FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2002 ------------------------------ OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ------------- ------------- Commission file number 1-10706 -------------------------------------- Comerica Incorporated ------------------------------------------------------ (Exact name of registrant as specified in its charter) Delaware 38-1998421 - ------------------------------- ----------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) Comerica Tower at Detroit Center Detroit, Michigan 48226 ---------------------------------------- (Address of principal executive offices) (Zip Code) (800) 521-1190 ---------------------------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ------- ------- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. $5 par value common stock: Outstanding as of October 31, 2002: 174,713,000 shares
COMERICA INCORPORATED AND SUBSIDIARIES TABLE OF CONTENTS PART I. FINANCIAL INFORMATION <TABLE> <S><C> ITEM 1. Financial Statements Consolidated Balance Sheets at September 30, 2002 (unaudited), December 31, 2001 and September 30, 2001 (unaudited).............................................3 Consolidated Statements of Income for the nine months and three months ended September 30, 2002 and 2001 (unaudited)..................................4 Consolidated Statements of Changes in Shareholders' Equity for the nine months ended September 30, 2002 and 2001 (unaudited)...........................5 Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and 2001 (unaudited)......................................................6 Notes to Consolidated Financial Statements (unaudited)..................................7 ITEM 2. Management's Discussion and Analysis of Results of Operations and Financial Condition.......................................................27 ITEM 3. Quantitative and Qualitative Disclosures about Market Risk.....................46 ITEM 4. Controls and Procedures........................................................47 PART II. OTHER INFORMATION ITEM 1. Legal Proceedings..............................................................49 ITEM 5. Other Information..............................................................50 ITEM 6. Exhibits and Reports on Form 8-K...............................................51 Signatures.............................................................................52 </TABLE> -2-
CONSOLIDATED BALANCE SHEETS Comerica Incorporated and Subsidiaries <TABLE> <CAPTION> September 30, December 31, September 30, (in millions, except share data) 2002 2001 2001 ------------- ------------ ------------- (unaudited) (unaudited) <S> <C> <C> <C> ASSETS Cash and due from banks $ 2,171 $ 1,925 $ 2,160 Short-term investments 1,880 1,079 388 Investment securities available for sale 4,486 4,291 4,206 Commercial loans 24,658 25,176 25,198 International loans 2,875 3,015 2,948 Real estate construction loans 3,446 3,258 3,161 Commercial mortgage loans 7,034 6,267 5,794 Residential mortgage loans 747 779 808 Consumer loans 1,541 1,484 1,509 Lease financing 1,288 1,217 1,147 ---------- ---------- ---------- Total loans 41,589 41,196 40,565 Less allowance for credit losses (789) (655) (645) ---------- ---------- ---------- Net loans 40,800 40,541 39,920 Premises and equipment 356 353 350 Customers' liability on acceptances outstanding 37 29 33 Accrued income and other assets 2,836 2,514 2,676 ---------- ---------- ---------- TOTAL ASSETS $ 52,566 $ 50,732 $ 49,733 ========== ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Noninterest-bearing deposits $ 15,815 $ 12,596 $ 11,717 Interest-bearing deposits 24,834 24,974 25,417 ---------- ---------- ---------- Total deposits 40,649 37,570 37,134 Short-term borrowings 689 1,986 1,347 Acceptances outstanding 37 29 33 Accrued expenses and other liabilities 834 837 870 Medium- and long-term debt 5,487 5,503 5,551 ---------- ---------- ---------- Total liabilities 47,696 45,925 44,935 Common stock - $5 par value: Authorized - 325,000,000 shares Issued - 178,749,198 shares at 9/30/02, 12/31/01 and 9/30/01 894 894 894 Capital surplus 356 336 334 Unearned employee stock ownership plan - 131,954 shares at 12/31/01 and 145,444 shares at 9/30/01 -- (5) (6) Accumulated other comprehensive income 292 225 286 Retained earnings 3,565 3,448 3,329 Less cost of common stock in treasury - 4,059,307 shares at 9/30/02, 1,674,659 shares at 12/31/01 and 687,940 shares at 9/30/01 (237) (91) (39) ---------- ---------- ---------- Total shareholders' equity 4,870 4,807 4,798 ---------- ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 52,566 $ 50,732 $ 49,733 ========== ========== ========== </TABLE> See notes to consolidated financial statements. -3-
CONSOLIDATED STATEMENTS OF INCOME (unaudited) Comerica Incorporated and Subsidiaries <TABLE> <CAPTION> Three Months Ended September 30, ------------------------ (in millions, except per share data) 2002 2001 -------- -------- <S> <C> <C> INTEREST INCOME Interest and fees on loans $ 625 $ 758 Interest on investment securities 63 62 Interest on short-term investments 6 3 -------- -------- Total interest income 694 823 INTEREST EXPENSE Interest on deposits 119 214 Interest on short-term borrowings 11 26 Interest on medium- and long-term debt 36 57 -------- -------- Total interest expense 166 297 -------- -------- Net interest income 528 526 Provision for credit losses 285 58 -------- -------- Net interest income after provision for credit losses 243 468 NONINTEREST INCOME Service charges on deposit accounts 56 54 Fiduciary income 42 45 Commercial lending fees 16 18 Letter of credit fees 16 15 Brokerage fees 9 11 Investment advisory revenue, net 2 (3) Bank-owned life insurance 15 9 Equity in earnings of unconsolidated subsidiaries 3 4 Warrant income 1 - Securities gains/(losses) (6) - Net gain on sales of businesses 12 21 Other noninterest income 50 50 -------- -------- Total noninterest income 216 224 NONINTEREST EXPENSES Salaries and employee benefits 214 207 Net occupancy expense 31 28 Equipment expense 15 16 Outside processing fee expense 16 15 Customer services 4 10 Goodwill impairment 86 - Restructuring charge - 18 Other noninterest expenses 67 79 -------- -------- Total noninterest expenses 433 373 -------- -------- Income before income taxes 26 319 Provision for income taxes 2 110 -------- -------- NET INCOME $ 24 $ 209 ======== ======== Net income applicable to common stock $ 24 $ 205 ======== ======== Basic net income per common share $ 0.14 $ 1.16 Diluted net income per common share $ 0.14 $ 1.14 Cash dividends declared on common stock $ 84 $ 78 Dividends per common share $ 0.48 $ 0.44 </TABLE> See notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF INCOME (unaudited) Comerica Incorporated and Subsidiaries <TABLE> <CAPTION> Nine Months Ended September 30, ------------------------ (in millions, except per share data) 2002 2001 -------- -------- <S> <C> <C> INTEREST INCOME Interest and fees on loans $ 1,904 $ 2,437 Interest on investment securities 188 182 Interest on short-term investments 19 19 -------- -------- Total interest income 2,111 2,638 INTEREST EXPENSE Interest on deposits 363 729 Interest on short-term borrowings 33 90 Interest on medium- and long-term debt 116 253 -------- -------- Total interest expense 512 1,072 -------- -------- Net interest income 1,599 1,566 Provision for credit losses 533 167 -------- -------- Net interest income after provision for credit losses 1,066 1,399 NONINTEREST INCOME Service charges on deposit accounts 169 156 Fiduciary income 130 136 Commercial lending fees 50 46 Letter of credit fees 45 43 Brokerage fees 29 34 Investment advisory revenue, net 21 1 Bank-owned life insurance 44 25 Equity in earnings of unconsolidated subsidiaries 7 (46) Warrant income 5 4 Securities gains/(losses) (16) 23 Net gain on sales of businesses 12 21 Other noninterest income 150 170 -------- -------- Total noninterest income 646 613 NONINTEREST EXPENSES Salaries and employee benefits 630 633 Net occupancy expense 92 86 Equipment expense 48 53 Outside processing fee expense 47 45 Customer services 19 30 Goodwill impairment 86 - Restructuring charge - 127 Other noninterest expenses 207 238 -------- -------- Total noninterest expenses 1,129 1,212 -------- -------- Income before income taxes 583 800 Provision for income taxes 188 289 -------- -------- NET INCOME $ 395 $ 511 ======== ======== Net income applicable to common stock $ 395 $ 499 ======== ======== Basic net income per common share $ 2.25 $ 2.81 Diluted net income per common share $ 2.22 $ 2.77 Cash dividends declared on common stock $ 252 $ 235 Dividends per common share $ 1.44 $ 1.32 </TABLE> See notes to consolidated financial statements. -4-
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (unaudited) Comerica Incorporated and Subsidiaries <TABLE> <CAPTION> Unearned Nonredeem- Employee Accumulated able Stock Other (in millions, except Preferred Common Capital Ownership Comprehensive share data) Stock Stock Surplus Plan Shares Income --------- -------- -------- ---------- ----------- <S> <C> <C> <C> <C> <C> <C> BALANCE AT JANUARY 1, 2001 $ 250 $ 888 $ 287 $ (7) $ 12 Net income - - - - - Other comprehensive income, net of tax - - - - 274 Total comprehensive income - - - - - Redemption of preferred stock (250) - - - - Cash dividends declared: Preferred stock - - - - - Common stock - - - - - Purchase of 1,140,800 shares of common stock - - - - - Net issuance of common stock under employee stock plans - 6 34 1 - Recognition of stock based compensation expense - - 13 - - --------- -------- -------- ---------- ----------- BALANCE AT SEPTEMBER 30, 2001 $ - $ 894 $ 334 $ (6) $ 286 ========= ======== ======== ========== =========== BALANCE AT JANUARY 1, 2002 $ - $ 894 $ 336 $ (5) $ 225 Net income - - - - - Other comprehensive income, net of tax - - - - 67 Total comprehensive income - - - - - Cash dividends declared on common stock - - - - - Purchase of 3,536,300 shares of common stock - - - - - Net issuance of common stock under employee stock plans - - 5 5 - Recognition of stock based compensation expense - - 15 - - --------- -------- -------- ---------- ----------- BALANCE AT SEPTEMBER 30, 2002 $ - $ 894 $ 356 $ - $ 292 ========= ======== ======== ========== =========== </TABLE> See notes to consolidated financial statements. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (unaudited) (continued) Comerica Incorporated and Subsidiaries <TABLE> <CAPTION> Total (in millions, except Retained Treasury Shareholders' share data) Earnings Stock Equity ---------- --------- ------------ <S> <C> <C> <C> BALANCE AT JANUARY 1, 2001 $ 3,086 $ (16) $ 4,500 Net income 511 - 511 Other comprehensive income, net of tax - - 274 ------------ Total comprehensive income - - 785 Redemption of preferred stock - - (250) Cash dividends declared: Preferred stock (12) - (12) Common stock (235) - (235) Purchase of 1,140,800 shares of common stock - (65) (65) Net issuance of common stock under employee stock plans (21) 42 62 Recognition of stock based compensation expense - - 13 ----------- --------- ------------ BALANCE AT SEPTEMBER 30, 2001 $ 3,329 $ (39) $ 4,798 =========== ========= ============ BALANCE AT JANUARY 1, 2002 $ 3,448 $ (91) $ 4,807 Net income 395 - 395 Other comprehensive income, net of tax - - 67 ------------ Total comprehensive income - - 462 Cash dividends declared on common stock (252) - (252) Purchase of 3,536,300 shares of common stock - (210) (210) Net issuance of common stock under employee stock plans (26) 64 48 Recognition of stock based compensation expense - - 15 ---------- --------- ------------ BALANCE AT SEPTEMBER 30, 2002 $ 3,565 $ (237) $ 4,870 ========== ========= ============ </TABLE> See notes to consolidated financial statements. -5-
