications and middle market portfolios, partially offset by the expansion of equipment leasing. Middle market loans declined in the period-to-period comparison primarily due to strategies to improve the risk profile of this portfolio. Noncredit revenue includes noninterest income and the benefit of compensating balances received in lieu of fees. Noncredit revenue decreased $42 million compared with the first six months of 2000 primarily due to the impact of weak equity market conditions that resulted in lower capital markets fees and valuation losses associated with equity investments. The provision for credit losses was $88 million for the first six months of 2001 compared with $38 million for the first six months of 2000. The higher provision was primarily related to portfolios that are being downsized. A sustained or further weakening of the economy, or other factors that adversely 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 Credit Risk in the Risk Management section of this Financial Review for additional information regarding credit risk. Treasury management and capital markets products offered through Corporate Banking are sold by several businesses across the Corporation and related profitability is included in the results of those businesses. Consolidated revenue from treasury management was $170 million for the first six months of 2001 compared with $169 million for the first six months of 2000. Increases in fee revenue were offset by lower income earned on customers' deposit balances resulting from the lower interest rate environment in 2001 and the impact of downsizing institutional lending. Consolidated revenue from capital markets was $57 million for the first six months of 2001, an $11 million decrease compared with the first six months of 2000. The decrease was primarily due to weak equity market conditions as well as the impact of downsizing certain lending portfolios. 7 PNC REAL ESTATE FINANCE Six months ended June 30 - dollars in millions 2001 2000 - ------------------------------------------------------------------ INCOME STATEMENT Net interest income $57 $59 Noninterest income Commercial mortgage banking 32 30 Other 17 14 - ------------------------------------------------------------------ Total noninterest income 49 44 - ------------------------------------------------------------------ Total revenue 106 103 Provision for credit losses (2) Noninterest expense 76 67 - ------------------------------------------------------------------ Pretax earnings 32 36 Income tax (benefit) expense (6) 3 - ------------------------------------------------------------------ Earnings $38 $33 - ------------------------------------------------------------------ AVERAGE BALANCE SHEET Loans Commercial - real estate related $1,804 $2,041 Commercial real estate 2,326 2,428 - ------------------------------------------------------------------ Total loans 4,130 4,469 Commercial mortgages held for sale 188 151 Other assets 973 984 - ------------------------------------------------------------------ Total assets $5,291 $5,604 - ------------------------------------------------------------------ Deposits $362 $244 Assigned funds and other liabilities 4,533 4,977 Assigned capital 396 383 - ------------------------------------------------------------------ Total funds $5,291 $5,604 - ------------------------------------------------------------------ PERFORMANCE RATIOS Return on assigned capital 19% 17% Noninterest income to total revenue 46 43 Efficiency 58 51 ================================================================== PNC Real Estate Finance provides credit, capital markets, treasury management, commercial mortgage loan servicing and other products and services to developers, owners and investors in commercial real estate. PNC's commercial real estate financial services platform includes lending as well as processing businesses. The processing businesses include Midland Loan Services, Inc., a leading third-party provider of loan servicing and technology to the commercial real estate finance industry, and Columbia Housing Partners, LP, a national syndicator of affordable housing equity. Over the past three years, PNC Real Estate Finance has been strategically shifting to a more balanced and valuable revenue stream by focusing on real estate processing businesses and increasing the value of its lending business by selling more fee-based products. During the first six months of 2001, 46% of total revenue was generated by fee-based activities compared with 43% for the first six months of 2000. Management also continues to evaluate opportunities to reduce credit exposure and improve the risk/return characteristics of the lending business. PNC Real Estate Finance contributed 6% of total business earnings for the first six months of 2001 compared with 5% for the first six months of 2000. Earnings increased $5 million or 15% in the period-to-period comparison primarily due to growth in processing businesses. Average loans decreased 8% in the period-to-period comparison reflecting management's ongoing strategy to reduce balance sheet leverage. Total revenue was $106 million for the first six months of 2001 compared with $103 million for the first six months of 2000. The increase of $3 million or 3% was primarily due to growth in commercial mortgage loan servicing fees, reflecting a larger servicing portfolio, partially offset by lower commercial mortgage-backed securitization gains. The commercial mortgage servicing portfolio grew 29% in the comparison to $62 billion at June 30, 2001. COMMERCIAL MORTGAGE SERVICING PORTFOLIO In billions 2001 2000 - ------------------------------------------------------------ January 1 $51 $45 Acquisitions/additions 15 6 Repayments/transfers (4) (3) - ------------------------------------------------------------ June 30 $62 $48 ============================================================ PNC Real Estate Finance had net recoveries of $2 million during the first six months of 2001. Noninterest expense was $76 million and the efficiency ratio was 58% for the first six months of 2001 compared with $67 million and 51%, respectively, in the same period last year. The increases were primarily due to non-cash (passive) losses on affordable housing investments that were more than offset by related income tax credits. 8 FINANCIAL REVIEW THE PNC FINANCIAL SERVICES GROUP, INC. PNC BUSINESS CREDIT Six months ended June 30 - dollars in millions 2001 2000 - ------------------------------------------------------------------ INCOME STATEMENT Net interest income $51 $49 Noninterest income 20 8 - ------------------------------------------------------------------ Total revenue 71 57 Provision for credit losses 8 2 Noninterest expense 16 14 - ------------------------------------------------------------------ Pretax earnings 47 41 Income taxes 17 15 - ------------------------------------------------------------------ Earnings $30 $26 - ------------------------------------------------------------------ AVERAGE BALANCE SHEET Loans $2,305 $2,100 Other assets 124 73 - ------------------------------------------------------------------ Total assets $2,429 $2,173 - ------------------------------------------------------------------ Deposits $80 $56 Assigned funds and other liabilities 2,188 1,973 Assigned capital 161 144 - ------------------------------------------------------------------ Total funds $2,429 $2,173 - ------------------------------------------------------------------ PERFORMANCE RATIOS Return on assigned capital 38% 36% Noninterest income to total revenue 28 14 Efficiency 21 23 ================================================================== PNC Business Credit provides asset-based lending, capital markets and treasury management 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 Business Credit's strategic focus is to build scale through expansion of existing offices as well as the addition of new marketing locations. The loan portfolio grew 10% to $2.3 billion at June 30, 2001 primarily as a result of this expansion. PNC Business Credit currently operates 15 offices in 13 states with a centralized back office to provide consistency to the control environment as well as cost efficiencies. PNC Business Credit contributed 5% of total business earnings for the first six months of 2001 compared with 4% for the first six months of 2000. Earnings increased $4 million or 15% in the period-to-period comparison to $30 million for the first six months of 2001 as higher revenue was partially offset by an increase in the provision for credit losses. Revenue was $71 million for the first six months of 2001, a $14 million or 25% increase compared with the first six months of 2000 primarily due to higher noninterest income. The increase in noninterest income primarily resulted from gains on equity interests received as compensation in conjunction with lending relationships. The provision for credit losses increased $6 million to $8 million for the first six months of 2001 as a result of declining credit conditions in a weaker economy. PNC Business Credit loans are secured loans to borrowers with a weaker financial condition. As a result, in a weaker economy, the provision for credit losses may be adversely affected. See Credit Risk in the Risk Management section of this Financial Review for additional information regarding credit risk. Noninterest expense was $16 million and the efficiency ratio improved to 21% for the first six months of 2001 compared with $14 million and 23%, respectively, for the first six months of 2000. The efficiency ratio improved in the comparison primarily due to higher noninterest income and economies of scale resulting from a centralized back office. 9 PNC ADVISORS Six months ended June 30 - dollars in millions 2001 2000 - ------------------------------------------------------------------ INCOME STATEMENT Net interest income $68 $68 Noninterest income Investment management and trust 210 205 Brokerage 70 90 Other 41 35 - ------------------------------------------------------------------ Total noninterest income 321 330 - ------------------------------------------------------------------ Total revenue 389 398 Provision for credit losses 1 3 Noninterest expense 256 258 - ------------------------------------------------------------------ Pretax earnings 132 137 Income taxes 49 51 - ------------------------------------------------------------------ Earnings $83 $86 - ------------------------------------------------------------------ AVERAGE BALANCE SHEET Loans Commercial $521 $643 Consumer 1,098 957 Residential mortgage 911 978 Other 405 548 - ------------------------------------------------------------------ Total loans 2,935 3,126 Other assets 485 451 - ------------------------------------------------------------------ Total assets $3,420 $3,577 - ------------------------------------------------------------------ Deposits $2,045 $2,086 Assigned funds and other liabilities 823 941 Assigned capital 552 550 - ------------------------------------------------------------------ Total funds $3,420 $3,577 - ------------------------------------------------------------------ PERFORMANCE RATIOS Return on assigned capital 30% 31% Noninterest income to total revenue 83 83 Efficiency 65 64 ================================================================== PNC Advisors provides a full range of tailored investment 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 advisory 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. PNC Advisors is focused on expanding Hilliard Lyons and Hawthorn, increasing market share in PNC's primary geographic region and leveraging its comprehensive distribution platform. PNC Advisors contributed 13% of total business earnings for the first six months of 2001 compared with 14% for the first six months of 2000. Earnings were $83 million and $86 million for the first six months of 2001 and 2000, respectively. Revenue decreased $9 million in the period-to-period comparison primarily due to lower levels of retail investor trading activity and weak equity markets. Management expects that revenues in this business will continue to be challenged at least until equity market conditions improve. Noninterest expense decreased $2 million in the period-to-period comparison primarily due to lower production-based compensation and effective expense management initiatives. ASSETS UNDER MANAGEMENT (a) June 30 - in billions 2001 2000(b) - ----------------------------------------------------------------- Personal investment management and trust $49 $49 Institutional trust 14 15 - ----------------------------------------------------------------- Total $63 $64 ================================================================= (a) Assets under management do not include brokerage assets administered. (b) Restated to reflect the transfer of assets under management between PNC businesses. Assets under management decreased $1 billion as approximately $4 billion of net new asset inflows during the past twelve months were more than offset by a decline in the value of the equity component of customers' portfolios. See Asset Management Performance in the Risk Factors section of this Financial Review for additional information regarding the potential impact of market conditions and asset management performance on PNC's revenue. Brokerage assets administered by PNC Advisors were $28 billion at June 30, 2001 and 2000 and were also impacted by weak market conditions. PNC Advisors will continue to focus on acquiring new customers and growing and expanding existing customer relationships while aggressively managing the revenue/expense relationship. 10 FINANCIAL REVIEW THE PNC FINANCIAL SERVICES GROUP, INC. BLACKROCK Six months ended June 30 - dollars in millions 2001 2000 - ---------------------------------------------------------------- INCOME STATEMENT Investment advisory and administrative fees $252 $209 Other income 17 12 - ---------------------------------------------------------------- Total revenue 269 221 Operating expense 147 111 Fund administration and servicing costs - affiliates 32 38 Amortization 5 5 - ---------------------------------------------------------------- Total expense 184 154 - ---------------------------------------------------------------- Operating income 85 67 Nonoperating income 4 2 - ---------------------------------------------------------------- Pretax earnings 89 69 Income taxes 37 29 - ---------------------------------------------------------------- Earnings $52 $40 - ---------------------------------------------------------------- PERIOD-END BALANCE SHEET Intangible assets $187 $197 Other assets 384 237 - ---------------------------------------------------------------- Total assets $571 $434 - ---------------------------------------------------------------- Other liabilities $142 $113 Stockholders' equity 429 321 - ---------------------------------------------------------------- Total liabilities and stockholders' equity $571 $434 - ---------------------------------------------------------------- PERFORMANCE DATA Return on equity 26% 27% Operating margin (a) 36 36 Diluted earnings per share $.80 $.62 =============================================================== (a) Excludes the impact of fund administration and servicing costs - affiliates. BlackRock is one of the largest publicly traded investment management firms in the United States with $213 billion of assets under management at June 30, 2001. BlackRock manages assets on behalf of institutions and individuals through a variety of fixed income, liquidity, equity and alternative investment separate accounts and mutual funds, including its flagship fund families, BlackRock Funds and BlackRock Provident Institutional Funds. In addition, BlackRock provides risk management and technology services to a growing number of institutional investors under the BlackRock Solutions brand name. BlackRock continues to focus on delivering superior 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 contributed 8% of total business earnings for the first six months of 2001 compared with 7% for the first six months of 2000. Earnings increased 29% in the period-to-period comparison primarily due to a 20% increase in assets under management. New client mandates and additional funding from existing clients was $31 billion or 86% of the increase in assets under management. Total revenue for the first six months of 2001 increased $48 million or 22% compared with the first six months of 2000 primarily due to new institutional business and strong fixed-income performance. The increase in operating expense in the period-to-period comparison supported revenue growth and business expansion. ASSETS UNDER MANAGEMENT June 30 - in billions 2001 2000 - ---------------------------------------------------------------- Separate accounts Fixed income $111 $84 Liquidity 7 7 Liquidity - securities lending 10 11 Equity 8 7 Alternative investment products 4 2 - ---------------------------------------------------------------- Total separate accounts 140 111 - ---------------------------------------------------------------- Mutual funds (a) Fixed income 12 14 Liquidity 49 36 Equity 12 16 - ---------------------------------------------------------------- Total mutual funds 73 66 - ---------------------------------------------------------------- Total assets under management $213 $177 ================================================================ (a) Includes BlackRock Funds, BlackRock Provident Institutional Funds, BlackRock Closed End Funds, Short Term Investment Funds and BlackRock Global Series Funds. BlackRock, Inc. is approximately 70% owned by PNC and is listed on the New York Stock Exchange under the symbol BLK. Additional information about BlackRock is available in its filings with the Securities and Exchange Commission ("SEC") and may be obtained electronically at the SEC's home page at www.sec.gov. 11 PFPC Six months ended June 30 - dollars in millions 2001 2000 - ------------------------------------------------------------------ INCOME STATEMENT Fund servicing revenue $370 $331 Operating expense 264 256 Amortization 13 16 - ------------------------------------------------------------------ Operating income 93 59 Nonoperating income (a) 7 14 Debt financing 47 47 - ------------------------------------------------------------------ Pretax earnings 53 26 Income taxes 21 10 - ------------------------------------------------------------------ Earnings $32 $16 - ------------------------------------------------------------------ AVERAGE BALANCE SHEET Intangible assets $1,079 $1,110 Other assets 663 477 - ------------------------------------------------------------------ Total assets $1,742 $1,587 - ------------------------------------------------------------------ Assigned funds and other liabilities $1,534 $1,380 Assigned capital 208 207 - ------------------------------------------------------------------ Total funds $1,742 $1,587 - ------------------------------------------------------------------ PERFORMANCE RATIOS Operating margin 25% 18% Return on assigned capital 31 16 ================================================================== (a) Net of nonoperating expense 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, providing a wide range of fund services to the investment management industry. PFPC also provides customized processing solutions to the international marketplace through its Dublin, Ireland and Luxembourg operations. To meet the growing needs of the European marketplace, PFPC continues its pursuit of offshore expansion. PFPC is also focusing technological resources on targeted Web-based initiatives and exploring strategic alliances. PFPC contributed 5% of total business earnings for the first six months of 2001 and 3% for the first six months of 2000. Earnings increased $16 million in the period-to-period comparison and performance ratios improved significantly. The increase in earnings was primarily due to strong growth in transfer agency and sub accounting revenue that resulted from an increase in shareholder accounts serviced. The first six months of 2001 also benefited from focused expense control efforts and the comparative impact of Investor Services Group integration costs incurred in the prior-year period. Revenue of $370 million for the first six months of 2001 increased $39 million or 12% compared with the first six months of 2000, primarily driven by existing client growth and new business. See Fund Servicing in the Risk Factors section of this Financial Review for additional information regarding matters that could impact fund servicing revenue. Operating expense increased 3% in the period-to-period comparison primarily due to business expansion partially offset by the comparative impact of one-time integration costs in the prior-year period. SERVICING STATISTICS June 30 2001 2000 - ---------------------------------------------------------------- Accounting/administration Assets ($ in billions) (a) $502 $449 Custody assets ($ in billions) 442 416 Shareholder accounts (in millions) 45 41 ================================================================ (a) Includes net assets serviced offshore of approximately $14 billion and $8 billion at June 30, 2001 and 2000, respectively. 12 FINANCIAL REVIEW THE PNC FINANCIAL SERVICES GROUP, INC. CONSOLIDATED INCOME STATEMENT REVIEW NET INTEREST INCOME ANALYSIS
Taxable-equivalent basis Average Balances Interest Income/Expense Average Yields/Rates Six months ended June 30 - ---------------------------- -------------------------- ----------------------------- dollars in millions 2001 2000 Change 2001 2000 Change 2001 2000 Change - ----------------------------------------------------------------------------------------------------------------------------------- Interest-earning assets Loans held for sale $1,862 $2,948 $(1,086) $68 $116 $(48) 7.19% 7.76% (57)bp Securities available for sale 9,895 6,068 3,827 300 193 107 6.06 6.35 (29) Loans, net of unearned income Commercial 20,575 21,917 (1,342) 797 911 (114) 7.70 8.23 (53) Commercial real estate 2,576 2,690 (114) 103 118 (15) 7.92 8.67 (75) Consumer 9,090 9,228 (138) 382 389 (7) 8.49 8.46 3 Residential mortgage 10,554 12,577 (2,023) 384 446 (62) 7.27 7.08 19 Lease financing 4,024 3,004 1,020 145 109 36 7.19 7.26 (7) Other 490 682 (192) 18 28 (10) 7.36 8.28 (92) - ---------------------------------------------------------------------- ---------------------------- Total loans, net of unearned income 47,309 50,098 (2,789) 1,829 2,001 (172) 7.72 7.95 (23) Other 1,592 1,194 398 63 41 22 8.03 6.99 104 - ---------------------------------------------------------------------- ---------------------------- Total interest-earning assets/ interest income 60,658 60,308 350 2,260 2,351 (91) 7.44 7.76 (32) Noninterest-earning assets 10,692 8,622 2,070 - ---------------------------------------------------------------------- Total assets $71,350 $68,930 $2,420 ====================================================================== Interest-bearing liabilities Deposits Demand and money market $20,707 $18,125 $2,582 296 297 (1) 2.88 3.30 (42) Savings 1,928 2,123 (195) 11 18 (7) 1.12 1.69 (57) Retail certificates of deposit 13,190 14,497 (1,307) 374 386 (12) 5.73 5.35 38 Other time 551 639 (88) 18 20 (2) 6.58 6.40 18 Deposits in foreign offices 1,248 1,486 (238) 32 45 (13) 5.05 5.94 (89) - ---------------------------------------------------------------------- ---------------------------- Total interest-bearing deposits 37,624 36,870 754 731 766 (35) 3.92 4.17 (25) Borrowed funds 14,201 14,877 (676) 401 475 (74) 5.63 6.33 (70) - ---------------------------------------------------------------------- ---------------------------- Total interest-bearing liabilities/ interest expense 51,825 51,747 78 1,132 1,241 (109) 4.38 4.79 (41) ---------------------------- ----------------------------- Noninterest-bearing liabilities, capital securities and shareholders' equity 19,525 17,183 2,342 - ---------------------------------------------------------------------- Total liabilities, capital securities and shareholders' equity $71,350 $68,930 $2,420 ====================================================================== Interest rate spread 3.06 2.97 9 Impact of noninterest-bearing sources .64 .68 (4) ----------------------------- Net interest income/margin $1,128 $1,110 $18 3.70% 3.65% 5bp ===================================================================================================================================
NET INTEREST INCOME Changes in net interest income and margin result from the interaction between 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. Taxable-equivalent net interest income of $1.128 billion for the first six months of 2001 increased 2% compared with the first six months of 2000. The net interest margin widened 5 basis points to 3.70% for the first six months of 2001 compared with 3.65% for the first six months of 2000. The increases were primarily due to the positive impact of transaction deposit growth and a lower rate environment that was partially offset by the impact of continued downsizing of the loan portfolio. PNC expects modest growth in net interest income during the second half of 2001 compared with the first six months of 2001. See Interest Rate Risk in the Risk Management section of this Financial Review for additional information regarding interest rate risk. Loans represented 78% of average earning assets for the first six months of 2001 compared with 83% for the first six months of 2000. The decrease was primarily due to the continued downsizing of certain institutional lending portfolios and the securitization of residential mortgage loans during the first six months of 2001. Average loans held for sale decreased $1.1 billion in the period-to-period comparison due to a reduction in commercial loans held for sale. Securities available for sale represented 16% of average earning assets for the first six months of 2001 compared with 10% for the first six months of 2000. The increase was primarily due to the purchase of U.S. agencies, asset-backed and other debt securities and the securitization of residential mortgage loans as part of balance sheet and interest rate risk management activities. 13 Funding cost is affected by the volume and composition of funding sources as well as related rates paid thereon. Average deposits comprised 64% and 65% of total sources of funds for the first six months of 2001 and 2000, respectively, with the remainder primarily comprised of wholesale funding obtained at prevailing market rates. Average demand and money market deposits increased $2.6 billion or 14% compared with the first six months of 2000, primarily reflecting the impact of strategic marketing initiatives to grow more valuable transaction accounts, while all other interest-bearing deposit categories decreased in the period-to-period comparison. Average borrowed funds for the first six months of 2001 decreased $676 million compared with the first six months of 2000 as lower bank notes and senior debt were partially offset by increases in federal funds purchased and repurchase agreements. The overall decrease in average borrowed funds was primarily due to deposit growth. PROVISION FOR CREDIT LOSSES The provision for credit losses was $125 million for the first six months of 2001 compared with $66 million for the first six months of 2000. The increase was primarily related to institutional lending portfolios that PNC is downsizing. See Credit Risk in the Risk Management section of this Financial Review for additional information regarding credit risk. NONINTEREST INCOME Noninterest income was $1.421 billion for the first six months of 2001 and included $69 million of equity management losses. Excluding equity management income and losses in both years, noninterest income increased 13% compared with the first six months of 2000 primarily due to growth in asset management and processing revenue. Asset management fees of $437 million for the first six months of 2001 increased $55 million or 14% primarily driven by new institutional business and strong fixed-income performance at BlackRock. Consolidated assets under management were $260 billion at June 30, 2001, a 16% increase compared with June 30, 2000. Fund servicing fees were $363 million for the first six months of 2001, a $44 million or 14% increase compared with the first six months of 2000 primarily driven by existing client growth and new business. Service charges on deposits increased 4% to $104 million for the first six months of 2001 primarily due to an increase in transaction deposit accounts. Brokerage fees were $109 million for the first six months of 2001 compared with $131 million for the first six months of 2000. The decrease was primarily due to a decline in equity markets activity. Consumer services revenue of $113 million for the first six months of 2001 increased $15 million or 15% compared with the first six months of 2000 primarily due to the expansion of PNC's ATM network and the increase in transaction deposit accounts. Corporate services revenue was $152 million for the first six months of 2001 compared with $162 million for the first six months of 2000. Higher commercial mortgage servicing revenue was more than offset by valuation adjustments of other assets, lower commercial mortgage-backed securitization gains and lower capital markets revenue. Equity management, which is comprised of venture capital activities, reflected a net loss of $69 million for the first six months of 2001 compared with $135 million of income for the first six months of 2000. The decrease primarily resulted from a decline in the estimated fair value of partnership and direct investments. Equity management investments totaling approximately $700 million were evenly split between direct and partnership investments. Net unrealized appreciation on equity management investments was $38 million at June 30, 2001. These valuations are subject to market conditions and may be volatile. PNC is currently evaluating strategies to mitigate the impact of the inherent volatility of this business. Net securities gains were $46 million for the first six months of 2001 and were mostly offset by valuation adjustments and write-downs of other assets and e-commerce investments totaling $32 million that are reflected in corporate services and other noninterest income. Other noninterest income was $166 million for the first six months of 2001 compared with $132 million for the first six months of 2000. The increase was primarily due to higher revenue from trading activities and residential mortgage loan securitizations. NONINTEREST EXPENSE Noninterest expense was $1.564 billion for the first six months of 2001 compared with $1.572 billion for the first six months of 2000 and the efficiency ratio remained flat at 58% during both periods. The decrease in expense was primarily due to aggressive expense management. Average full-time equivalent employees totaled approximately 24,700 and 23,900 for the first six months of 2001 and 2000, respectively. The increase was primarily in asset management and processing businesses. 