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) Comerica Incorporated and Subsidiaries <TABLE> <CAPTION> Nine Months Ended September 30, -------------------------- (in millions) 2002 2001 ----------- ----------- <S> <C> <C> OPERATING ACTIVITIES: Net income $ 395 $ 511 Adjustments to reconcile net income to net cash provided by operating activities: Provision for credit losses 533 167 Depreciation 43 48 Net amortization of intangibles 3 26 Merger-related and restructuring charges (8) 59 (Gain)loss on investment securities available for sale 16 (23) Contribution to pension plan fund (74) (37) Goodwill impairment 86 -- Net (increase) decrease in trading account securities 50 (25) Net decrease in assets held for sale 4 27 Net decrease in accrued income receivable 30 107 Net (increase) decrease in accrued expenses (150) 40 Net gain on sales of businesses (12) (21) Other, net 30 (134) ------- ------- Total adjustments 551 234 ------- ------- Net cash provided by operating activities 946 745 INVESTING ACTIVITIES: Net (increase) decrease in short-term investments (739) 1,340 Proceeds from sale of investment securities available for sale 384 2,330 Proceeds from maturity of investment securities available for sale 1,250 912 Purchases of investment securities available for sale (1,855) (3,620) Net increase in loans (895) (524) Fixed assets, net (51) (34) Purchase of bank-owned life insurance (8) (107) Net increase in customers' liability on acceptances outstanding (8) (7) Net cash provided by acquisitions/sales 8 21 ------- ------- Net cash provided by (used in) investing activities (1,914) 311 FINANCING ACTIVITIES: Net increase in deposits 3,084 3,261 Net decrease in short-term borrowings (1,296) (746) Net increase in acceptances outstanding 8 7 Proceeds from issuance of medium- and long-term debt 1,101 1,125 Repayments and purchases of medium- and long-term debt (1,282) (3,985) Redemption of preferred stock -- (250) Proceeds from issuance of common stock and other capital transactions 56 62 Purchase of common stock (210) (65) Dividends paid (247) (236) ------- ------- Net cash provided by (used in) financing activities 1,214 (827) ------- ------- Net increase in cash and due from banks 246 229 Cash and due from banks at beginning of period 1,925 1,931 ------- ------- Cash and due from banks at end of period $ 2,171 $ 2,160 ======= ======= Interest paid $ 527 $ 1,172 ======= ======= Income taxes paid $ 244 $ 218 ======= ======= Noncash investing and financing activities: Loans transferred to other real estate $ 8 $ 10 Loans transferred to loans held for sale 116 -- ======= ======= </TABLE> See notes to consolidated financial statements. -6-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) COMERICA INCORPORATED AND SUBSIDIARIES NOTE 1 - BASIS OF PRESENTATION AND ACCOUNTING POLICIES The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, the statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. The results of operations for the nine months ended September 30, 2002, are not necessarily indicative of the results that may be expected for the year ending December 31, 2002. Certain items in prior periods have been reclassified to conform to the current presentation. For further information, refer to the consolidated financial statements and footnotes thereto included in the annual report of Comerica Incorporated and Subsidiaries (the "Corporation") on Form 10-K for the year ended December 31, 2001. Comerica merged with Imperial Bancorp (Imperial), a $7 billion (assets) bank holding company, in the first quarter of 2001, in a transaction accounted for as a pooling of interests. The Corporation uses derivative financial instruments, including foreign exchange contracts, to manage the Corporation's exposure to interest rate and foreign currency risks. All derivative instruments are carried at fair value as either assets or liabilities on the balance sheet. The accounting for changes in the fair value (i.e. gains or losses) of a derivative instrument is determined by 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 -7-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) COMERICA INCORPORATED AND SUBSIDIARIES NOTE 1 - BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED) Corporation designates the hedging instrument, based upon the exposure being hedged, as either a fair value hedge, cash flow hedge or a hedge of a net investment in a foreign operation. For further information, see Note 10. In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets". The Corporation adopted SFAS No. 142 on January 1, 2002. Under SFAS No. 142, goodwill is no longer amortized, but is subject to annual impairment tests. Other intangible assets that do not have an indefinite life continue to be amortized over their useful lives. For further information on the adoption of SFAS No. 142, see Note 4. In the third quarter of 2002, the Corporation adopted the fair value method of accounting for stock options, as outlined in SFAS No. 123, "Accounting for Stock-Based Compensation," effective for stock options granted subsequent to December 31, 2001. Financial results for the second quarter of 2002 have been restated in accordance with SFAS No. 123. Under SFAS No. 123, compensation expense equal to the fair value of stock-based compensation as of the date of grant is recognized over the vesting period. For further information on the adoption of SFAS No. 123, see Note 12. NOTE 2 - INVESTMENT SECURITIES At September 30, 2002, investment securities having a carrying value of $2.0 billion were pledged, primarily with the Federal Reserve Bank and state and local government agencies. Securities are pledged where permitted or required by law to secure liabilities and public and other deposits, including deposits of the State of Michigan of $115 million. -8-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) COMERICA INCORPORATED AND SUBSIDIARIES NOTE 3 - ALLOWANCE FOR CREDIT LOSSES The following summarizes the changes in the allowance for credit losses: <TABLE> <CAPTION> NINE MONTHS ENDED SEPTEMBER 30, (IN MILLIONS) 2002 2001 -------- -------- <S> <C> <C> Balance at beginning of period $ 655 $ 608 Charge-offs (424) (165) Recoveries 25 35 -------- -------- Net charge-offs (399) (130) Provision for credit losses 533 167 -------- -------- Balance at end of period $ 789 $ 645 ======== ======== </TABLE> SFAS No. 114, "Accounting by Creditors for Impairment of a Loan," considers a loan impaired when it is probable that interest and principal payments will not be made in accordance with the contractual terms of the loan agreement. Consistent with this definition, all nonaccrual and reduced-rate loans (with the exception of residential mortgage and consumer loans) are impaired. Impaired loans include $24 million of loans which were formerly on nonaccrual status, but were restructured and met the requirements to be restored to an accrual basis. These restructured loans are performing in accordance with their modified terms, but, in accordance with impaired loan disclosures, must continue to be disclosed as impaired for the remainder of the calendar year of the restructuring. Impaired loans averaged $647 million and $645 million for the three and nine month periods ended September 30, 2002, compared to $561 million and $501 million, respectively, for the comparable periods last year. The following presents information regarding the period-end balances of impaired loans: <TABLE> <CAPTION> (IN MILLIONS) SEPTEMBER 30, 2002 DECEMBER 31, 2001 ------------------ ----------------- <S> <C> <C> Total period-end impaired loans $639 $674 Less: Loans returned to accrual status during the period 24 62 ---- ---- Total period-end nonaccrual business loans $615 $612 Impaired loans requiring an allowance $443 $562 Allowance allocated to impaired loans $113 $228 </TABLE> -9-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) COMERICA INCORPORATED AND SUBSIDIARIES NOTE 3 - ALLOWANCE FOR CREDIT LOSSES (CONTINUED) Those impaired loans not requiring an allowance represent loans for which the fair value exceeded the recorded investment in the loan. NOTE 4 - GOODWILL AND OTHER INTANGIBLE ASSETS - ADOPTION OF SFAS NO. 142 In accordance with the Corporation's adoption of SFAS No. 142, the Corporation performed the first required impairment test of goodwill and indefinite-lived intangible assets as of January 1, 2002. Based on this test, the Corporation was not required to record a transition adjustment upon adoption. Goodwill was again evaluated for impairment as of July 1, 2002. As a result of this test, the Corporation was required to record a goodwill impairment charge of $86 million in the third quarter of 2002. This charge resulted from the continued decline in equity markets, and its related impact on the valuation of the Corporation's investment advisory reporting unit (Munder), which is a part of the Investment Bank for business segment reporting purposes. Further declines in equity markets could trigger additional goodwill impairment charges related to this unit in future quarters. The fair value of Munder used in the determination of the impairment charge was based on a valuation prepared by an investment banker not affiliated with the Corporation. The valuation used a combination of valuation techniques, including discounted cash flows and the prices of external comparable