14 FINANCIAL REVIEW THE PNC FINANCIAL SERVICES GROUP, INC. CONSOLIDATED BALANCE SHEET REVIEW LOANS Loans were $44.2 billion at June 30, 2001, a $6.4 billion decrease from year-end 2000 primarily due to residential mortgage loan securitizations and reductions in most commercial loan categories as a result of continuing efforts to reduce balance sheet leverage. DETAILS OF LOANS June 30 December 31 In millions 2001 2000 (a) - ----------------------------------------------------------------------- Commercial Manufacturing $5,054 $5,581 Retail/wholesale 4,485 4,413 Service providers 2,584 2,944 Real estate related 1,831 1,783 Financial services 1,592 1,726 Communications 948 1,296 Health care 593 722 Other 2,465 2,742 - ----------------------------------------------------------------------- Total commercial 19,552 21,207 - ----------------------------------------------------------------------- Commercial real estate Mortgage 635 673 Real estate project 1,922 1,910 - ----------------------------------------------------------------------- Total commercial real estate 2,557 2,583 - ----------------------------------------------------------------------- Consumer Home equity 6,751 6,228 Automobile 953 1,166 Other 1,410 1,739 - ----------------------------------------------------------------------- Total consumer 9,114 9,133 - ----------------------------------------------------------------------- Residential mortgage 8,219 13,264 Lease financing 5,354 4,845 Other 444 568 Unearned income (1,073) (999) - ----------------------------------------------------------------------- Total, net of unearned income $44,167 $50,601 ======================================================================= (a) Certain amounts have been reclassified to conform to the current year presentation. Loan portfolio composition continued to be geographically diversified among numerous industries and types of businesses. During 1999, total outstandings and exposure designated for downsizing totaled $3.7 billion and $10.5 billion, respectively. At June 30, 2001, remaining outstandings associated with this initiative were $572 million, of which $472 million were classified as loans with the remainder included in loans held for sale. Total remaining exposure related to this initiative was $1.6 billion at June 30, 2001. In addition, outstandings and exposure totaling approximately $2.5 billion and $7.0 billion, respectively, were designated for downsizing during the first quarter of 2001, primarily consisting of the communications portfolio and certain portions of the energy, metals and mining and large corporate portfolios in Corporate Banking. At June 30, 2001, remaining outstandings and exposure associated with this initiative were $1.9 billion and $5.4 billion, respectively. NET UNFUNDED COMMITMENTS (a) June 30 December 31 In millions 2001 2000 - -------------------------------------------------------------------- Commercial $19,859 $24,253 Commercial real estate 1,233 1,039 Consumer 4,693 4,414 Lease financing 112 123 Other 130 173 - -------------------------------------------------------------------- Total $26,027 $30,002 ==================================================================== (a) Excludes unfunded commitments related to loans designated for downsizing in 1999 and 2001. Commitments to extend credit represent arrangements to lend funds subject to specified contractual conditions. Commercial commitments are reported net of participations, assignments and syndications, primarily to financial institutions, totaling $7.2 billion at both June 30, 2001 and December 31, 2000. Net outstanding letters of credit totaled $4.1 billion and $4.0 billion at June 30, 2001 and December 31, 2000, respectively, and consisted primarily of standby letters of credit that commit the Corporation to make payments on behalf of customers if specified future events occur. Unfunded commitments and letters of credit related to loans designated for downsizing in 2001 and 1999 totaled $4.5 billion at June 30, 2001 and $1.7 billion at December 31, 2000. SECURITIES AVAILABLE FOR SALE The fair value of securities available for sale at June 30, 2001 was $11.3 billion compared with $5.9 billion at December 31, 2000. Securities represented 16% of total assets at June 30, 2001 compared with 8% at December 31, 2000. The increase was primarily due to residential mortgage loan securitizations and purchases of U.S. agencies, asset-backed and other debt securities during the first six months of 2001. The expected weighted-average life of securities available for sale was 5 years and 6 months at June 30, 2001 compared with 4 years and 5 months at December 31, 2000. At June 30, 2001, the securities available for sale balance included a net unrealized loss of $92 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. 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 changes in a hedged risk as part of a fair value hedge strategy, in net income. 15 DETAILS OF SECURITIES AVAILABLE FOR SALE Amortized Fair In millions Cost Value - ------------------------------------------------------------------ JUNE 30, 2001 Debt securities U.S. Treasury and government agencies $1,467 $1,439 Mortgage-backed 7,643 7,601 Asset-backed 1,333 1,317 State and municipal 67 69 Other debt 439 439 Corporate stocks and other 401 393 - ------------------------------------------------------------------ Total securities available for sale $11,350 $11,258 ================================================================== DECEMBER 31, 2000 Debt securities U.S. Treasury and government agencies $313 $313 Mortgage-backed 4,037 4,002 Asset-backed 902 893 State and municipal 94 96 Other debt 73 73 Corporate stocks and other 537 525 - ------------------------------------------------------------------ Total securities available for sale $5,956 $5,902 ================================================================== FUNDING SOURCES Total funding sources were $57.9 billion at June 30, 2001 and decreased $1.4 billion compared with December 31, 2000. Demand, savings and money market deposits increased due to ongoing strategic marketing efforts to retain customers and increase money market balances as funds shifted from certificates of deposit. The change in the composition of borrowed funds reflected the impact of closing the sale of the residential mortgage banking business as well as a shift within categories to manage overall funding costs. DETAILS OF FUNDING SOURCES June 30 December 31 In millions 2001 2000 - ------------------------------------------------------------------- Deposits Demand, savings and money market $31,861 $30,686 Retail certificates of deposit 12,057 14,175 Other time 516 567 Deposits in foreign offices 1,392 2,236 - ------------------------------------------------------------------- Total deposits 45,826 47,664 - ------------------------------------------------------------------- Borrowed funds Federal funds purchased 1,444 1,445 Repurchase agreements 569 607 Bank notes and senior debt 4,496 6,110 Federal Home Loan Bank borrowings 2,464 500 Subordinated debt 2,349 2,407 Other borrowed funds 797 649 - ------------------------------------------------------------------- Total borrowed funds 12,119 11,718 - ------------------------------------------------------------------- Total $57,945 $59,382 =================================================================== 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, deposit insurance costs, and the level and nature of regulatory oversight depend, in large part, on a financial institution's capital strength. At June 30, 2001, the Corporation and each bank subsidiary were considered well capitalized based on regulatory capital ratio requirements. RISK-BASED CAPITAL June 30 December 31 Dollars in millions 2001 2000 - ------------------------------------------------------------------ Capital components Shareholders' equity Common $6,532 $6,344 Preferred 216 312 Trust preferred capital securities 848 848 Goodwill and other (2,140) (2,214) Net unrealized securities losses 58 77 - ------------------------------------------------------------------ Tier I risk-based capital 5,514 5,367 Subordinated debt 1,665 1,811 Eligible allowance for credit losses 675 667 - ------------------------------------------------------------------ Total risk-based capital $7,854 $7,845 ================================================================== Assets Risk-weighted assets and off-balance-sheet instruments $61,569 $62,430 Average tangible assets 68,500 66,809 ================================================================== Capital ratios Tier I risk-based 9.0% 8.6% Total risk-based 12.8 12.6 Leverage 8.1 8.0 ================================================================== 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. On February 15, 2001, the Board of Directors authorized the Corporation to purchase up to 15 million shares of its common stock through February 28, 2002. This new program replaces the prior program that was rescinded. During the first six months of 2001, PNC repurchased 3.4 million shares of its common stock. Management currently expects that share repurchases will increase in the second half of 2001 compared with the first half of 2001. On March 6, 2001, the Corporation commenced a cash tender offer for its nonconvertible Series F preferred stock at a price of $50.35 per share plus accrued and unpaid dividends. Approximately 1.9 million shares of a total of 6 million shares outstanding were tendered through this offer and were purchased by the Corporation on April 5, 2001. 16 FINANCIAL REVIEW THE PNC FINANCIAL SERVICES GROUP, INC. 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 and results of operations. 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. An economic downturn or higher interest rates could 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 provision for credit losses and a higher level of net charge-offs. Changes in interest rates could affect the value of certain on-balance-sheet and off-balance-sheet financial instruments of the Corporation. Higher interest rates would also increase the Corporation's cost to borrow funds and may increase the rate paid on deposits. 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 net asset value of assets under management and administration. A decline in the equity markets could negatively affect noninterest revenues. 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 Federal Reserve Board, the Office of the Comptroller of Currency and the Federal Deposit Insurance Corporation as well as state regulators. The Corporation is particularly affected by the policies of the Federal Reserve Board, which regulates the supply of money and credit in the United States. The Federal Reserve Board's policies influence the rates of interest that PNC charges on loans and pays on 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. 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 services, and through alternative delivery channels such as the World Wide Web. Technological advances and new legislation, among other changes, have lowered barriers to entry and have made it possible for non-bank institutions to offer products and services that traditionally have been provided by banks. Many of the Corporation's competitors benefit from fewer regulatory constraints and lower cost structures, allowing for more competitive pricing of products and services. The Gramm-Leach-Bliley Act ("the Act"), which was enacted on November 12, 1999, permits affiliations among banks, securities firms and insurance companies. The Act significantly changes the competitive environment in which the Corporation conducts business. This environment could result in expanded competition and a loss of customers and related revenue. 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. 17 FUND SERVICING Fund servicing fees are primarily based on 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 decline in the debt and equity markets could influence an investor's decision to invest or maintain an investment in a mutual fund. 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 investments could have a negative impact on the Corporation's revenues by reducing the assets and the number of shareholder accounts it administers. There has been and continues to be merger, acquisition and consolidation activity in the financial services industry. Mergers or consolidations of financial institutions in the future could reduce the number of existing or potential fund servicing clients. 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: o anticipated cost savings or potential revenue enhancements that may not be fully realized or realized within the expected time frame; o key employee, customer or revenue loss following an acquisition that may be greater than expected; and o costs or difficulties related to the integration of businesses that may be greater than expected. RISK MANAGEMENT In the normal course of business, the Corporation assumes various types of risk, which include, among other things, credit risk, interest rate risk, liquidity risk, and risk associated with trading activities and financial derivatives. PNC has risk management processes designed to provide for risk identification, measurement and monitoring. 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 off-balance-sheet financial derivative transactions. The Corporation seeks to manage credit risk through, among other things, diversification, limiting exposure to any single industry or customer, requiring collateral, selling participations to third parties, and purchasing credit-related derivatives. NONPERFORMING ASSETS BY TYPE June 30 December 31 Dollars in millions 2001 2000 - ----------------------------------------------------------------------- Nonaccrual loans Commercial $334 $312 Commercial real estate 20 3 Consumer 4 2 Residential mortgage 4 4 Lease financing 12 2 - ----------------------------------------------------------------------- Total nonaccrual loans 374 323 Foreclosed and other assets Commercial real estate 2 3 Residential mortgage 3 8 Other 11 38 - ----------------------------------------------------------------------- Total foreclosed and other assets 16 49 - ----------------------------------------------------------------------- Total nonperforming assets $390 $372 ======================================================================= Nonaccrual loans to total loans .85% .64% Nonperforming assets to total loans, loans held for sale and foreclosed assets .85 .71 Nonperforming assets to total assets .56 .53 ======================================================================= The above table excludes $24 million and $18 million of equity management assets carried at estimated fair value at June 30, 2001 and December 31, 2000, respectively. The amount of nonperforming loans that were current as to principal and interest was $108 million at June 30, 2001 and $67 million at December 31, 2000. Approximately one-fourth of nonperforming assets were from portfolios that were designated for downsizing at June 30, 2001. A sustained or further weakening of the economy, or other factors that adversely 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. 18 FINANCIAL REVIEW THE PNC FINANCIAL SERVICES GROUP, INC. CHANGE IN NONPERFORMING ASSETS In millions 2001 2000 - ----------------------------------------------------------------- January 1 $372 $325 Transferred from accrual 371 190 Returned to performing (13) (3) Principal reductions (96) (73) Sales (110) (11) Charge-offs and other (134) (75) - ----------------------------------------------------------------- June 30 $390 $353 ================================================================= ACCRUING LOANS PAST DUE 90 DAYS OR MORE Amount Percent of Loans -------------------------------------------------- June 30 December 31 June 30 December 31 Dollars in millions 2001 2000 2001 2000 - ------------------------------------------------------------------------- Commercial $11 $46 .06% .22% Commercial real estate 1 6 .04 .23 Consumer 21 24 .23 .26 Residential mortgage 37 36 .45 .27 Lease financing 2 1 .05 .03 - ----------------------------------------------- Total $72 $113 .16 .22 ========================================================================= Loans not included in nonaccrual 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 $130 million at June 30, 2001. ALLOWANCE FOR CREDIT LOSSES In determining the adequacy of the allowance for credit losses, the Corporation makes specific allocations to impaired loans and to pools of watchlist and nonwatchlist loans for various credit risk factors. 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. Those factors may include, among other things, actual versus estimated losses, regional and national economic conditions, business segment and portfolio concentrations, industry competition and consolidation, and the impact of government regulations. 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 such risks. While allocations are made to specific loans and pools of loans, the total reserve is available for all credit losses. Senior management's 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. The provision for credit losses for the first six months of 2001 and the evaluation of the allowance for credit losses as of June 30, 2001 reflected changes in loan portfolio composition, the net impact of downsizing credit exposure and changes in asset quality. The unallocated portion of the allowance for credit losses represented 17% of the total allowance and .26% of total loans at June 30, 2001 compared with 20% and .26%, respectively, at December 31, 2000. ROLLFORWARD OF ALLOWANCE FOR CREDIT LOSSES In millions 2001 2000 - ----------------------------------------------------------------- January 1 $675 $674 Charge-offs (148) (88) Recoveries 23 23 - ----------------------------------------------------------------- Net charge-offs (125) (65) Provision for credit losses 125 66 - ----------------------------------------------------------------- June 30 $675 $675 ================================================================= The allowance as a percent of nonaccrual loans and total loans was 180% and 1.53%, respectively, at June 30, 2001. The comparable year-end 2000 percentages were 209% and 1.33%, respectively. CHARGE-OFFS AND RECOVERIES Percent of Six months ended June 30 Net Average Dollars in millions Charge-offs Recoveries Charge-offs Loans - ------------------------------------------------------------------------------- 2001 Commercial $119 $12 $107 1.05% Consumer 20 9 11 .24 Residential mortgage 1 1 .02 Lease financing 8 2 6 .30 - ---------------------------------------------------------------- Total $148 $23 $125 .53 =============================================================================== 2000 Commercial $59 $10 $49 .45% Consumer 23 11 12 .26 Residential mortgage 3 1 2 .03 Lease financing 3 1 2 .13 - ---------------------------------------------------------------- Total $88 $23 $65 .26 =============================================================================== Net charge-offs were $125 million or .53% of average loans for the first six months of 2001 compared with $65 million or .26% for the same period in 2000. The increase was primarily related to loans in institutional lending portfolios that PNC is downsizing. CREDIT-RELATED INSTRUMENTS 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 and lower the required regulatory capital associated with commercial lending activities. At June 30, 2001, credit default swaps of $4.4 billion in notional value were used by the Corporation to hedge credit risk associated with commercial lending activities. 19 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. Interest rate risk is centrally managed by Asset and Liability Management. 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 is designed to measure the sensitivity of net interest income to changing interest rates over the next twenty-four month period. An economic value of equity model is designed to measure 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 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'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. At June 30, 2001, if interest rates were to gradually increase by 100 basis points over the next twelve months, the model indicated that net interest income would decrease by .5%. If interest rates were to gradually decrease by 100 basis points over the next twelve months, the model indicated that net interest income would decrease by .3%. 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 the economic value of equity should not decline by more than 1.5% of the book value of assets for a 200 basis point instantaneous increase or decrease in interest rates. Based on the results of the economic value of equity model at June 30, 2001, if interest rates were to instantaneously increase by 200 basis points, the model indicated that the economic value of existing on-balance-sheet and off-balance-sheet positions would decline by 1.3% of assets. If interest rates were to instantaneously decrease by 200 basis points, the model indicated that the economic value of existing on-balance-sheet and off-balance-sheet positions would increase by .4% of assets. 20 FINANCIAL REVIEW THE PNC FINANCIAL SERVICES GROUP, INC. LIQUIDITY RISK 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 Corporate Asset and Liability Committee and the Finance Committee of the Board of Directors. Access to capital markets funding sources 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. Liquidity can also be provided through the sale of liquid assets, which consist of short-term investments, loans held for sale and securities available for sale. At June 30, 2001, such assets totaled $13.7 billion, with $5.9 billion pledged as collateral for borrowings, trust and other commitments. Liquidity can also be obtained through secured advances from the Federal Home Loan Bank, of which PNC Bank, N.A., PNC's largest bank subsidiary, is a member. These borrowings are generally secured by residential mortgages, other real-estate related loans and mortgage-backed securities. At June 30, 2001, approximately $12.0 billion of residential mortgages and other real-estate related loans were available as collateral for borrowings from the Federal Home Loan Bank. Funding can also be obtained through alternative forms of borrowing, including federal funds purchased, repurchase agreements and short-term and long-term debt issuances. Liquidity for the parent company and subsidiaries is also generated through the issuance of securities in public or private markets and lines of credit. At June 30, 2001, the Corporation had unused capacity under effective shelf registration statements of approximately $1.4 billion of debt and equity securities and $400 million of trust preferred capital securities. In addition, the Corporation had an unused line of credit of $485 million at June 30, 2001. The principal source of parent company revenue and cash flow is dividends from subsidiary banks. PNC Bancorp, Inc. is a wholly-owned subsidiary of the parent company and is the holding company for all bank subsidiaries. There are legal limitations on the ability of bank subsidiaries to pay dividends and make other distributions to PNC Bancorp, Inc. and in turn to the parent company. Without regulatory approval, the amount available for dividend payments to PNC Bancorp, Inc. by all bank subsidiaries was $313 million at June 30, 2001. Dividends may also be impacted by capital needs, regulatory requirements, corporate policies, contractual restrictions and other factors. Management believes the Corporation has sufficient liquidity to meet current obligations to borrowers, depositors, debt holders and others. The impact of replacing maturing liabilities is reflected in the income simulation model in the overall asset and liability management process. 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 "market making" in equity securities as an accommodation to customers. PNC also engages in trading activities as part of risk management strategies. 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, spread risk and volatility risk. Using this approach, exposure is measured as the potential loss due to a two standard deviation, one-day move in interest rates. The combined period-end value-at-risk of all trading operations using this measurement was estimated as less than $600 thousand at June 30, 2001. 21 FINANCIAL DERIVATIVES 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. For interest rate 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 table sets forth changes, during the first six months of 2001, in the notional value of financial derivatives used for risk management and designated as accounting hedges under Statement of Financial Accounting Standards ("SFAS") No. 133.
FINANCIAL DERIVATIVES ACTIVITY Weighted- December 31 January 1 June 30 Average Dollars in millions 2000 Adjustments (a) 2001 Additions Maturities Terminations 2001 Maturity - ------------------------------------------------------------------------------------------------------------------------------------ Interest rate risk management Interest rate swaps Receive fixed $4,756 $180 $4,936 $4,700 $(1,368) $(120) $8,148 2 yrs. 10 mos. Pay fixed 1 248 249 243 (284) 208 3 yrs. Basis swaps 2,230 (1,773) 457 190 (360) 287 3 yrs. 2 mos. Interest rate caps 308 (243) 65 44 (74) 35 3 yrs. 10 mos. Interest rate floors 3,238 (238) 3,000 55 (3,020) 35 10 mos. Futures contracts 116 (116) - --------------------------------------------------------------------------------------------------------------------- Total interest rate risk management 10,533 (1,826) 8,707 5,348 (1,368) (3,974) 8,713 - --------------------------------------------------------------------------------------------------------------------- Commercial mortgage banking risk management Interest rate swaps 311 311 588 (556) 343 9 yrs. 5 mos. Total rate of return swaps 75 75 75 (75) 75 2 mos. - --------------------------------------------------------------------------------------------------------------------- Total commercial mortgage banking risk management 386 386 663 (75) (556) 418 Student lending activities - Forward contracts 347 (347) Credit-related activities - Credit default swaps 4,391 (4,391) - --------------------------------------------------------------------------------------------------------------------- Total $15,657 $(6,564) $9,093 $6,011 $(1,443) $(4,530) $9,131 ===================================================================================================================================
(a) Primarily consists of derivatives that are not designated as accounting hedges under SFAS No. 133 and instruments no longer considered financial derivatives under SFAS No. 133. 22 FINANCIAL REVIEW THE PNC FINANCIAL SERVICES GROUP, INC. The following table sets forth the notional value and the fair value of financial derivatives used for risk management and designated as accounting hedges under SFAS No. 133. Weighted-average interest rates presented are based on the implied forward yield curve at June 30, 2001.
FINANCIAL DERIVATIVES Weighted-Average Interest Rates Notional ----------------------------------- June 30, 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 $6,835 $ 48 4.77% 5.34% Pay fixed designated to loans 208 (3) 5.59 5.15 Basis swaps designated to loans 287 5.23 5.43 Interest rate caps designated to loans (b) 35 NM NM Interest rate floors designated to loans (c) 35 NM NM - ----------------------------------------------------------------------------------------------- Total asset rate conversion 7,400 45 - ----------------------------------------------------------------------------------------------- Liability rate conversion Interest rate swaps (a) Receive fixed designated to borrowed funds 1,313 60 5.99 6.61 - ----------------------------------------------------------------------------------------------- Total liability rate conversion 1,313 60 - ----------------------------------------------------------------------------------------------- Total interest rate risk management 8,713 105 - ----------------------------------------------------------------------------------------------- Commercial mortgage banking risk management Pay fixed interest rate swaps designated to securities (a) 154 6.02 6.16 Pay fixed interest rate swaps designated to loans (a) 189 4 5.99 6.29 Pay total rate of return swaps designated to loans (a) 75 (1) 6.45 3.31 - ----------------------------------------------------------------------------------------------- Total commercial mortgage banking risk management 418 3 - ----------------------------------------------------------------------------------------------- Total financial derivatives $9,131 $108 ===========================================================================================================================
(a) The floating rate portion of interest rate contracts is based on money-market indices. As a percent of notional value, 78% were based on 1-month LIBOR, 20% on 3-month LIBOR and the remainder on other short-term indices. (b) Interest rate caps with notional values of $25 million require the counterparty to pay the Corporation the excess, if any, of 3-month LIBOR over a weighted-average strike of 6.34%. At June 30, 2001, 3-month LIBOR was 3.84%. (c) Interest rate floors with notional values of $28 million require the counterparty to pay the excess, if any, weighted-average strike of 4.30% over 3-month LIBOR. At June 30, 2001, 3-month LIBOR was 3.84%. NM- Not meaningful 23 The following table sets forth the notional value and the estimated fair value of financial derivatives used for risk management. Weighted-average interest rates presented are based on the implied forward yield curve at December 31, 2000.
FINANCIAL DERIVATIVES Weighted-Average Interest Rates Notional Estimated ------------------------------- December 31, 2000 - dollars in millions Value Fair Value Paid Received - ------------------------------------------------------------------------------------------------------------------------------ Interest rate risk management Asset rate conversion Interest rate swaps (a) Receive fixed designated to loans $3,250 $27 5.96% 5.56% Basis swaps designated to other earning assets 226 3 5.63 5.85 Interest rate caps designated to loans (b) 308 4 NM NM Interest rate floors designated to loans (c) 3,238 (1) NM NM - --------------------------------------------------------------------------------------------- Total asset rate conversion 7,022 33 - --------------------------------------------------------------------------------------------- Liability rate conversion Interest rate swaps (a) Receive fixed designated to: Interest-bearing deposits 125 4 5.85 6.73 Borrowed funds 1,381 57 5.96 6.60 Pay fixed designated to borrowed funds 1 5.88 5.78 Basis swaps designated to borrowed funds 2,004 10 5.76 5.79 - --------------------------------------------------------------------------------------------- Total liability rate conversion 3,511 71 - --------------------------------------------------------------------------------------------- Total interest rate risk management 10,533 104 - --------------------------------------------------------------------------------------------- Commercial mortgage banking risk management Pay fixed interest rate swaps designated to securities (a) 135 (8) 6.94 6.04 Pay fixed interest rate swaps designated to loans (a) 176 3 5.76 5.99 Pay total rate of return swaps designated to loans (a) 75 (5) 5.76 6.15 - --------------------------------------------------------------------------------------------- Total commercial mortgage banking risk management 386 (10) - --------------------------------------------------------------------------------------------- Student lending activities - Forward contracts (d) 347 NM NM Credit-related activities - Credit default swaps (d) 4,391 (2) NM NM - --------------------------------------------------------------------------------------------- Total financial derivatives $15,657 $92 ==============================================================================================================================
(a) The floating rate portion of interest rate contracts is based on money-market indices. As a percent of notional value, 62% were based on 1-month LIBOR, 36% on 3-month LIBOR and the remainder on other short-term indices. (b) Interest rate caps with notional values of $61 million, $95 million and $150 million require the counterparty to pay the Corporation the excess, if any, of 3-month LIBOR over a weighted-average strike of 6.00%, 1-month LIBOR over a weighted-average strike of 5.68% and Prime over a weighted-average strike of 8.76%, respectively. At December 31, 2000, 3-month LIBOR was 6.40%, 1-month LIBOR was 6.56% and Prime was 9.50%. (c) Interest rate floors with notional values of $3.0 billion, require the counterparty to pay the excess, if any, of the weighted-average strike of 4.63% over 3-month LIBOR. At December 31, 2000, 3-month LIBOR was 6.40%. (d) Due to the structure of these contracts, they are no longer considered financial derivatives under SFAS No. 133. NM- Not meaningful 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.