businesses. -10-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) COMERICA INCORPORATED AND SUBSIDIARIES NOTE 4 - GOODWILL AND OTHER INTANGIBLE ASSETS - ADOPTION OF SFAS NO. 142 (CONTINUED) <TABLE> <CAPTION> THREE MONTHS ENDED (IN MILLIONS, SEPTEMBER 30, ----------------------- EXCEPT PER SHARE AMOUNTS) 2002 2001 ---------- ---------- <S> <C> <C> Reported net income applicable to common stock $ 24 $ 205 Add back: Goodwill amortization, net of tax - 7 ---------- ---------- Adjusted net income applicable to common stock $ 24 $ 212 ========== ========== Basic net income per common share Reported net income applicable to common stock $0.14 $1.16 Goodwill amortization, net of tax - 0.04 ---------- ---------- Adjusted net income applicable to common stock $0.14 $1.20 ========== ========== Diluted net income per common share Reported net income applicable to common stock $0.14 $1.14 Goodwill amortization, net of tax - 0.04 ---------- ---------- Adjusted net income applicable to common stock $0.14 $1.18 ========== ========== <CAPTION> NINE MONTHS ENDED (IN MILLIONS, SEPTEMBER 30, ----------------------- EXCEPT PER SHARE AMOUNTS) 2002 2001 ---------- ---------- <S> <C> <C> Reported net income applicable to common stock $ 395 $ 499 Add back: Goodwill amortization, net of tax - 21 ---------- ---------- Adjusted net income applicable to common stock $ 395 $ 520 ========== ========== Basic net income per common share Reported net income applicable to common stock $2.25 $2.81 Goodwill amortization, net of tax - 0.12 ---------- ---------- Adjusted net income applicable to common stock $2.25 $2.93 ========== ========== Diluted net income per common share Reported net income applicable to common stock $2.22 $2.77 Goodwill amortization, net of tax - 0.12 ---------- ---------- Adjusted net income applicable to common stock $2.22 $2.89 ========== ========== </TABLE> -11-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) COMERICA INCORPORATED AND SUBSIDIARIES NOTE 4 - GOODWILL AND OTHER INTANGIBLE ASSETS - ADOPTION OF SFAS NO. 142 (CONTINUED) The changes in the carrying amount of goodwill for the nine months ended September 30, 2002, are as follows: <TABLE> <CAPTION> BUSINESS INDIVIDUAL INVESTMENT (IN MILLIONS) BANK BANK BANK TOTAL -------- ---------- ---------- ----- <S> <C> <C> <C> <C> Balance at January 1, 2002 $ 90 $ 54 $ 189 $ 333 Goodwill impairment - - (86) (86) -------- ---------- ---------- ----- Balance as of September 30, 2002 $ 90 $ 54 $ 103 $ 247 ======== ========== ========== ===== </TABLE> NOTE 5 - ACQUIRED INTANGIBLE ASSETS <TABLE> <CAPTION> (IN MILLIONS) SEPTEMBER 30, 2002 DECEMBER 31, 2001 SEPTEMBER 30, 2001 ---------------------- ---------------------- ---------------------- GROSS GROSS GROSS AMORTIZED INTANGIBLE CARRYING ACCUMULATED CARRYING ACCUMULATED CARRYING ACCUMULATED ASSETS AMOUNT AMORTIZATION AMOUNT AMORTIZATION AMOUNT AMORTIZATION - ------------------------ ---------------------- ---------------------- ---------------------- <S> <C> <C> <C> <C> <C> <C> Core deposit intangibles $ 28 $ 25 $ 27 $ 22 $ 27 $ 22 Other 6 5 6 5 6 5 ------------------- ------------------- ------------------- Total $ 34 $ 30 $ 33 $ 27 $ 33 $ 27 =================== =================== =================== </TABLE> <TABLE> <S> <C> Aggregate amortization expense for the: Three months ended September 30, 2002 $ 1 ===== Nine months ended September 30, 2002 $ 3 ===== Year ended December 31, 2001 $ 3 ===== Three months ended September 30, 2001 $ 1 ===== Nine months ended September 30, 2001 $ 2 ===== Estimated amortization expense for the: Year ending December 31, 2002 $ 4 Year ending December 31, 2003 2 Year ending December 31, 2004 1 Year ending December 31, 2005 - Year ending December 31, 2006 - </TABLE> -12-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) COMERICA INCORPORATED AND SUBSIDIARIES NOTE 6 - MEDIUM- AND LONG-TERM DEBT Medium- and long-term debt consisted of the following at September 30, 2002 and December 31, 2001: <TABLE> <CAPTION> (DOLLAR AMOUNTS IN MILLIONS) SEPTEMBER 30, 2002 DECEMBER 31, 2001 ------------------ ----------------- <S> <C> <C> Parent Company 7.25% subordinated notes due 2007 $ 176 $ 157 Subsidiaries Subordinated notes: 7.25% subordinated notes due 2007 232 216 8.375% subordinated notes due 2024 206 187 7.25% subordinated notes due 2002 150 155 6.875% subordinated notes due 2008 117 108 7.125% subordinated notes due 2013 179 168 7.875% subordinated notes due 2026 206 179 6.00% subordinated notes due 2008 284 256 7.65% subordinated notes due 2010 280 268 8.50% subordinated notes due 2009 112 102 ------ ------ Total subordinated notes 1,766 1,639 Medium-term notes: Floating rate based on LIBOR indices 2,150 2,356 Variable rate secured debt financings due 2007 973 956 9.98% trust preferred securities due 2026 56 56 7.60% trust preferred securities due 2050 341 339 Notes payable 25 - ------ ------ Total subsidiaries 5,311 5,346 ------ ------ Total medium- and long-term debt $5,487 $5,503 ====== ====== </TABLE> The carrying value of medium- and long-term debt has been adjusted to reflect the gain or loss attributable to the risk hedged. NOTE 7 - INCOME TAXES The provision for income taxes is computed by applying statutory federal income tax rates to income before income taxes as reported in the financial statements after deducting non-taxable items, principally income on bank-owned life insurance and interest income on state and municipal securities. State and foreign taxes are then added to the federal provision. The effective tax rate for the nine months ended September 30, 2001 was affected by adjustments in the -13-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) COMERICA INCORPORATED AND SUBSIDIARIES NOTE 7 - INCOME TAXES (CONTINUED) first quarter 2001 to Imperial's tax liabilities at merger date, partially offset by a $7 million tax benefit related to the Imperial acquisition that was recognizable immediately, but only after Imperial became part of Comerica. NOTE 8 - ACCUMULATED OTHER COMPREHENSIVE INCOME Other comprehensive income includes the change in net unrealized gains and losses on investment securities available for sale, the change in the accumulated foreign currency translation adjustment, the change in accumulated gains and losses on cash flow hedges and the change in accumulated minimum pension liability. The Consolidated Statements of Changes in Shareholders' Equity include only combined, net of tax, other comprehensive income. The following presents reconciliations of the components of accumulated other comprehensive income for the nine months ended September 30, 2002 and 2001. Total comprehensive income totaled $462 million and $785 million, for the nine months ended September 30, 2002 and 2001, respectively, and $73 million and $376 million for the three months ended September 30, 2002 and 2001, respectively. <TABLE> <CAPTION> NINE MONTHS ENDED SEPTEMBER 30, ------------------------- (IN MILLIONS) 2002 2001 -------- -------- <S> <C> <C> Net unrealized gains/(losses) on investment securities available for sale: Balance at beginning of period $ 16 $ 8 Net unrealized holding gains/(losses) arising during the period 37 61 Less: Reclassification adjustment for gains/(losses) included in net income (16) 23 ---- ---- Change in net unrealized gains/(losses) before income taxes 53 38 Less: Provision for income taxes 19 13 ---- ---- Change in net unrealized gains/(losses) on investment securities available for sale, net of tax 34 25 ---- ---- Balance at end of period $ 50 $ 33 ---- ---- </TABLE> -14-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) COMERICA INCORPORATED AND SUBSIDIARIES NOTE 8 - ACCUMULATED OTHER COMPREHENSIVE INCOME (CONTINUED) <TABLE> <CAPTION> NINE MONTHS ENDED SEPTEMBER 30, ------------------------- (IN MILLIONS) 2002 2001 -------- -------- <S> <C> <C> Accumulated foreign currency translation adjustment: Balance at beginning of period $ - $ 4 Net translation gains/(losses) arising during the period (4) (4) Less: Reclassification adjustment for gains/(losses) included in net income - - ---- ---- Change in translation adjustment before income taxes (4) (4) Less: Provision for income taxes - - ---- ---- Change in foreign currency translation adjustment, net of tax (4) (4) ---- ---- Balance at end of period $ (4) $ - ---- ---- Accumulated net gains/(losses) on cash flow hedges: Balance at beginning of period $209 $ - Transition adjustment upon adoption of accounting standard - 65 Net cash flow hedge gains/(losses) arising during the period 346 413 Less: Reclassification adjustment for gains/(losses) included in net income 272 89 ---- ---- Change in cash flow hedges before income taxes 74 389 Less: Provision for income taxes 26 136 ---- ---- Change in cash flow hedges, net of tax 48 253 ---- ---- Balance at end of period $257 $253 ---- ---- Accumulated minimum pension liability adjustment: Balance at beginning of period $ - $ - Minimum pension liability adjustment arising during the period (17) - ---- ---- Minimum pension liability before taxes (17) - Less: Provision for income taxes (6) - ---- ---- Change in minimum pension liability, net of tax (11) - ---- ---- Balance at end of period $(11) $ - ---- ---- Accumulated other comprehensive income, net of taxes, at end of period $292 $286 ==== ==== </TABLE> -15-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) COMERICA INCORPORATED AND SUBSIDIARIES NOTE 9 - MERGER-RELATED AND RESTRUCTURING CHARGES The Corporation recorded merger-related and restructuring charges of $173 million in 2001 related to the acquisition of Imperial, of which $25 million was recorded in the provision for credit losses. The remaining $148 million of charges were recorded in noninterest expenses. The Corporation also recorded a 2001 restructuring charge of $4 million related to its subsidiary, Official Payments Corporation (OPAY). The OPAY restructuring charge was recorded net of the portion of the charge attributable to the minority shareholders in OPAY. The Corporation sold its OPAY subsidiary as of July 24, 2002, therefore, no liability remains for OPAY restructuring charges as of the sale date. The 2001 Imperial restructuring charge included employee termination costs, other employee related costs, a charge related to conforming policies, facilities and operations and other charges. Employee termination costs included the cost of severance, outplacement and other benefits associated with the involuntary termination of employees, primarily senior management and employees in corporate support and data processing functions. A total of 352 employees were