OTHER DERIVATIVES At June 30, 2001 ---------------------------------------------------------------------- 2001 Positive Negative Average Notional Fair Fair Net Asset Fair In millions Value Value Value (Liability) Value (a) - ----------------------------------------------------------------------------------------------------------------------- Customer-related Interest rate Swaps $15,551 $182 $(196) $(14) $(8) Caps/floors Sold 4,361 (20) (20) (20) Purchased 3,349 18 18 18 Foreign exchange 4,306 62 (53) 9 12 Other 3,659 51 (48) 3 2 - ----------------------------------------------------------------------------------------------------------------------- Total customer-related 31,226 313 (317) (4) 4 Other 4,615 23 (5) 18 19 - ----------------------------------------------------------------------------------------------------------------------- Total other derivatives $35,841 $336 $(322) $14 $23 =======================================================================================================================
(a) Represents average for six months ended June 30, 2001. 24 FINANCIAL REVIEW THE PNC FINANCIAL SERVICES GROUP, INC. SECOND QUARTER 2001 VS. SECOND QUARTER 2000 Earnings for the second quarter of 2001 were $295 million or $1.00 per diluted share compared with earnings of $299 million or $1.01 per diluted share for the second quarter of 2000. Excluding a $22 million or $0.08 per diluted share net loss from venture capital activities, second quarter 2001 earnings per diluted share increased 7% to $1.08 per diluted share. Return on average common shareholders' equity was 18.13% and return on average assets was 1.67% for the second quarter of 2001 compared with 20.77% and 1.74%, respectively, for the second quarter of 2000. Taxable-equivalent net interest income of $569 million for the second quarter of 2001 increased $19 million or 3% compared with the second quarter of 2000 and the net interest margin widened 13 basis points to 3.76% for the second quarter of 2001. The increases were primarily due to the positive 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 provision for credit losses was $45 million for the second quarter of 2001 compared with $35 million for the second quarter of 2000. The increase was primarily related to institutional lending portfolios that PNC is downsizing. Noninterest income was $720 million for the second quarter of 2001 and included $30 million of venture capital losses. Excluding venture capital gains and losses in both years, noninterest income increased 10% compared with the second quarter of 2000 primarily due to growth in asset management and processing revenue. Asset management fees of $214 million for the second quarter of 2001 increased $18 million or 9% compared with the second quarter of 2000. The increase was primarily driven by new institutional business and strong fixed-income performance at BlackRock, partially offset by the impact of weak equity markets on investment management and trust revenue in PNC Advisors. Fund servicing fees of $182 million for the second quarter of 2001 increased $18 million or 11% compared with the second quarter of 2000 primarily due to existing and new client growth. Service charges on deposits were $54 million for the second quarter of 2001, up 8% compared with the same period last year primarily due to an increase in transaction deposit accounts. Brokerage fees were $55 million for the second quarter of 2001 compared with $60 million for the second quarter of 2000. The decrease was primarily due to a decline in equity markets activity. Consumer services revenue of $58 million for the second quarter of 2001 increased $7 million or 14% compared with the prior-year quarter primarily due to the expansion of PNC's ATM network and the increase in transaction deposit accounts. Corporate services revenue was $76 million for the second quarter of 2001 compared with $80 million for the second quarter of 2000. Higher commercial mortgage servicing and treasury management revenue was more than offset by valuation adjustments of other assets and lower commercial mortgage-backed securitization gains. Equity management reflected net losses of $30 million for the second quarter of 2001 compared with $48 million of net gains for the second quarter of 2000. The decrease primarily resulted from a decline in the estimated fair value of partnership and direct investments. Net securities gains were $17 million for the second quarter of 2001. The gains were mostly offset by $10 million of valuation adjustments that are reflected in corporate services revenue. Other noninterest income was $94 million for the second quarter of 2001 compared with $79 million for the second quarter of 2000. The increase was primarily due to higher revenue from trading activities and residential mortgage loan securitization gains. Noninterest expense was $789 million and the efficiency ratio was 58% in the second quarter of 2001 compared with $780 million and 57%, respectively, during the second quarter of 2000. The increases were primarily related to the expansion of asset management and processing businesses. Total assets were $70.0 billion at June 30, 2001 compared with $75.7 billion at June 30, 2000 prior to the sale of PNC's residential mortgage banking business. On the same basis, average interest-earning assets were $60.0 billion for the second quarter of 2001 compared with $64.8 billion for the second quarter of 2000. The decrease was primarily due to an $8.7 billion reduction in loans and loans held for sale that resulted from the sale of the residential mortgage banking business and other balance sheet downsizing initiatives, partially offset by a $3.7 billion increase in securities available for sale that primarily resulted from the securitization of certain residential mortgage loans. Average deposits from continuing operations were $45.4 billion and represented 64% of total sources of funds for the second quarter of 2001 compared with $45.5 billion and 66%, respectively, in the second quarter of 2000. While total deposits remained essentially unchanged, an increase in transaction deposits of $2.3 billion or 8% was mostly offset by a $2.2 billion decrease in higher-cost retail certificates and wholesale deposits. Average borrowed funds declined to $14.0 billion for the second quarter of 2001 compared with $19.4 billion for the second quarter of 2000 prior to the sale of PNC's residential mortgage banking business. 25 Nonperforming assets were $390 million at June 30, 2001 compared with $353 million at June 30, 2000. The ratio of nonperforming assets to total loans, loans held for sale and foreclosed assets was .85% at June 30, 2001 compared with .67% at June 30, 2000. The increase primarily resulted from the downsizing of the loan portfolio. The allowance for credit losses was $675 million and represented 1.53% of period-end loans and 180% of nonaccrual loans at June 30, 2001. The comparable ratios were 1.34% and 217%, respectively, at June 30, 2000. Net charge-offs were $45 million or .40% of average loans in the second quarter of 2001. The comparable amounts were $34 million or .27%, respectively, in the second quarter of 2000. FORWARD-LOOKING STATEMENTS This report and other statements made by the Corporation may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act with respect to the outlook or expectations for earnings, revenues, asset quality, share repurchases, and other future financial or business performance, strategies and expectations. Forward-looking statements are typically identified by words or phrases such as "believe," "expect," "anticipate," "intend," "outlook," "forecast," "estimate," "position," "target," "mission," "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. Actual results could differ materially from those anticipated in forward-looking statements and future results could differ materially from historical performance. Forward-looking statements speak only as of the date they are made, and the Corporation assumes no duty to update forward-looking statements. In addition to factors mentioned elsewhere in this report or previously disclosed in the Corporation's SEC reports (accessible on the SEC's website at www.sec.gov), the following factors, among others, could cause actual results to differ materially from forward-looking statements or historical performance: (1) adjustments to recorded results of the sale of the residential mortgage banking business after final settlement is completed; (2) changes in economic or industry conditions, the interest rate environment or financial and capital markets, which could result in: a deterioration in credit quality and increased credit losses; an adverse effect on the allowance for loan losses; a reduction in demand for credit or fee-based products and services, net interest income, value of assets under management and assets serviced, value of debt and equity investments, or value of on-balance sheet and off-balance-sheet assets; or changes in the availability and terms of funding necessary to meet PNC's liquidity needs; (3) relative investment performance of assets under management; (4) the introduction, withdrawal, success and timing of business initiatives and strategies, decisions regarding further reductions in balance sheet leverage, and PNC's inability to realize cost savings or revenue enhancements, implement integration plans and other consequences of mergers, acquisitions, restructurings and divestitures; (5) customer borrowing, repayment, investment and deposit practices and their acceptance of PNC's products and services; (6) the impact of increased competition; (7) the means PNC chooses to redeploy available capital, including the extent and timing of any share repurchases and investments in PNC businesses; (8) the inability to manage risks inherent in PNC's business; (9) the unfavorable resolution of legal proceedings; (10) the denial of insurance coverage for claims made by PNC; (11) 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 loan loss provision and reduced profitability; (12) the impact, extent and timing of technological changes; and (13) actions of the Federal Reserve Board and legislative and regulatory actions and reforms. Some of the above factors are described in more detail in the Risk Factors section of this Financial Review and factors relating to credit risk, interest rate risk, liquidity risk, trading activities, and financial and other derivatives are discussed in the Risk Management section of this Financial Review. Other factors are described elsewhere in this report. 26 CONSOLIDATED STATEMENT OF INCOME THE PNC FINANCIAL SERVICES GROUP, INC.
Three months ended June 30 Six months ended June 30 ------------------------------- ----------------------------- In millions, except per share data 2001 2000 2001 2000 - ---------------------------------------------------------------------------------------------------------------------------------- INTEREST INCOME Loans and fees on loans $839 $1,009 $1,820 $1,993 Securities available for sale 177 97 299 191 Loans held for sale 31 52 68 116 Other 32 22 64 41 - ---------------------------------------------------------------------------------------------------------------------------------- Total interest income 1,079 1,180 2,251 2,341 - ---------------------------------------------------------------------------------------------------------------------------------- INTEREST EXPENSE Deposits 334 397 731 766 Borrowed funds 180 238 401 475 - ---------------------------------------------------------------------------------------------------------------------------------- Total interest expense 514 635 1,132 1,241 - ---------------------------------------------------------------------------------------------------------------------------------- Net interest income 565 545 1,119 1,100 Provision for credit losses 45 35 125 66 - ---------------------------------------------------------------------------------------------------------------------------------- Net interest income less provision for credit losses 520 510 994 1,034 - ---------------------------------------------------------------------------------------------------------------------------------- NONINTEREST INCOME Asset management 214 196 437 382 Fund servicing 182 164 363 319 Service charges on deposits 54 50 104 100 Brokerage 55 60 109 131 Consumer services 58 51 113 98 Corporate services 76 80 152 162 Equity management (30) 48 (69) 135 Net securities gains (losses) 17 46 (3) Other 94 79 166 132 - ---------------------------------------------------------------------------------------------------------------------------------- Total noninterest income 720 728 1,421 1,456 - ---------------------------------------------------------------------------------------------------------------------------------- NONINTEREST EXPENSE Staff expense 418 396 839 807 Net occupancy 54 48 107 101 Equipment 60 55 117 111 Amortization 27 28 53 56 Marketing 16 19 25 32 Distributions on capital securities 16 17 33 33 Other 198 217 390 432 - ---------------------------------------------------------------------------------------------------------------------------------- Total noninterest expense 789 780 1,564 1,572 - ---------------------------------------------------------------------------------------------------------------------------------- Income from continuing operations before income taxes 451 458 851 918 Income taxes 156 159 291 317 - ---------------------------------------------------------------------------------------------------------------------------------- Income from continuing operations 295 299 560 601 - ---------------------------------------------------------------------------------------------------------------------------------- Income from discontinued operations (less applicable income taxes of $10, $0 and $15) 16 40 22 - ---------------------------------------------------------------------------------------------------------------------------------- Net income before cumulative effect of accounting change 295 315 600 623 Cumulative effect of accounting change (less applicable income taxes of $2) (5) - ---------------------------------------------------------------------------------------------------------------------------------- Net income $295 $315 $595 $623 - ---------------------------------------------------------------------------------------------------------------------------------- EARNINGS PER COMMON SHARE Continuing operations Basic $1.01 $1.01 $1.91 $2.03 Diluted 1.00 1.01 1.89 2.02 Net income Basic $1.01 $1.07 $2.03 $2.11 Diluted 1.00 1.06 2.01 2.09 CASH DIVIDENDS DECLARED PER COMMON SHARE $.48 $.45 $.96 $.90 AVERAGE COMMON SHARES OUTSTANDING Basic 288 290 289 291 Diluted 291 292 292 293 ==================================================================================================================================
See accompanying Notes to Consolidated Financial Statements. 27 CONSOLIDATED BALANCE SHEET THE PNC FINANCIAL SERVICES GROUP, INC.
June 30 December 31 In millions, except par value 2001 2000 - ------------------------------------------------------------------------------------------------------------------ ASSETS Cash and due from banks $3,659 $3,662 Short-term investments 793 1,151 Loans held for sale 1,613 1,655 Securities available for sale 11,258 5,902 Loans, net of unearned income of $1,073 and $999 44,167 50,601 Allowance for credit losses (675) (675) - ------------------------------------------------------------------------------------------------------------------ Net loans 43,492 49,926 Goodwill and other amortizable assets 2,405 2,468 Investment in discontinued operations 356 Other 6,793 4,724 - ------------------------------------------------------------------------------------------------------------------ Total assets $70,013 $69,844 ================================================================================================================== LIABILITIES Deposits Noninterest-bearing $9,009 $8,490 Interest-bearing 36,817 39,174 - ------------------------------------------------------------------------------------------------------------------ Total deposits 45,826 47,664 Borrowed funds Federal funds purchased 1,444 1,445 Repurchase agreements 569 607 Bank notes and senior debt 4,496 6,110 Federal Home Loan Bank borrowings 2,464 500 Subordinated debt 2,349 2,407 Other borrowed funds 797 649 - ------------------------------------------------------------------------------------------------------------------ Total borrowed funds 12,119 11,718 Other 4,472 2,958 - ------------------------------------------------------------------------------------------------------------------ Total liabilities 62,417 62,340 - ------------------------------------------------------------------------------------------------------------------ Mandatorily redeemable capital securities of subsidiary trusts 848 848 SHAREHOLDERS' EQUITY Preferred stock 5 7 Common stock - $5 par value Authorized 800 and 450 shares Issued 353 shares 1,764 1,764 Capital surplus 1,257 1,303 Retained earnings 7,010 6,736 Deferred benefit expense (25) (25) Accumulated other comprehensive loss from continuing operations (60) (43) Accumulated other comprehensive loss from discontinued operations (45) Common stock held in treasury at cost: 64 and 63 shares (3,203) (3,041) - ------------------------------------------------------------------------------------------------------------------ Total shareholders' equity 6,748 6,656 - ------------------------------------------------------------------------------------------------------------------ Total liabilities, capital securities and shareholders' equity $70,013 $69,844 ==================================================================================================================
See accompanying Notes to Consolidated Financial Statements. 28 CONSOLIDATED STATEMENT OF CASH FLOWS THE PNC FINANCIAL SERVICES GROUP, INC.
Six months ended June 30 - in millions 2001 2000 - --------------------------------------------------------------------------------------------------------------------------------- OPERATING ACTIVITIES Net income $595 $623 Discontinued operations (40) (22) Cumulative effect of accounting change 5 - --------------------------------------------------------------------------------------------------------------------------------- Income from continuing operations 560 601 Adjustments to reconcile income from continuing operations to net cash provided by operating activities Provision for credit losses 125 66 Depreciation, amortization and accretion 167 173 Deferred income taxes 171 191 Net securities (gains) losses (45) 1 Valuation adjustments 9 23 Change in Loans held for sale 26 1,149 Other (284) (936) - --------------------------------------------------------------------------------------------------------------------------------- Net cash provided by operating activities 729 1,268 - --------------------------------------------------------------------------------------------------------------------------------- INVESTING ACTIVITIES Net change in loans 90 (717) Repayment of securities available for sale 1,153 442 Sales Securities available for sale 10,301 3,455 Loans 2,557 16 Foreclosed assets 11 20 Purchases Securities available for sale (13,113) (3,293) Loans (234) Net cash received (paid) for acquisitions/divestitures 503 (4) Other 11 (117) - --------------------------------------------------------------------------------------------------------------------------------- Net cash provided (used) by investing activities 1,279 (198) - --------------------------------------------------------------------------------------------------------------------------------- FINANCING ACTIVITIES Net change in Noninterest-bearing deposits 519 705 Interest-bearing deposits (2,357) (126) Federal funds purchased (1) (399) Sales/issuances Repurchase agreements 115,246 76,929 Bank notes and senior debt 2,847 Federal Home Loan Bank borrowings 3,123 2,081 Subordinated debt 1 593 Other borrowed funds 18,960 20,335 Common stock 128 71 Repayments/maturities Repurchase agreements (115,284) (76,827) Bank notes and senior debt (1,615) (2,945) Federal Home Loan Bank borrowings (1,155) (3,000) Subordinated debt (100) (494) Other borrowed funds (18,813) (20,292) Acquisition of treasury stock (279) (238) Series F preferred stock tender offer (96) Cash dividends paid (288) (271) - --------------------------------------------------------------------------------------------------------------------------------- Net cash used by financing activities (2,011) (1,031) - --------------------------------------------------------------------------------------------------------------------------------- (DECREASE) INCREASE IN CASH AND DUE FROM BANKS (3) 39 Cash and due from banks at beginning of year 3,662 3,080 - --------------------------------------------------------------------------------------------------------------------------------- Cash and due from banks at end of period $3,659 $3,119 ================================================================================================================================= CASH PAID FOR Interest $1,105 $1,262 Income taxes 100 185 NON-CASH ITEMS Transfer of residential loans to securities available for sale 3,775 Transfer from loans held for sale to loans 6 Transfer from loans to other assets 5 22 =================================================================================================================================
See accompanying Notes to Consolidated Financial Statements. 29 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, corporate banking, real estate finance, asset-based lending, wealth management, asset management and global fund 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 asset management and global fund services internationally. PNC is subject to intense competition from other financial services companies and is subject to regulation by various domestic and international authorities. ACCOUNTING POLICIES BASIS OF FINANCIAL STATEMENT PRESENTATION The unaudited consolidated interim financial statements include the accounts of PNC and its subsidiaries, most of which are wholly owned. Such statements have been prepared in accordance with accounting principles generally accepted in the United States. All significant intercompany accounts and transactions have been eliminated. In the opinion of management, the financial statements reflect all adjustments of a normal recurring nature necessary for a fair statement of results for the interim periods presented. 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. 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. The notes included herein should be read in conjunction with the audited consolidated financial statements included in The PNC Financial Services Group, Inc.'s 2000 Annual Report. FINANCIAL DERIVATIVES 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 the credit risk by entering into transactions with only a select number of high-quality institutions, establishing credit limits, requiring bilateral-netting agreements, and, in certain instances, segregated collateral. 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 the derivative is reported in other assets or other liabilities and offset in accumulated other comprehensive income for the effective portion of the derivative. Ineffectiveness of the strategy, as defined under Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended by SFAS No. 137 and No. 138, if any, is reported in net interest income. Amounts reclassed into earnings, when the hedged transaction affects earnings, are included in net interest income. 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 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 either net interest income or noninterest income depending on the hedged item. 30 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THE PNC FINANCIAL SERVICES GROUP, INC. 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. Interest rate and foreign exchange risk exposures from customer positions are managed through transactions with other dealers. These positions are recorded at estimated fair value and changes in value are included in noninterest income. Effective January 1, 2001, the Corporation implemented SFAS No. 133. The statement requires the Corporation to recognize all derivative instruments as either assets or liabilities on the balance sheet at fair value. 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 and further, on the type of hedging relationship. 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. 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. 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 in the same period or periods during which the hedged transaction affects earnings. The remaining gain or loss on the derivatives in excess of the hedged future cash flows, if any, is recognized in current earnings. For derivatives not designated as hedges, the gain or loss is recognized in current earnings. FINANCIAL DERIVATIVES - 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, 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. Credit default swaps were entered into to mitigate credit risk and lower the required regulatory capital associated with commercial lending activities. If the credit default swaps qualified for hedge accounting treatment, the premium paid to enter into the credit default swaps were 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. Due to the particular structure of the Corporation's credit default swaps discussed in the preceding paragraphs, these instruments are not considered financial derivatives under the provisions of SFAS No. 133. Commencing January 1, 2001, the premiums paid to enter credit default swaps not considered to be derivatives are recorded in other assets and amortized to noninterest expense over the life of the agreement. 31 RECENT ACCOUNTING PRONOUNCEMENTS SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" (a replacement of Financial Accounting Standards Board ("FASB") Statement No. 125) was issued in September 2000. Although SFAS No. 140 has changed many of the rules regarding securitizations, it continues to require an entity to recognize the financial and servicing assets it controls and the liabilities it has incurred and to derecognize financial assets when control has been surrendered in accordance with the criteria provided in the standard. As required, the Corporation began application of the new rules prospectively to transactions beginning in the second quarter of 2001. SFAS No. 140 also requires certain disclosures pertaining to securitization transactions effective for fiscal years ended after December 15, 2000. PNC included these required disclosures in its December 31, 2000 consolidated financial statements. In July 2001, the FASB issued SFAS No. 141, "Business Combinations." SFAS No. 141 requires the purchase method of accounting be used for all business combinations initiated or completed after June 30, 2001 and eliminates the pooling-of-interests method of accounting. The statement also addresses disclosure requirements for business combinations and initial recognition and measurement criteria for goodwill and other intangible assets as a result of purchase business combinations. Also in July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets," which changes the accounting from amortizing goodwill to an impairment-only approach. The amortization of goodwill, including goodwill recognized relating to past business combinations, will cease upon adoption of the new standard. Impairment testing for goodwill at a reporting unit level will be required on at least an annual basis. The new standard also addresses other accounting matters, disclosure requirements and financial statement presentation issues relating to goodwill and other intangible assets. The Corporation will adopt SFAS No. 142 effective January 1, 2002. Assuming no impairment adjustments are necessary, no future business combinations and no other changes to goodwill, the Corporation expects net income to increase by approximately $94 million in 2002 resulting from the cessation of goodwill amortization. DISCONTINUED OPERATIONS On January 31, 2001, PNC closed the sale of its residential mortgage banking business to Washington Mutual, F.A. The income and net assets of the residential mortgage banking business, which are presented on one line in the income statement and balance sheet, respectively, are as follows: INCOME FROM DISCONTINUED OPERATIONS Six months ended June 30 - in millions 2001 2000 - ----------------------------------------------------------------- Total income from operations after tax $15 $22 Total gain on disposal after tax 25 - ----------------------------------------------------------------- Total income from discontinued operations $40 $22 ================================================================= Certain closing date adjustments are currently in dispute between PNC and the buyer. The disputed matters will be resolved in accordance with procedures provided for in the purchase agreement. The ultimate financial impact of the sale will not be determined until final settlement is completed. INVESTMENT IN DISCONTINUED OPERATIONS December 31 - in millions 2000 - ----------------------------------------------------------------- Loans held for sale $3,003 Securities available for sale 3,016 Loans, net of unearned income 739 Goodwill and other amortizable assets 1,925 All other assets 1,168 - ----------------------------------------------------------------- Total assets 9,851 - ----------------------------------------------------------------- Deposits 1,150 Borrowed funds 7,601 Other liabilities 744 - ----------------------------------------------------------------- Total liabilities 9,495 - ----------------------------------------------------------------- Net assets $356 ================================================================= CASH FLOWS During the first six months of 2001, divestiture activity that affected cash flows consisted of $383 million of divested net assets and cash receipts of $503 million. During the first six months of 2000, acquisition activity that affected cash flows consisted of $22 million of acquired assets, $2 million of acquired liabilities and cash payments of $3 million. 32 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THE PNC FINANCIAL SERVICES GROUP, INC. 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 "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 for the first six months of 2001 totaled $78 million compared with $37 million for the prior-year period and was included in noninterest income as follows: Six months ended June 30 - in millions 2001 2000 - ---------------------------------------------------------------- Corporate services $1 Equity management $(4) Other noninterest income Market making 25 21 Derivatives trading 39 7 Foreign exchange 12 11 Other 1 2 - ---------------------------------------------------------------- Net trading income $78 $37 ================================================================ SECURITIES AVAILABLE FOR SALE
Unrealized Amortized ------------------------------------- Fair In millions Cost Gains Losses Value - ----------------------------------------------------------------------------------------------------------------------- JUNE 30, 2001 Debt securities U.S. Treasury and government agencies $1,467 $1 $(29) $1,439 Mortgage-backed 7,643 12 (54) 7,601 Asset-backed 1,333 (16) 1,317 State and municipal 67 2 69 Other debt 439 439 - ----------------------------------------------------------------------------------------------------------------------- Total debt securities 10,949 15 (99) 10,865 Corporate stocks and other 401 53 (61) 393 - ----------------------------------------------------------------------------------------------------------------------- Total securities available for sale $11,350 $68 $(160) $11,258 ======================================================================================================================= DECEMBER 31, 2000 Debt securities U.S. Treasury and government agencies $313 $1 $(1) $313 Mortgage-backed 4,037 13 (48) 4,002 Asset-backed 902 1 (10) 893 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 =======================================================================================================================