terminated in 2001 as part of the restructuring plan. Other employee-related costs included cash payments related to change in control provisions in employment contracts and retention bonuses. Charges related to conforming policies represented costs associated with conforming the credit and accounting policies of Imperial with those of the Corporation. The Corporation also incurred facilities and operations charges associated with closing excess facilities and replacing signage. Other merger-related restructuring costs were primarily comprised of investment banking, accounting, consulting and legal fees. As a result of the Imperial restructuring, the Corporation's annual savings on operating expenses are estimated to be $60 million, beginning in 2002. -16-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) COMERICA INCORPORATED AND SUBSIDIARIES NOTE 9 - MERGER-RELATED AND RESTRUCTURING CHARGES (CONTINUED) As shown in the table below, there is no remaining liability related to the Imperial charge as of September 30, 2002. No additional Imperial related restructuring charges are expected. <TABLE> <Caption> (IN MILLIONS) <S> <C> Balance at December 31, 2001 $ 8 Cash outlays (8) -------- Balance at September 30, 2002 $ - ======== </TABLE> -17-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) COMERICA INCORPORATED AND SUBSIDIARIES NOTE 10 - DERIVATIVES AND FOREIGN EXCHANGE CONTRACTS <TABLE> <CAPTION> SEPTEMBER 30, 2002 DECEMBER 31, 2001 ------------------------------ ------------------------------ NOTIONAL/ NOTIONAL/ CONTRACT UNREALIZED FAIR CONTRACT UNREALIZED FAIR AMOUNT GAINS LOSSES VALUE AMOUNT GAINS LOSSES VALUE (IN MILLIONS) (1) (2) (2) (3) (1) (2) (2) (3) ------------------------------ ------------------------------ <S> <C> <C> <C> <C> <C> <C> <C> <C> RISK MANAGEMENT Interest rate contracts: Swaps $12,230 $751 $ - $ 751 $14,497 $573 $ (2) $ 571 Foreign exchange contracts: Spot, forward and options 510 10 (5) 5 535 10 (4) 6 Swaps 211 2 (1) 1 285 2 (17) (15) ------- ---- ----- ----- ------- ---- ----- ----- Total foreign exchange contracts 721 12 (6) 6 820 12 (21) (9) ------- ---- ----- ----- ------- ---- ----- ----- Total risk management 12,951 763 (6) 757 15,317 585 (23) 562 CUSTOMER-INITIATED AND OTHER Interest rate contracts: Caps and floors written 328 - (4) (4) 365 - (4) (4) Caps and floors purchased 313 5 - 5 352 4 - 4 Swaps 1,064 28 (27) 1 981 14 (13) 1 ------- ---- ----- ----- ------- ---- ----- ----- Total interest rate contracts 1,705 33 (31) 2 1,698 18 (17) 1 ------- ---- ----- ----- ------- ---- ----- ----- Foreign exchange contracts: Spot, forward and options 1,685 32 (31) 1 2,323 35 (29) 6 Swaps 288 1 - 1 366 2 (1) 1 ------- ---- ----- ----- ------- ---- ----- ----- Total foreign exchange contracts 1,973 33 (31) 2 2,689 37 (30) 7 ------- ---- ----- ----- ------- ---- ----- ----- Total customer-initiated and other 3,678 66 (62) 4 4,387 55 (47) 8 ------- ---- ----- ----- ------- ---- ----- ----- Total derivatives and foreign exchange contracts $16,629 $829 $ (68) $ 761 $19,704 $640 $ (70) $ 570 ======= ==== ===== ===== ======= ==== ===== ===== </TABLE> (1) Notional or contract amounts, which represent the extent of involvement in the derivatives market, are generally used to determine the contractual cash flows required in accordance with the terms of the agreement. These amounts are typically not exchanged, significantly exceed amounts subject to credit or market risk, and are not reflected in the consolidated balance sheets. (2) Represents credit risk, which is measured as the cost to replace, at current market rates, contracts in a profitable position. Credit risk is calculated before consideration is given to bilateral collateral agreements or master netting arrangements that effectively reduce credit risk. (3) The fair values of derivatives and foreign exchange contracts generally represent the estimated amounts the Corporation would receive or pay to terminate or otherwise settle the contracts at the balance sheet date. The fair values of all derivatives and foreign exchange contracts are reflected in the consolidated balance sheets. -18-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) COMERICA INCORPORATED AND SUBSIDIARIES NOTE 10 - DERIVATIVES AND FOREIGN EXCHANGE CONTRACTS (CONTINUED) Risk Management Fluctuations in net interest income due to interest rate risk result from the composition of assets and liabilities and the mismatches in the timing of the repricing of these assets and liabilities. In addition, external factors such as interest rates, and the dynamics of yield curve and spread relationships can affect net interest income. The Corporation utilizes simulation analyses to project the sensitivity of the Corporation's net interest income to changes in interest rates. Foreign exchange rate risk arises from changes in the value of certain assets and liabilities denominated in foreign currencies. The Corporation employs cash instruments, such as investment securities, as well as derivative financial instruments and foreign exchange contracts, to manage exposure to these and other risks, including liquidity risk. As an end-user, the Corporation accesses the interest rate markets to obtain derivative instruments for use principally in connection with asset and liability management activities. As part of a fair value hedging strategy, the Corporation has entered into interest rate swap agreements for interest rate risk management purposes. The interest rate swap agreements effectively modify the Corporation's exposure to interest rate risk by converting fixed-rate deposits and debt to a floating rate. These agreements involve the receipt of fixed rate interest amounts in exchange for floating rate interest payments over the life of the agreement, without an exchange of the underlying principal amount. For instruments that support a fair value hedging strategy, no ineffectiveness was required to be recorded in the statement of income. As part of a cash flow hedging strategy, the Corporation has entered into predominantly 3-year interest rate swap agreements that effectively convert a portion of its existing and forecasted floating-rate loans to a fixed-rate basis, thus reducing the impact of interest rate changes on future interest income over -19-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) COMERICA INCORPORATED AND SUBSIDIARIES NOTE 10 - DERIVATIVES AND FOREIGN EXCHANGE CONTRACTS (CONTINUED) the next 3 years. Approximately 22 percent ($9 billion) of the Corporation's outstanding loans were designated as the hedged items to interest rate swap agreements at September 30, 2002. During the three and nine month periods ended September 30, 2002, interest rate swap agreements designated as cash flow hedges increased interest and fees on loans by $83 and $272 million, respectively, compared to $53 and $89 million, respectively, for the comparable periods last year. The ineffectiveness associated with these hedging instruments was not significant to the Corporation's statement of income in the third quarter of 2002. If interest rates and interest curves remain at their current levels, the Corporation expects to reclassify $186 million of net gains on derivative instruments from accumulated other comprehensive income to earnings during the next twelve months due to receipt of variable interest associated with the existing and forecasted floating-rate loans. Management believes these strategies achieve an optimal relationship between the rate maturities of assets and their funding sources which, in turn, reduces the overall exposure of net interest income to interest rate risk, although, there can be no assurance that such strategies will be successful. The Corporation also uses various other types of financial instruments to mitigate interest rate and foreign currency risks associated with specific assets or liabilities, which are reflected in the table above. Such instruments include interest rate caps and floors, foreign exchange forward contracts, and foreign exchange cross-currency swaps. The following table summarizes the expected maturity distribution of the notional amount of interest rate swaps used for risk management purposes and indicates the weighted average interest rates associated with amounts to be received or paid on interest rate swap agreements as of September 30, 2002. The swaps are grouped by the assets or liabilities to which they have been designated. -20-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) COMERICA INCORPORATED AND SUBSIDIARIES NOTE 10 - DERIVATIVES AND FOREIGN EXCHANGE CONTRACTS (CONTINUED) <TABLE> <CAPTION> - ----------------------------------------------------------------------------------------------------------------------------------- REMAINING EXPECTED MATURITY OF RISK MANAGEMENT INTEREST RATE SWAPS AS OF SEPTEMBER 30, 2002: (DOLLAR AMOUNTS 2007- DEC. 31, IN MILLIONS) 2002 2003 2004 2005 2006 2026 TOTAL 2001 - ----------------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> <C> <C> VARIABLE RATE ASSET DESIGNATION: Generic receive fixed swaps $ 40 $4,750 $2,000 $1,800 $ 500 $ - $ 9,090 $11,069 Weighted average: (1) Receive rate 3.09% 8.31% 7.57% 7.43% 5.83% -% 7.49% 7.68% Pay rate 1.87% 3.75% 4.75% 4.75% 1.86% -% 3.95% 4.07% FIXED RATE ASSET DESIGNATION: Pay fixed swaps Generic $ 4 $ 13 $ - $ - $ - $ - $ 17 $ 34 Amortizing - 1 4 - - - 5 1 Weighted average: (2) Receive rate 1.86% 1.60% 5.97% -% -% -% 2.50% 2.22% Pay rate 2.51% 1.61% 6.68% -% -% -% 2.76% 2.56% FIXED RATE DEPOSIT DESIGNATION: Generic receive fixed swaps $ - $1,468 $ - $ - $ - $ - $ 1,468 $ 1,743 Weighted average: (1) Receive rate -% 4.22% -% -% -% -% 4.22% 4.87% Pay rate -% 3.57% -% -% -% -% 3.57% 2.00% MEDIUM- AND LONG-TERM DEBT DESIGNATION: Generic receive fixed swaps $ 150 $ - $ - $ 250 $ - $ 1,250 $ 1,650 $ 1,650 Weighted average: (1) Receive rate 7.22% -% -% 7.04% -% 6.73% 6.82% 6.82% Pay rate 2.24% -% -% 1.75% -% 2.01% 1.99% 2.66% Total notional amount $ 194 $6,232 $2,004 $2,050 $ 500 $ 1,250 $12,230 $14,497 </TABLE> (1) Variable rates paid on receive fixed swaps are based on one-month and three-month LIBOR or one-month Canadian Dollar Offered Rate (CDOR) rates in effect at September 30, 2002. Variable rates received on pay fixed swaps are based on prime at September 30, 2002. (2) Variable rates received are based on three-month and six-month LIBOR or one-month and three-month CDOR rates in effect at September 30, 2002. -21-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) COMERICA INCORPORATED AND SUBSIDIARIES NOTE 10 - DERIVATIVES AND FOREIGN EXCHANGE