The fair value of securities available for sale at June 30, 2001 was $11.3 billion compared with $5.9 billion at December 31, 2000. Securities represented 16% of total assets at June 30, 2001 compared with 8% at December 31, 2000. The increase was primarily due to residential mortgage loan securitizations and purchases of U.S. agencies, asset-backed and other debt securities during the first six months of 2001. The expected weighted-average life of securities available for sale was 5 years and 6 months at June 30, 2001 compared with 4 years and 5 months at December 31, 2000. At June 30, 2001, the securities available for sale balance included a net unrealized loss of $92 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. 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 changes in a hedged risk as part of a fair value hedge strategy, in net income. Net securities gains associated with the disposition of securities available for sale were $46 million for the first six months of 2001 compared with net losses of $3 million for the first six months of 2000. Net securities losses of $1 million for the first six months of 2001, and net securities gains of $2 million for the first 6 months of 2000, related to commercial mortgage banking activities, were included in corporate services revenue. 33 NONPERFORMING ASSETS Nonperforming assets were as follows: June 30 December 31 In millions 2001 2000 - ------------------------------------------------------------------- Nonaccrual loans $374 $323 Foreclosed and other assets 16 49 - ------------------------------------------------------------------- Total nonperforming assets $390 $372 =================================================================== The above table excludes $24 million and $18 million of equity management assets carried at estimated fair value at June 30, 2001 and December 31, 2000, respectively. ALLOWANCE FOR CREDIT LOSSES Changes in the allowance for credit losses were as follows: In millions 2001 2000 - ------------------------------------------------------------------- Allowance at January 1 $675 $674 Charge-offs Commercial (119) (59) Consumer (20) (23) Residential mortgage (1) (3) Lease financing (8) (3) - ------------------------------------------------------------------- Total charge-offs (148) (88) Recoveries Commercial 12 10 Consumer 9 11 Residential mortgage 1 Lease financing 2 1 - ------------------------------------------------------------------- Total recoveries 23 23 - ------------------------------------------------------------------- Net charge-offs Commercial (107) (49) Consumer (11) (12) Residential mortgage (1) (2) Lease financing (6) (2) - ------------------------------------------------------------------- Total net charge-offs (125) (65) Provision for credit losses 125 66 - ------------------------------------------------------------------- Allowance at June 30 $675 $675 =================================================================== 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 that was sold 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 the first six months of 2001. During the next twelve months, the Corporation expects to reclassify to earnings $50 million of pretax net gains on cash flow hedge derivatives currently reported in accumulated other comprehensive income. These net gains may result from anticipated net cash flows on receive fixed interest rate swaps and would offset reductions in net interest income recognized on the related floating rate commercial loans. At June 30, 2001 and December 31, 2000, the Corporation's exposure to credit losses with respect to financial derivatives was not material. LEGAL PROCEEDINGS The Corporation and persons to whom the Corporation may have indemnification obligations, in the normal course of business, are subject to various pending and threatened legal proceedings in which claims for monetary damages and other relief are asserted. Management, after consultation with legal counsel, does not at the present time anticipate the ultimate aggregate liability, if any, arising out of such legal proceedings will have a material adverse effect on the Corporation's financial condition. At the present time, management is not in a position to determine whether any such pending or threatened legal proceedings will have a material adverse effect on the Corporation's results of operations in any future reporting period. 34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THE PNC FINANCIAL SERVICES GROUP, INC. COMPREHENSIVE INCOME Comprehensive income from continuing operations was $228 million for the second quarter of 2001 and $543 million for the first six months of 2001, compared with $301 million and $595 million, respectively, in 2000. The Corporation's other comprehensive income consists of unrealized gains or losses on securities available for sale and cash flow hedge derivatives, foreign currency translation and minimum pension liability adjustments. The income effects allocated to each component of other comprehensive income are as follows: Six months ended June 30, 2001 Pretax Tax Benefit After-tax In millions Amount (Expense) Amount - ----------------------------------------------------------------------------- Unrealized securities losses $(43) $15 $(28) Less: Reclassification adjustment for losses realized in net income (5) 2 (3) - ----------------------------------------------------------------------------- Net unrealized securities losses (38) 13 (25) - ----------------------------------------------------------------------------- SFAS No. 133 transition adjustment (6) 2 (4) Unrealized gains on cash flow hedge derivatives 9 (3) 6 Less: Reclassification adjustment for losses realized in net income (11) 4 (7) - ----------------------------------------------------------------------------- Net unrealized gains on cash flow hedge derivatives 14 (5) 9 Foreign currency translation adjustment (2) 1 (1) - ----------------------------------------------------------------------------- Other comprehensive loss from continuing operations $(26) $9 $(17) ============================================================================= Year ended December 31, 2000 Pretax Tax Benefit After-tax In millions Amount (Expense) Amount - ----------------------------------------------------------------------------- Unrealized securities gains $127 $(41) $86 Less: Reclassification adjustment for losses realized in net income (3) 1 (2) - ----------------------------------------------------------------------------- Net unrealized securities gains 130 (42) 88 Minimum pension liability adjustment 2 (1) 1 - ----------------------------------------------------------------------------- Other comprehensive income from continuing operations $132 $(43) $89 ============================================================================= The accumulated balances related to each component of other comprehensive loss are as follows: June 30 December 31 In millions 2001 2000 - --------------------------------------------------------------------- Net unrealized securities losses $(57) $(32) Net unrealized gains on cash flow hedge derivatives 9 Minimum pension liability adjustment (11) (11) Foreign currency translation adjustment (1) - --------------------------------------------------------------------- Accumulated other comprehensive loss from continuing operations $(60) $(43) ===================================================================== 35 EARNINGS PER SHARE The following table sets forth basic and diluted earnings per share calculations.
Three months ended Six months ended June 30 June 30 -------------------- ------------------- In millions, except share and per share data 2001 2000 2001 2000 - ----------------------------------------------------------------------------------------------------------------------------------- CALCULATION OF BASIC EARNINGS PER COMMON SHARE Income from continuing operations $295 $299 $560 $601 Less: Preferred dividends declared 5 5 10 10 - ----------------------------------------------------------------------------------------------------------------------------------- Income from continuing operations applicable to basic earnings per common share 290 294 550 591 Income from discontinued operations applicable to basic earnings per common share 16 40 22 Cumulative effect of accounting change applicable to basic earnings per common share (5) - ----------------------------------------------------------------------------------------------------------------------------------- Net income applicable to basic earnings per common share $290 $310 $585 $613 Basic weighted-average common shares outstanding (in thousands) 288,269 289,804 288,734 290,847 Basic earnings per common share from continuing operations $1.01 $1.01 $1.91 $2.03 Basic earnings per common share from discontinued operations .06 .14 .08 Basic earnings per common share from cumulative effect of accounting change (.02) - ----------------------------------------------------------------------------------------------------------------------------------- Basic earnings per common share $1.01 $1.07 $2.03 $2.11 =================================================================================================================================== CALCULATION OF DILUTED EARNINGS PER COMMON SHARE Income from continuing operations $295 $299 $560 $601 Less: Dividends declared on nonconvertible preferred stock Series F 5 4 9 9 - ----------------------------------------------------------------------------------------------------------------------------------- Income from continuing operations applicable to diluted earnings per common share 290 295 551 592 Income from discontinued operations applicable to diluted earnings per common share 16 40 22 Cumulative effect of accounting change applicable to diluted earnings per common share (5) - ----------------------------------------------------------------------------------------------------------------------------------- Net income applicable to diluted earnings per common share $290 $311 $586 $614 Basic weighted-average common shares outstanding (in thousands) 288,269 289,804 288,734 290,847 Weighted-average common shares to be issued using average market price and assuming: Conversion of preferred stock Series A and B 107 121 109 121 Conversion of preferred stock Series C and D 884 1,012 892 1,020 Conversion of debentures 17 20 17 21 Exercise of stock options 1,830 1,163 2,044 924 Incentive share awards 309 69 305 216 - ----------------------------------------------------------------------------------------------------------------------------------- Diluted weighted-average common shares outstanding (in thousands) 291,416 292,189 292,101 293,149 Diluted earnings per common share from continuing operations $1.00 $1.01 $1.89 $2.02 Diluted earnings per common share from discontinued operations .05 .14 .07 Diluted earnings per common share from cumulative effect of accounting change (.02) - ----------------------------------------------------------------------------------------------------------------------------------- Diluted earnings per common share $1.00 $1.06 $2.01 $2.09 ===================================================================================================================================
36 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS THE PNC FINANCIAL SERVICES GROUP, INC. SEGMENT REPORTING PNC operates seven major businesses engaged in regional community banking, corporate banking, real estate finance, asset-based lending, wealth management, asset management and global fund services. Business results 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 business results are not necessarily comparable with similar information for any other financial services institution. 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 change from time to time as management accounting practices are enhanced and businesses change. Securities available for sale 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. 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 primarily due to differences between management accounting practices and generally accepted accounting principles, loan portfolios and businesses that have been designated for downsizing during 2000 or earlier, equity management activities, minority interests, residual asset and liability management activities, eliminations and unassigned items, the impact of which is reflected in the "Other" category. BUSINESS SEGMENT PRODUCTS AND SERVICES Regional Community Banking provides deposit, branch-based brokerage, electronic banking and credit products and services to retail customers as well as deposit, credit, treasury management and capital markets products and services to small businesses primarily within PNC's geographic region. Corporate Banking provides credit, equipment leasing, treasury management and capital markets products and services to large and mid-sized corporations, institutions and government entities primarily within PNC's geographic region. PNC Real Estate Finance provides credit, capital markets, treasury management, commercial mortgage loan servicing and other products and services to developers, owners and investors in commercial real estate. PNC's commercial real estate financial services platform includes lending as well as processing businesses. The processing businesses include Midland Loan Services, Inc., a leading third-party provider of loan servicing and technology to the commercial real estate finance industry, and Columbia Housing Partners, LP, a national syndicator of affordable housing equity. PNC Business Credit provides asset-based lending, capital markets and treasury management 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 products and services to affluent individuals and families including full-service brokerage through J.J.B. Hilliard, W.L. Lyons, Inc. and investment advisory 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. BlackRock is one of the largest publicly traded investment management firms in the United States with $213 billion of assets under management at June 30, 2001. BlackRock manages assets on behalf of institutions and individuals through a variety of fixed income, liquidity, equity and alternative investment separate accounts and mutual funds, including its flagship fund families, BlackRock Funds and BlackRock Provident Institutional Funds. In addition, BlackRock provides risk management and technology services to a growing number of 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, providing a wide range of fund services to the investment management industry. PFPC also provides customized processing solutions to the international marketplace through its Dublin, Ireland and Luxembourg operations. 37 RESULTS OF BUSINESSES
PNC Regional Real PNC Three months ended June 30 Community Corporate Estate Business PNC In millions Banking Banking Finance Credit Advisors BlackRock PFPC Other Total - ----------------------------------------------------------------------------------------------------------------------------------- 2001 INCOME STATEMENT Net interest income (a) $364 $128 $28 $27 $36 $2 $(16) $569 Noninterest income 194 64 25 6 154 135 183 $(41) 720 - ----------------------------------------------------------------------------------------------------------------------------------- Total revenue 558 192 53 33 190 137 167 (41) 1,289 Provision for credit losses 10 31 (2) 3 1 2 45 Depreciation and amortization 21 4 6 4 6 11 15 67 Other noninterest expense 251 91 34 8 124 86 131 (3) 722 - ----------------------------------------------------------------------------------------------------------------------------------- Pretax earnings 276 66 15 22 61 45 25 (55) 455 Income taxes 99 24 (3) 8 22 19 10 (19) 160 - ----------------------------------------------------------------------------------------------------------------------------------- Earnings $177 $42 $18 $14 $39 $26 $15 $(36) $295 =================================================================================================================================== Inter-segment revenue $1 $1 $16 $5 $3 $(26) =================================================================================================================================== AVERAGE ASSETS $40,028 $16,289 $5,205 $2,480 $3,336 $571 $1,749 $1,058 $70,716 =================================================================================================================================== 2000 INCOME STATEMENT Net interest income (a) $359 $138 $32 $25 $33 $1 $(12) $(26) $550 Noninterest income 155 68 25 4 161 113 165 37 728 - ----------------------------------------------------------------------------------------------------------------------------------- Total revenue 514 206 57 29 194 114 153 11 1,278 Provision for credit losses 10 23 2 35 Depreciation and amortization 21 4 5 3 5 13 12 63 Other noninterest expense 249 91 27 7 120 73 124 26 717 - ----------------------------------------------------------------------------------------------------------------------------------- Pretax earnings 234 88 25 20 71 36 16 (27) 463 Income taxes 82 32 5 7 26 15 6 (9) 164 - ----------------------------------------------------------------------------------------------------------------------------------- Earnings $152 $56 $20 $13 $45 $21 $10 $(18) $299 =================================================================================================================================== Inter-segment revenue $1 $1 $21 $3 $(26) =================================================================================================================================== AVERAGE ASSETS $38,498 $16,270 $5,826 $2,262 $3,556 $434 $1,571 $240 $68,657 =================================================================================================================================== Six months ended June 30 In millions - ----------------------------------------------------------------------------------------------------------------------------------- 2001 INCOME STATEMENT Net interest income (a) $718 $268 $57 $51 $68 $4 $(31) $(7) $1,128 Noninterest income 382 116 49 20 321 269 363 (99) 1,421 - ----------------------------------------------------------------------------------------------------------------------------------- Total revenue 1,100 384 106 71 389 273 332 (106) 2,549 Provision for credit losses 20 88 (2) 8 1 10 125 Depreciation and amortization 42 7 11 1 8 12 21 29 131 Other noninterest expense 509 189 65 15 248 172 258 (23) 1,433 - ----------------------------------------------------------------------------------------------------------------------------------- Pretax earnings 529 100 32 47 132 89 53 (122) 860 Income taxes 190 34 (6) 17 49 37 21 (42) 300 - ----------------------------------------------------------------------------------------------------------------------------------- Earnings $339 $66 $38 $30 $83 $52 $32 $(80) $560 =================================================================================================================================== Inter-segment revenue $2 $2 $35 48 $3 $(50) =================================================================================================================================== AVERAGE ASSETS $40,321 $16,612 $5,291 $2,429 $3,420 $571 $1,742 $861 $71,247 =================================================================================================================================== 2000 INCOME STATEMENT Net interest income (a) $703 $272 $59 $49 $68 $2 $(22) $(21) $1,110 Noninterest income 288 148 44 8 330 221 320 97 1,456 - ----------------------------------------------------------------------------------------------------------------------------------- Total revenue 991 420 103 57 398 223 298 76 2,566 Provision for credit losses 22 38 2 3 1 66 Depreciation and amortization 42 7 10 1 7 10 26 26 129 Other noninterest expense 492 189 57 13 251 144 246 51 1,443 - ----------------------------------------------------------------------------------------------------------------------------------- Pretax earnings 435 186 36 41 137 69 26 (2) 928 Income taxes 154 66 3 15 51 29 10 (1) 327 - ----------------------------------------------------------------------------------------------------------------------------------- Earnings $281 $120 $33 $26 $86 $40 $16 $(1) $601 =================================================================================================================================== Inter-segment revenue $2 $2 $43 $6 $(53) =================================================================================================================================== AVERAGE ASSETS $38,182 $16,110 $5,604 $2,173 $3,577 $434 $1,587 $833 $68,500 ===================================================================================================================================
(a) Taxable-equivalent basis 38 Statistical Information THE PNC FINANCIAL SERVICES GROUP, INC. CONSOLIDATED AVERAGE BALANCE SHEET AND NET INTEREST ANALYSIS
Six months ended June 30 --------------------------------------------------------------------- 2001 2000 --------------------------------------------------------------------- Average Average Dollars in millions Average Yields/ Average Yields/ Taxable-equivalent basis Balances Interest Rates Balances Interest Rates - ----------------------------------------------------------------------------------------------------------------------------------- ASSETS Interest-earning assets Loans held for sale $1,862 $68 7.19% $2,948 $116 7.76% Securities available for sale U.S. Treasury and government agencies and corporations 3,813 111 5.82 1,792 52 5.76 Other debt 5,968 185 6.22 3,660 120 6.52 Other 114 4 6.39 616 21 6.97 - ------------------------------------------------------------------------------------ ------------------------ Total securities available for sale 9,895 300 6.06 6,068 193 6.35 Loans, net of unearned income Commercial 20,575 797 7.70 21,917 911 8.23 Commercial real estate 2,576 103 7.92 2,690 118 8.67 Consumer 9,090 382 8.49 9,228 389 8.46 Residential mortgage 10,554 384 7.27 12,577 446 7.08 Lease financing 4,024 145 7.19 3,004 109 7.26 Other 490 18 7.36 682 28 8.28 - ------------------------------------------------------------------------------------ ------------------------ Total loans, net of unearned income 47,309 1,829 7.72 50,098 2,001 7.95 Other 1,592 63 8.03 1,194 41 6.99 - ------------------------------------------------------------------------------------ ------------------------ Total interest-earning assets/interest income 60,658 2,260 7.44 60,308 2,351 7.76 Noninterest-earning assets Investment in discontinued operations 103 430 Allowance for credit losses (683) (686) Cash and due from banks 2,942 2,571 Other assets 8,330 6,307 - ------------------------------------------------------------------------- ----------- Total assets $71,350 $68,930 - ------------------------------------------------------------------------- ----------- LIABILITIES, CAPITAL SECURITIES AND SHAREHOLDERS' EQUITY Interest-bearing liabilities Interest-bearing deposits Demand and money market $20,707 296 2.88 $18,125 297 3.30 Savings 1,928 11 1.12 2,123 18 1.69 Retail certificates of deposit 13,190 374 5.73 14,497 386 5.35 Other time 551 18 6.58 639 20 6.40 Deposits in foreign offices 1,248 32 5.05 1,486 45 5.94 - ------------------------------------------------------------------------------------ ------------------------ Total interest-bearing deposits 37,624 731 3.92 36,870 766 4.17 Borrowed funds Federal funds purchased 2,775 72 5.14 2,221 67 5.96 Repurchase agreements 1,116 23 4.04 682 19 5.49 Bank notes and senior debt 5,540 158 5.67 6,869 217 6.25 Federal Home Loan Bank borrowings 2,001 52 5.20 1,922 57 5.89 Subordinated debt 2,386 86 7.22 2,398 89 7.44 Other borrowed funds 383 10 5.29 785 26 6.43 - ------------------------------------------------------------------------------------ ------------------------ Total borrowed funds 14,201 401 5.63 14,877 475 6.33 - ------------------------------------------------------------------------------------ ------------------------ Total interest-bearing liabilities/interest expense 51,825 1,132 4.38 51,747 1,241 4.79 Noninterest-bearing liabilities and shareholders' equity Demand and other noninterest-bearing deposits 8,210 8,028 Accrued expenses and other liabilities 3,803 2,341 Mandatorily redeemable capital securities of subsidiary trusts 848 848 Shareholders' equity 6,664 5,966 - ------------------------------------------------------------------------- ----------- Total liabilities, capital securities and shareholders' $71,350 $68,930 equity - ----------------------------------------------------------------------------------------------------------------------------------- Interest rate spread 3.06 2.97 Impact of noninterest-bearing sources .64 .68 - ----------------------------------------------------------------------------------------------------------------------------------- Net interest income/margin $1,128 3.70% $1,110 3.65% - -----------------------------------------------------------------------------------------------------------------------------------
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 income/expense 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). Loan fees for the six months ended June 30, 2001 and June 30, 2000, were $59 million and $60 million, respectively. For each of the three months ended June 30, 2001, March 31, 2001 and June 30, 2000 loan fees were $30 million, $29 million and $31 million, respectively. 39
- ----------------------------------------------------------------------------------------------------------------------------------- Second Quarter 2001 First Quarter 2001 Second Quarter 2000 - ----------------------------------------------------------------------------------------------------------------------------------- Average Average Average Average Yields/ Average Yields/ Average Yields/ Balances Interest Rates Balances Interest Rates Balances Interest Rates - ----------------------------------------------------------------------------------------------------------------------------------- $1,720 $31 7.06% $2,005 $37 7.31% $2,577 $52 8.11% 3,696 54 5.79 3,933 57 5.84 1,648 25 6.11 7,913 122 6.18 4,001 63 6.32 3,742 62 6.58 101 2 7.33 127 2 5.63 619 11 7.02 - -------------------------- ------------------------ --------------------------- 11,710 178 6.07 8,061 122 6.08 6,009 98 6.50 20,271 375 7.31 20,882 422 8.09 22,042 464 8.33 2,572 48 7.40 2,580 55 8.44 2,682 59 8.74 9,096 188 8.29 9,085 194 8.70 9,209 198 8.63 8,459 152 7.18 12,673 232 7.32 12,571 223 7.09 4,149 74 7.08 3,897 71 7.32 3,049 55 7.19 459 7 6.66 520 11 7.98 676 14 8.50 - -------------------------- ------------------------ --------------------------- 45,006 844 7.46 49,637 985 7.96 50,229 1,013 8.03 1,562 30 7.94 1,831 33 7.20 1,276 22 7.01 - -------------------------- ------------------------ --------------------------- 59,998 1,083 7.19 61,534 1,177 7.67 60,091 1,185 7.86 207 448 (683) (683) (689) 2,907 2,977 2,837 8,494 7,957 6,418 - ----------- ----------- ------------ $70,716 $71,992 $69,105 - ----------- ----------- ------------ $20,944 134 2.57 $20,468 162 3.20 $18,549 159 3.46 1,936 5 .94 1,919 6 1.31 2,107 9 1.75 12,662 175 5.54 13,724 199 5.90 14,403 195 5.45 537 8 6.48 565 10 6.67 641 10 6.44 1,096 12 4.17 1,402 20 5.75 1,483 24 6.25 - -------------------------- ------------------------ --------------------------- 37,175 334 3.60 38,078 397 4.22 37,183 397 4.30 2,604 28 4.31 2,948 44 5.89 2,162 34 6.28 958 9 3.64 1,145 14 4.83 769 11 5.56 5,189 67 5.09 5,896 91 6.19 6,762 110 6.40 2,550 31 4.78 1,576 21 5.46 1,514 24 6.35 2,364 42 7.15 2,408 44 7.09 2,420 45 7.45 365 3 3.32 402 7 7.30 795 14 6.89 - -------------------------- ------------------------ --------------------------- 14,030 180 5.09 14,375 221 6.15 14,422 238 6.54 - -------------------------- ------------------------ --------------------------- 51,205 514 4.01 52,453 618 4.75 51,605 635 4.92 8,229 8,190 8,357 3,777 3,830 2,290 848 848 848 6,657 6,671 6,005 - ----------- ----------- ------------ $70,716 $71,992 $69,105 - ----------------------------------------------------------------------------------------------------------------------------------- 3.18 2.92 2.94 .58 .70 .69 - ----------------------------------------------------------------------------------------------------------------------------------- $569 3.76% $559 3.62% $550 3.63% - -----------------------------------------------------------------------------------------------------------------------------------
40 QUARTERLY REPORT ON FORM 10-Q THE PNC FINANCIAL SERVICES GROUP, INC. Securities and Exchange Commission Washington, D.C. 20549 Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended June 30, 2001. Commission File Number 1-9718 THE PNC FINANCIAL SERVICES GROUP, INC. Incorporated in the Commonwealth of Pennsylvania IRS Employer Identification No. 25-1435979 Address: One PNC Plaza 249 Fifth Avenue Pittsburgh, Pennsylvania 15222-2707 Telephone: (412) 762-2000 As of July 31, 2001 The PNC Financial Services Group, Inc. had 287,972,782 shares of common stock ($5 par value) outstanding. The PNC Financial Services Group, Inc. (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. The following sections of the Financial Review set forth in the cross-reference index are incorporated in the Quarterly Report on Form 10-Q. Cross-reference Page(s) - ----------------------------------------------------------------- PART I FINANCIAL INFORMATION Item 1 Financial Statements Consolidated Statement of Income for the three months and six months ended June 30, 2001 and 2000 27 Consolidated Balance Sheet as of June 30, 2001 and December 31, 2000 28 Consolidated Statement of Cash Flows for the six months ended June 30, 2001 and 2000 29 Notes to Consolidated Financial Statements 30 - 38 Consolidated Average Balance Sheet and Net Interest Analysis 39 - 40 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 3 - 26 Item 3 Quantitative and Qualitative Disclosures About Market Risk 17 - 24 - ----------------------------------------------------------------- PART II OTHER FINANCIAL INFORMATION ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K The following exhibit index lists Exhibits filed with this Quarterly Report on Form 10-Q: 10.5 The Corporation's 1997 Long-Term Incentive Award Plan, as amended 10.6 The Corporation's 1996 Executive Incentive Award Plan, as amended 12.1 Computation of Ratio of Earnings to Fixed Charges 12.2 Computation of Ratio of Earnings to Fixed Charges and Preferred Stock Dividends ================================================================================ Copies of these Exhibits may be obtained electronically at the Securities and Exchange Commission's home page at www.sec.gov. Copies may also be obtained without charge by writing to Lynn Fox Evans, Director of Financial Reporting, at corporate headquarters, by calling (412) 762-1553 or via e-mail at financial.reporting@pnc.com. Since June 30, 2001, the Corporation filed a Current Report on Form 8-K dated as of July 25, 2001, reporting the public offering of $450,000,000 of Floating Rate Senior Notes due 2003, and $700,000,000 of 5.75% Senior Notes due 2006, filed pursuant to Item 5. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on August 14, 2001, on its behalf by the undersigned thereunto duly authorized. THE PNC FINANCIAL SERVICES GROUP, INC. By: /s/ Robert L. Haunschild ------------------------- Robert L. Haunschild Senior Vice President and Chief Financial Officer 41 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. 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. Copies may also be obtained without charge by writing to Lynn Fox Evans, Director of Financial Reporting, at corporate headquarters, by calling (412) 762-1553 or via e-mail at financial.reporting@pnc.com. INQUIRIES For financial services call 1-888-PNC-2265. Individual shareholders should contact Shareholder Relations at (800) 982-7652. Analysts and institutional investors should contact William H. Callihan, Vice President, Investor Relations, 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, Director of Corporate Communications, at (412) 762-8221 or via e-mail at corporate.communications@pnc.com. 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 ===================================================================== 2001 QUARTER - --------------------------------------------------------------------- First $75.813 $56.000 $67.750 $.48 Second 71.110 62.400 65.790 .48 - --------------------------------------------------------------------- Total $.96 ===================================================================== 2000 QUARTER - --------------------------------------------------------------------- First $48.500 $36.000 $45.063 $.45 Second 57.500 41.000 46.875 .45 Third 66.375 47.625 65.000 .45 Fourth 75.000 56.375 73.063 .48 - --------------------------------------------------------------------- Total $1.83 ===================================================================== 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 card may be obtained by writing to Shareholder Relations at corporate headquarters. REGISTRAR AND TRANSFER AGENT The Chase Manhattan Bank 85 Challenger Road Ridgefield Park, New Jersey 07660 (800) 982-7652 42