CONTRACTS (CONTINUED) The Corporation had commitments to purchase investment securities for its trading account and available for sale portfolio totaling $522 million at September 30, 2002 and totaling $67 million at December 31, 2001. Commitments to sell investment securities related to the trading account totaled $22 million at September 30, 2002, and $10 million at December 31, 2001. Outstanding commitments expose the Corporation to both credit and market risk. Customer-Initiated and Other The Corporation earns additional income by executing various derivative transactions, primarily foreign exchange contracts and interest rate contracts, at the request of customers. Market risk inherent in customer-initiated contracts is often mitigated by taking offsetting positions. The Corporation generally does not speculate in derivative financial instruments for the purpose of profiting in the short-term from favorable movements in market rates. Average fair values and income from customer-initiated and other foreign exchange contracts and interest rate contracts were not material for the nine-month periods ended September 30, 2002 and 2001 and for the year ended December 31, 2001. Derivative and Foreign Exchange Activity The following table provides a reconciliation of the beginning and ending notional amounts for interest rate derivatives and foreign exchange contracts for the nine months ended September 30, 2002. -22-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) COMERICA INCORPORATED AND SUBSIDIARIES NOTE 10 - DERIVATIVE AND FOREIGN EXCHANGE CONTRACTS (CONTINUED) <TABLE> <CAPTION> CUSTOMER-INITIATED RISK MANAGEMENT AND OTHER ------------------------ ----------------------- INTEREST FOREIGN INTEREST FOREIGN RATE EXCHANGE RATE EXCHANGE (IN MILLIONS) CONTRACTS CONTRACTS CONTRACTS CONTRACTS ------------------------ ----------------------- <S> <C> <C> <C> <C> Balance at December 31, 2001 $ 14,497 $ 820 $ 1,698 $ 2,689 Additions 2,448 12,664 589 35,386 Maturities/amortizations (4,715) (12,763) (582) (36,102) -------- -------- -------- -------- Balance at September 30, 2002 $ 12,230 $ 721 $ 1,705 $ 1,973 ======== ======== ======== ======== </TABLE> Additional information regarding the nature, terms and associated risks of the above derivatives and foreign exchange contracts, can be found in the Corporation's 2001 annual report on page 40 and in Notes 1 and 20 to the consolidated financial statements. NOTE 11 - BUSINESS SEGMENT INFORMATION The Corporation has strategically aligned its operations into three major lines of business: the Business Bank, the Individual Bank and the Investment Bank. These lines of business are differentiated based on the products and services provided. In addition to the three major lines of business, the Finance Division is also reported as a segment. Lines of business results are produced by the Corporation's internal management accounting system. This system measures financial results based on the internal organizational structure of the Corporation; information presented is not necessarily comparable with any other financial institution. Lines of business/segment financial results for the nine months ended September 30, 2002 and 2001 are presented below. -23-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) COMERICA INCORPORATED AND SUBSIDIARIES NOTE 11 - BUSINESS SEGMENT INFORMATION (CONTINUED) Nine Months Ended September 30, <TABLE> <CAPTION> (DOLLAR AMOUNTS IN BUSINESS INDIVIDUAL INVESTMENT MILLIONS) BANK BANK BANK* -------------------------------------------------------- 2002 2001 2002 2001 2002*** 2001** -------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Average assets $ 35,197 $36,365 $ 8,498 $7,714 $ 297 $ 407 Total revenues (FTE) 1,352 1,212 807 807 129 57 Net income (loss) 375 375 216 208 (62) (69) Return on average assets 1.42% 1.38% 1.47% 1.45% (26.70)% (21.79)% Return on average common equity 16.68% 18.01% 29.95% 31.75% (41.11)% (33.77)% </TABLE> <TABLE> <CAPTION> FINANCE OTHER TOTAL ----------------------------------------------------- 2002 2001 2002 2001 2002 2001 ----------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Average assets $ 4,811 $3,633 $ 1,855 $ 1,365 $50,658 $49,484 Total revenues (FTE) (66) 78 26 28 2,248 2,182 Net income (loss) (44) 37 (90) (40) 395 511 Return on average assets (0.33)% 0.30% N/M N/M 1.04% 1.38% Return on average common equity (6.42)% 7.39% N/M N/M 10.79% 14.74% </TABLE> N/M - Not Meaningful * Net income was reduced by charges for fees internally transferred to other lines of business for referrals to the Investment Bank. If excluded, Investment Bank net loss would have been ($49) million and ($58) million, and return on average common equity would have been (32.10)% and (28.41)%, in 2002 and 2001, respectively. ** Net income in 2001 was reduced by a $40 million pre-tax deferred distribution costs impairment charge and a $53 million pre-tax charge related to long-term incentive plans at an unconsolidated subsidiary. Excluding these charges, Investment Bank total revenues (FTE) and net loss in 2001 would have been $154 million and ($8) million, respectively, while return on average assets and return on common equity would have been (2.69)% and (4.16)%, respectively. *** Net income in 2002 was reduced by a $86 million pre-tax goodwill impairment charge at the investment advisory reporting unit (Munder) and a $5 million pre- tax deferred distribution cost impairment charge. Excluding these charges, Investment Bank total revenues (FTE) and net loss in 2002 would have been $134 million and ($3) million, respectively, while return on average assets and return on common equity would have been (1.43)% and (2.20)%, respectively. For a description of the business activities of each line of business and the methodologies, which form the basis for these results, refer to Note 24 to the consolidated financial statements in the Corporation's 2001 Annual Report. -24-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) COMERICA INCORPORATED AND SUBSIDIARIES NOTE 12 - STOCK-BASED COMPENSATION In the third quarter of 2002, the Corporation adopted the fair value method of accounting for stock options, as outlined in SFAS No. 123. Transition rules require that all current year grants be accounted for under the fair value method in the year of adoption, thus, the new method was applied prospectively to all grants made after December 31, 2001. Substantially all current year grants were issued in the second quarter of 2002. Under SFAS No. 123, compensation expense, equal to the fair value of stock-based compensation as of the date of grant, is recognized over the vesting period. Awards under the Corporation's plans vest over periods ranging from one to four years. Therefore, the expense related to stock-based compensation included in the determination of net income for 2002 is less than which would have been recognized if the fair value method had been applied to all awards since the original effective date of SFAS 123. Options granted prior to January 1, 2002 continue to be accounted for under APB Opinion No. 25, "Accounting for Stock Issued to Employees". The fair value of stock options granted was estimated at the date of grant using a Black-Scholes option pricing model. The Black-Scholes model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferrable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. The model may not necessarily provide a reliable single measure of the fair value of employee and director options. The Corporation's employee and director stock options have characteristics significantly different from those of traded options and changes in subjective input assumptions can materially affect the fair value estimate. -25-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) COMERICA INCORPORATED AND SUBSIDIARIES NOTE 12 - STOCK-BASED COMPENSATION (CONTINUED) The fair value of the 2002 options granted was estimated at $15.53-$18.07 using an option valuation model with the following weighted average assumptions: <TABLE> <S> <C> Risk-free interest rate 4.69% Expected dividend yield 2.65% Expected volatility factors of the market price of Comerica common stock 33% Expected option life (in years) 4.8 </TABLE> The net income and diluted earnings per share impacts were $7 million and $0.04, respectively, for the nine months ended September 30, 2002, and $4 million and $0.02, respectively, for the three months ended September 30, 2002. -26-
ITEM 2. Management's Discussion and Analysis of Results of Operations and Financial Condition Results of Operations Net income for the quarter ended September 30, 2002 was $24 million, down $185 million, or 89 percent, from $209 million reported for the third quarter of 2001. Quarterly diluted net income per share decreased to $0.14 from $1.14 a year ago. Return on average common shareholders' equity was 1.93 percent and return on average assets was 0.19 percent, compared to 17.68 percent and 1.68 percent, respectively, for the comparable quarter last year. The decline in earnings in the third quarter 2002 from the comparable quarter last year resulted primarily from a $227 million ($148 million after-tax, or $0.84 per diluted share) increase in provision for credit losses due to the continued uncertainty of an economic recovery and higher noninterest expenses resulting from a third quarter 2002 goodwill impairment charge of $86 million ($56 million after-tax, or $0.31 per diluted share), partially offset by third quarter 2001 Imperial restructuring charges of $18 million ($11 million after-tax, or $0.06 per diluted share). Net income for the first nine months of 2002 was $2.22 per diluted share, or $395 million, compared to $2.77 per diluted share, or $511 million, for the same period in 2001, decreases of 20 percent and 23 percent, respectively. Return on average common shareholders' equity was 10.79 percent and return on average assets was 1.04 percent for the first nine months of 2002, compared to 14.74 percent and 1.38 percent, respectively, for the first nine months of 2001. The decline in earnings in the nine months ended September 30, 2002 from the comparable period last year resulted from a $366 million ($238 million after-tax, or $1.34 per diluted share) increase in provision for credit losses primarily for the reasons cited in the quarterly discussion in the preceding paragraph and Argentine transfer risk reserves associated with a second quarter U.S. bank regulatory directive. The third quarter 2002 goodwill impairment charge -27-
discussed above and a decrease in securities gains and losses also contributed to the earnings decline. Partially offsetting the decline in earnings was a $33 million increase in net interest income over the comparable period last year and unusual items in 2001, including a one-time charge related to long-term incentive plans at an unconsolidated subsidiary of $53 million ($34 million after-tax, or $0.19 per diluted share) and Imperial restructuring charges totaling $152 million ($114 million after-tax, or $0.63 per diluted share), partially offset the earnings decline. Net Interest Income The rate-volume analysis in Table I details the components of the change in net interest income on a fully taxable equivalent (FTE) basis for the quarter ended September 30, 2002. On a FTE basis, net interest income increased to $529 million for the three months ended September 30, 2002, from $527 million for the comparable quarter in 2001. Average earning assets increased three percent when compared to the third quarter of last year, while the net interest margin decreased to 4.46 percent for the three months ended September 30, 2002, from 4.59 percent for the comparable three months of 2001. The margin decline was primarily due to compressed loan spreads, partially offset by the benefit from a 16 percent increase in average noninterest-bearing deposits. This increase is primarily attributed to the strong growth of title and escrow deposits in the California-based Financial Services business. Table II provides an analysis of net interest income for the first nine months of 2002. On a FTE basis, net interest income for the nine months ended September 30, 2002, was $1,602 million compared to $1,569 million for the same period in 2001. This increase was due to a two percent increase in average earning assets and a relatively stable net interest margin supported by strong growth in average noninterest-bearing deposits, up 12 percent when compared to the first nine months of 2001 for the same reason cited in the quarterly discussion. The net interest margin for the first nine months ended September 30, 2002, decreased to 4.59 percent, from 4.60 percent for the same period in 2001. -28-
TABLE I - QUARTERLY ANALYSIS OF NET INTEREST INCOME & RATE/VOLUME (FTE) <TABLE> <CAPTION> THREE MONTHS ENDED ------------------------------------------------------------- SEPTEMBER 30, 2002 SEPTEMBER 30, 2001 ------------------------------------------------------------- (DOLLAR AMOUNTS AVERAGE AVERAGE AVERAGE AVERAGE IN MILLIONS) BALANCE INTEREST RATE BALANCE INTEREST RATE ------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Commercial loans $25,473 $297 4.62% $26,343 $427 6.43% International loans 2,997 35 4.63 2,809 49 6.92 Real Estate construction loans 3,415 50 5.83 3,127 60 7.64 Commercial mortgage loans 6,921 107 6.12 5,705 107 7.44 Residential mortgage loans 746 13 7.11 796 15 7.54 Consumer loans 1,514 24 6.43 1,494 30 8.01 Lease financing 1,252 17 5.40 1,123 18 6.31 Business loan swap income - 83 - - 53 - ------------------------------------------------------------- Total loans 42,318 626 5.87 41,397 759 7.27 Investment securities (1) 4,395 63 5.81 3,989 62 6.29 Short-term investments 456 6 5.35 317 3 4.37 ------------------------------------------------------------- Total earning assets 47,169 695 5.86 45,703 824 7.17 Cash and due from banks 1,752 1,800 Allowance for credit losses (776) (663) Other assets 3,202 2,889 ------- ------- Total assets $51,347 $49,729 ======= ======= Money market and NOW accounts $13,643 51 1.49 $10,035 61 2.40 Savings deposits 1,598 4 0.98 1,354 5 1.34 Certificates of deposit 9,805 58 2.33 13,455 138 4.08 Foreign office time deposits 780 7 3.42 805 10 4.99 ------------------------------------------------------------- Interest-bearing deposits 25,826 120 1.84 25,649 214 3.31 Short-term borrowings 2,016 9 1.88 2,903 26 3.60 Medium- and long-term debt 5,810 37 2.54 5,323 57 4.24 ------------------------------------------------------------- Total interest-bearing sources 33,652 166 1.96 33,875 297 3.48 --------------- --------------- Noninterest-bearing deposits 11,901 10,225 Other liabilities 855 815 Preferred stock - 166 Common shareholders' equity 4,939 4,648 ------- ------- Total liabilities and shareholders' equity $51,347 $49,729 ======= ======= Net interest income/ rate spread (FTE) $529 3.90 $527 3.69 ==== ==== FTE adjustment $ 1 $ 1 ==== ==== Impact of net interest-free sources of funds 0.56 0.90 ----- ----- Net interest margin as a percent of average earning assets (FTE) 4.46% 4.59% ===== ===== </TABLE> (1) The average rate for investment securities was computed using average historical cost. -29-
<TABLE> <CAPTION> THREE MONTHS ENDED SEPTEMBER 30, 2002/SEPTEMBER 30, 2001 -------------------------------------- INCREASE INCREASE (DECREASE) (DECREASE) NET DUE TO DUE TO INCREASE (IN MILLIONS) RATE VOLUME* (DECREASE) ---------- ---------- ---------- <S> <C> <C> <C> Loans $(146) $ 13 $(133) Investment securities (5) 6 1 Short-term investments 1 2 3 --------------------------------- Total earning assets (150) 21 (129) Interest-bearing deposits (86) (8) (94) Short-term borrowings (13) (4) (17) Medium- and long-term debt (23) 3 (20) --------------------------------- Total interest-bearing sources (122) (9) (131) --------------------------------- Net interest income/rate spread (FTE) $ (28) $ 30 $ 2 ================================= </TABLE> * Rate/Volume variances are allocated to variances due to volume. -30-
<TABLE> <CAPTION> TABLE II - YEAR-TO-DATE ANALYSIS OF NET INTEREST INCOME & RATE/VOLUME (FTE) NINE MONTHS ENDED ------------------------------------------------------------ SEPTEMBER 30, 2002 SEPTEMBER 30, 2001 ----------------------------- ---------------------------- (DOLLAR AMOUNTS AVERAGE AVERAGE AVERAGE AVERAGE IN MILLIONS) BALANCE INTEREST RATE BALANCE INTEREST RATE ------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Commercial loans $25,344 $ 904 4.77% $26,683 $1,466 7.34% International loans 3,038 109 4.78 2,714 164 8.05 Real estate construction loans 3,337 146 5.83 3,047 194 8.51 Commercial mortgage loans 6,672 311 6.23 5,605 333 7.96 Residential mortgage loans 753 41 7.21 795 46 7.65 Consumer loans 1,495 74 6.66 1,484 96 8.66 Lease financing 1,230 50 5.44 1,089 52 6.41 Business loan swap income - 272 - - 88 - ------------------------------------------------------------- Total loans 41,869 1,907 6.09 41,417 2,439 7.87 Investment securities (1) 4,338 188 5.87 3,788 183 6.48 Short-term investments 455 19 5.57 415 19 6.12 ------------------------------------------------------------- Total earning assets 46,662 2,114 6.06 45,620 2,641 7.74 Cash and due from banks 1,741 1,805 Allowance for credit losses (716) (649) Other assets 2,971 2,708 ------- ------- Total assets $50,658 $49,484 ======= ======= Money market and NOW accounts $12,374 134 1.45 $ 9,769 203 2.78 Savings deposits 1,672 13 1.05 1,332 14 1.40 Certificates of deposits 10,783 196 2.43 13,203 482 4.88 Foreign office time deposits 790 20 3.38 643 30 6.36 ------------------------------------------------------------- Interest-bearing deposits 25,619 363 1.90 24,947 729 3.91 Short-term borrowings 2,280 33 1.90 2,564 90 4.69 Medium- and long-term debt 5,928 116 2.62 6,491 253 5.21 ------------------------------------------------------------- Total interest-bearing sources 33,827 512 2.02 34,002 1,072 4.22 ----------------- ----------------- Noninterest-bearing deposits 11,112 9,941 Other liabilities 840 805 Preferred stock - 222 Common shareholders' equity 4,879 4,514 ------- ------- Total liabilities and shareholders' equity $50,658 $49,484 ======= ======= Net interest income/ rate spread (FTE) $1,602 4.04 $1,569 3.52 ====== ====== FTE adjustment $ 3 $ 3 ====== ====== Impact of net interest-free sources of funds 0.55 1.08 ----- ----- Net interest margin as a percent of average earning assets (FTE) 4.59% 4.60% ===== ===== </TABLE> (1) The average rate for investment securities was computed using average historical cost. -31-
<Table> <Caption> NINE MONTHS ENDED SEPTEMBER 30, 2002/SEPTEMBER 30, 2001 -------------------------------------- INCREASE INCREASE (DECREASE) (DECREASE) NET DUE TO DUE TO INCREASE (IN MILLIONS) RATE VOLUME* (DECREASE) ---------- ---------- ---------- <S> <C> <C> <C> Loans $(548) $ 16 $(532) Investment securities (19) 24 5 Short-term investments (2) 2 - ----------------------------------- Total earning assets (569) 42 (527) Interest-bearing deposits (357) (9) (366) Short-term borrowings (53) (4) (57) Medium- and long-term debt (126) (11) (137) ----------------------------------- Total interest-bearing sources (536) (24) (560) ----------------------------------- Net interest income/rate spread (FTE) $ (33) $ 66 $ 33 =================================== </Table> * Rate/Volume variances are allocated to variances due to volume. -32-
Provision for Credit Losses The provision for credit losses was $285 million for the third quarter of 2002, compared to $58 million for the same period in 2001. The provision for the first nine months of 2002 was $533 million compared to $167 million for the same period in 2001. The Corporation establishes this provision to maintain an adequate allowance for credit losses, which is discussed in the section entitled "Allowance for Credit Losses and Nonperforming Assets." The significant increase in the provision for credit losses in the third quarter 2002 resulted from the continued uncertainty in the economy and a decision to sell certain loans. The economic uncertainty has impacted many of the Corporation's customers, as evidenced by a higher allowance, even after increased net charge-offs. The third quarter 2002 provision for credit losses also included $104 million to cover charge-offs in conjunction with management's decision to sell certain loans. These loans were reclassified from loans to short-term investments during the quarter and total $116 million net of charge-offs at September 30, 2002. Also included in the provision for credit losses for the first nine months of 2002 is an increase in reserves for Argentina. Included in the provision for the first nine months of 2001 is a $25 million merger-related charge to conform the credit policies of Imperial with Comerica. Noninterest Income Noninterest income was $216 million for the three months ended September 30, 2002, a decrease of $8 million, or four percent, over the same period in 2001. Included in third quarter 2002 noninterest income is a pre-tax gain of $12 million related to the sale of the Corporation's OPAY subsidiary and a $5 million impairment charge on deferred distribution costs related to the Corporation's Munder Capital Management subsidiary (Munder), further discussed below. Included in the third quarter 2001 is a pre-tax gain of $21 million on the sale of the Corporation's ownership in an ATM network provider and a $14 million impairment -33-
charge on deferred distribution costs. Excluding the effects of the gains on sale of businesses and impairment charges, gains and losses on securities, warrant income and divestitures, noninterest income decreased $3 million, or two percent, over the same period last year. Certain of the Corporation's noninterest income, primarily fiduciary income and investment advisory revenue, is at risk to fluctuations in the market values of underlying assets, particularly equity securities. Other income, primarily brokerage service fees, is at risk to changes in the level of market activity. The noninterest income decline reflects a $10 million decrease in this market-related revenue, excluding the deferred distribution costs impairment charges in both periods. This decrease was partially offset by increased revenue on bank-owned life insurance due to death benefits received and increased earnings on policies held. The Corporation recorded a $5 million pre-tax deferred distribution costs impairment charge in the third quarter of 2002 related to the Corporation's Munder subsidiary. This charge resulted from a continued reassessment of the recoverability of the unamortized cost of commissions to brokers for selling Class B mutual fund shares. Net asset values in these funds have declined as general market conditions continued to weaken. This prompted the Corporation's revaluation of expected future cash flows from the funds, which are based on a percentage of assets under management and early redemption fees over a prescribed number of years. Net remaining deferred distribution costs at September 30, 2002 were $20 million. Given net asset values at September 30, 2002, it would take a decline of approximately 10 percent in the assets under management associated with those costs to trigger further impairment, which at that level would be approximately $2 million. Each additional five percent decline results in a further impairment of $1 million. For the first nine months of 2002, noninterest income was $646 million, an increase of $33 million, or five percent, from the first nine months of 2001. In addition to the unusual items cited above, noninterest income for the first -34-
nine months of 2002 included $9 million of non-taxable proceeds from bank-owned life insurance policies from the death of an executive. Noninterest income in the first nine months of 2001 was reduced by a total of $40 million of deferred distribution costs impairment charges and a one-time $57 million charge related to long-term incentive plans at an unconsolidated subsidiary. Noninterest income in the first nine months of 2001 also included $11 million in net gains resulting from the purchase and subsequent sale, all within the first quarter, of interest rate derivative contracts which failed to meet the Corporation's risk-reduction criteria. Excluding the effect of the large unusual items noted above, gains and losses on securities, warrant income and divestitures, noninterest income in the first nine months of 2002 decreased $5 million, or one percent, over the same period in 2001. Market-related income revenue declined $26 million, excluding the deferred distribution costs impairment charges in both periods, for the reasons cited in the quarterly discussion. This was offset by increases in service charges on deposit accounts, reflecting the benefit of lower earnings credit allowances provided to business customers, and higher levels of revenue on bank-owned life insurance. Noninterest Expenses Noninterest expenses were $433 million for the quarter ended September 30, 2002, an increase of $60 million, or 16 percent, from the comparable quarter in 2001. Noninterest expenses in the third quarter of 2002 include a goodwill impairment charge of $86 million as a result of the Corporation's annual evaluation of goodwill in accordance with SFAS No. 142 and a $6 million charge related to the Corporation's third quarter 2002 adoption of the fair value method of accounting for stock options. Additional information on the goodwill impairment charge and the adoption of the fair value method of accounting for stock options can be found in Notes 4 and 12, respectively, to the unaudited consolidated financial statements in this report. Noninterest expenses in the -35-
third quarter of 2001 included merger-related and restructuring costs related to the Imperial Bancorp acquisition of $18 million and goodwill amortization of $8 million. Goodwill amortization was discontinued January 1, 2002, as a result of new accounting rules. Excluding these items and the impact of divestitures, noninterest expenses in the third quarter of 2002 decreased by $3 million, or one percent, over the same period in 2001. Contributing to this decline was savings in customer services expense of $6 million due to reduced credits provided to customers as a result of the lower interest rate environment. For the nine months ended September 30, 2002, noninterest expenses were $1,129 million, a decrease of $83 million, or seven percent, from the comparable period of 2001. Included in the first nine months of 2002 was a total charge of $11 million related to the Corporation's adoption of the fair value method of accounting for stock options and the goodwill impairment charge discussed above. Included in the first nine months of 2001 were restructuring charges totaling $127 million and a reduction in other noninterest expenses of $5 million that resulted from recording the minority interest holders' share of the long-term incentive plan charge discussed in noninterest income above. Also affecting the first nine months of 2001 was $24 million in goodwill amortization. Excluding these items and the impact of divestitures, noninterest expenses in the first nine months of 2002 decreased by $21 million, or two percent, over the same period in 2001. This decrease is primarily attributed to lower salaries and benefits of $10 million, due primarily to reduced revenue related incentives, and a reduction in customer services expense of $11 million for the reasons cited in the quarterly discussion. Provision for Income Taxes The provision for income taxes for the third quarter of 2002 totaled $2 million, compared to $110 million reported for the same period a year ago. The effective tax rate was eight percent for the third quarter of 2002, compared to -36-
35 percent for the same quarter of 2001. The provision for the first nine months of 2002 was $188 million compared to $289 million for the same period of 2001. The effective tax rate was 32 percent for the first nine months of 2002 and 36 percent for the first nine months of 2001. The low effective tax rate in the third quarter 2002 resulted from the significant reduction in income before income taxes, which increased the proportion of permanent tax differences to pre- tax income. The effective tax rate in the first nine months of 2002 was impacted by increased non-taxable revenue on bank-owned life insurance policies. The effective tax rate in the first nine months of 2001 was affected by adjustments in the first quarter to Imperial's tax liabilities at the merger date, partially offset by a $7 million tax benefit related to the Imperial acquisition that was immediately recognizable, but only after Imperial became part of Comerica. Financial Condition Total assets were $52.6 billion at September 30, 2002, compared with $50.7 billion at year-end 2001 and $49.7 billion at September 30, 2001. The Corporation has experienced an increase (one percent) in total loans since December 31, 2001. Management believes that this slight increase reflects the cautiousness of borrowers in an uncertain economy. Weak loan demand, coupled with an increase in noninterest-bearing deposits, resulted in an increase in short-term investments of $801 million since year-end 2001. This increase was primarily attributable to higher amounts of federal funds sold. Total liabilities increased $1.8 billion, or four percent, since December 31, 2001, to $47.7 billion. Total deposits increased eight percent to $40.6 billion at September 30, 2002, from $37.6 billion at year-end 2001 due to growth in noninterest-bearing deposits. The growth in noninterest-bearing deposits is primarily attributed to the strong growth of title and escrow deposits in the California-based Financial Services business. The deposit increase was partially offset in short-term borrowings, which decreased $1.3 billion since -37-
December 31, 2001, to $689 million at September 30, 2002. Medium- and long-term debt decreased $16 million to $5.5 billion at September 30, 2002. Allowance for Credit Losses and Nonperforming Assets The allowance for credit losses represents management's assessment of probable losses inherent in the Corporation's loan portfolio, including all binding commitments to lend. The allowance provides for probable losses that have been identified with specific customer relationships and for probable losses believed to be inherent but that have not been specifically identified. The Corporation allocates the allowance for credit losses to each loan category based on a defined methodology which has been in use, without material change, for several years. Internal risk ratings are assigned to each business loan at the time of approval and are subject to subsequent periodic reviews by the senior management of the Credit Policy Group. The Corporation defines business loans as those belonging to the commercial, international, real estate construction, commercial mortgage and lease financing categories. The Corporation performs a detailed credit quality review quarterly on large business loans which have deteriorated below certain levels of credit risk and allocates a specific portion of the allowance to such loans based upon this review. The portion of the allowance allocated to the remaining business loans is determined by applying projected loss ratios to each risk rating based on numerous factors identified below. The portion of the allowance allocated to consumer loans is determined by applying projected loss ratios to various segments of the loan portfolio. Projected loss ratios incorporate factors such as recent charge-off experience, current economic conditions and trends, and trends with respect to past due and nonaccrual amounts. The allocated allowance was $540 million at September 30, 2002, a decrease of $6 million from year-end 2001. This decrease was attributable, in part, to the decision to sell certain nonperforming loans in the third quarter 2002. These loans were written down to net realizable value and -38-
transferred to short-term investments, thus eliminating the need for an allocated allowance. Offsetting this reduction was increased reserves related to Argentine and non-trade Brazilian exposure. Actual loss ratios experienced in the future could vary from those projected. This uncertainty occurs because other factors affecting the determination of probable losses inherent in the loan portfolio may exist which are not necessarily captured by the application of historical loss ratios. An unallocated allowance is maintained to capture these probable losses. The unallocated portion of the loss reserve reflects management's view that the reserve should have a margin that recognizes the imprecision underlying the process of estimating expected credit losses. Determination of the probable losses inherent in the portfolio, which are not necessarily captured by the allocated methodology discussed above, involves the exercise of judgement. Factors which were considered in the evaluation of the adequacy of the Corporation's unallocated reserve include portfolio exposures to the healthcare, technology and life sciences, entertainment and energy industries, as well as Latin American transfer risks and the risk associated with new customer relationships. The unallocated allowance was $249 million at September 30, 2002, an increase of $140 million from December 31, 2001. This increase results from the Corporation's belief that the continued uncertainty of an economic recovery, and its impact on the Corporation's customers, requires increased unallocated coverage for all factors considered in the unallocated allowance. Management also considers industry norms and the expectations from rating agencies and banking regulators in determining the adequacy of the allowance. The total allowance, including the unallocated amount, is available to absorb losses from any segment of the portfolio. Unanticipated economic events, including political, economic and regulatory stability in countries where the Corporation has a concentration of loans, could cause changes in the credit characteristics of the portfolio and result in an unanticipated increase in the -39-
allocated allowance. Inclusion of other portfolio exposures in the unallocated allowance, as well as significant increases in the current portfolio exposures, could increase the amount of the unallocated allowance. Either of these events, or some combination, may result in the need for additional provision for credit losses in order to maintain an allowance that complies with credit risk and accounting policies. The Corporation is closely monitoring its Argentine and Brazilian exposure as a result of recent political and economic events in those countries. The total Argentine exposure at September 30, 2002, was $103 million and consisted of $83 million of loans, $11 million of securities and $9 million of unfunded commitments. This represents a decrease of $116 million from total Argentine exposure of $219 million at December 31, 2001. Allocations in the allowance for credit losses cover approximately 50 percent of loans and unfunded commitments. The total Brazilian exposure at September 30, 2002, was $576 million and consisted of $447 million of loans, $52 million of securities and $77 million of unfunded commitments. This represents a decrease of $136 million from total Brazilian exposure of $712 million at December 31, 2001. Allocations in the allowance for credit losses cover approximately five percent of loans and unfunded commitments. At September 30, 2002, the Corporation had $39 million of loans and $8 million in securities related to Argentina and $5 million of loans related to Brazil that were reported in nonperforming assets. At September 30, 2002, the allowance for credit losses was $789 million, an increase of $134 million since December 31, 2001. The allowance as a percentage of total loans was 1.90 percent, compared to 1.59 percent at December 31, 2001. As a percentage of nonperforming assets, the allowance was 123 percent at September 30, 2002, versus 105 percent at year-end 2001. The continued uncertainty in the economy, and its impact on the Corporation's customers, has required increased levels of allowance to be maintained on the Corporation's business loans. These increased allowance levels -40-
have also impacted the allowance coverage of nonperforming assets. Net charge-offs for the third quarter of 2002 were $258 million, or 2.44 percent of average total loans, compared with $58 million, or 0.56 percent, for the third quarter of 2001. The increase in net charge-offs was attributable to the decision to sell certain nonperforming loans in the third quarter 2002 and the continued uncertainty of an economic recovery, and its impact on the Corporation's customers. Net charge-offs in the third quarter 2002 on loans transferred to short-term investments totaled $104 million. Nonperforming assets increased $13 million, or two percent, since December 31, 2001, and were categorized as follows: <TABLE> <CAPTION> SEPTEMBER 30, DECEMBER 31, (IN MILLIONS) 2002 2001 ------------ ------------ <S> <C> <C> Nonaccrual loans: Commercial $ 365 $ 467 International 101 109 Real estate construction 17 10 Commercial mortgage 15 18 Residential mortgage 1 - Consumer 4 5 Lease financing 1 8 Nonaccrual loans held for sale 116 - ------------ ------------ Total nonaccrual loans 620 617 Reduced-rate loans - - ------------ ------------ Total nonperforming loans 620 617 Other real estate 12 10 Nonaccrual debt securities 8 - ------------ ------------ Total nonperforming assets $ 640 $ 627 ============ ============ Loans past due 90 days or more $ 51 $ 44 ============ ============ </TABLE> Loans to customers in the automotive industry comprised 12 percent of nonperforming loans at September 30, 2002, and was the only industry classification comprising more than 10 percent of nonperforming loans. Six credits in excess of $10 million were added to nonperforming loans during the third quarter 2002. The largest nonaccrual loan at September 30, 2002, was to an automotive supplier totaling $24 million. Approximately 46 percent of total nonperforming assets at September 30, 2002 were Shared National Credit Program -41-
(SNC) loans. SNC loans are large credits shared by multiple financial institutions and reviewed by regulatory authorities at the lead or agent bank level. These loans comprised approximately 20 percent of total loans at September 30, 2002. Nonperforming assets as a percentage of total loans and other real estate were 1.54 percent at September 30, 2002 and 1.52 percent at December 31, 2001. The following table presents a roll-forward of nonaccrual loans from December 31, 2001 to September 30, 2002, based on an analysis of nonaccrual loans with book balances greater than $2 million. <TABLE> <CAPTION> <S> <C> (IN MILLIONS) Nonaccrual loans at December 31, 2001 $617 Loans transferred to nonaccrual 548 Net loans charged off (399) Loans transferred to accrual status (39) Loans sold (17) Payments/Other (90)* ---- Nonaccrual loans at September 30, 2002 $620 ==== </TABLE> * Net change related to nonaccrual loans with balances less than $2 million, other than net charge-offs, included in Payments/Other. During the third quarter 2002, $276 million of loans were transferred to nonaccrual status. Included were 35 loans with balances greater than $2 million. Six of these loans were greater than $10 million (totaling $124 million) to customers in the manufacturing and service sectors. Assuming the economy remains unchanged from current levels, the Corporation's management expects that nonperforming assets will decrease slightly to between $550-625 million by December 31, 2002. The reduction in nonperforming assets that will result from the expected sale of $116 million of loans held for sale will be partially offset by assets transferred to nonaccrual. Charge-offs are expected to decline significantly from third quarter 2002 levels in the fourth quarter of 2002, and are projected to be in the $60-80 million range. As of November 7, 2002, the Corporation had sold $112 million of the $116 million of nonaccrual loans categorized as held for sale at September 30, 2002. Gains -42-
and losses resulting from the sale of this portfolio of loans are not expected to be material. Capital Common shareholders' equity, excluding the $67 million increase in other comprehensive income, remained relatively flat from December 31, 2001 to September 30, 2002. The retention of $143 million of current year earnings and the effect of employee stock plan activity, which increased common shareholders' equity $63 million, were offset by the decrease in equity of $210 million that resulted from repurchasing approximately 3.5 million shares of common stock in the open market during the first nine months of 2002. Capital ratios exceed minimum regulatory requirements as follows: <TABLE> <CAPTION> SEPTEMBER 30, DECEMBER 31, 2002 2001 ------------ ----------- <S> <C> <C> Tier 1 common capital ratio 7.32% 7.30% Tier 1 risk-based capital ratio (4.00% - minimum) 7.99% 7.98 Total risk-based capital ratio (8.00% - minimum) 11.71% 11.70 Leverage ratio (3.00% - minimum) 9.25% 9.36 </TABLE> At September 30, 2002, the capital ratios of all the Corporation's banking subsidiaries exceeded the minimum ratios required of "well capitalized" institutions as defined in the final rule under FDICIA. Accounting Policies The Corporation's consolidated financial statements are prepared based on the application of accounting policies, the most significant of which are described in Note 1 to the consolidated financial statements included in the Corporation's 2001 Annual Report, as updated in Note 1 to the unaudited consolidated financial statements in this report. These policies require numerous estimates and strategic or economic assumptions which may prove inaccurate or subject to variations and may significantly affect the Corporation's reported results for the period or in future periods. Changes in -43-
underlying factors, assumptions or estimates in any of these areas could have a material impact on the Corporation's future financial condition and results of operations. In management's opinion, some of these areas have a more significant impact than others on the Corporation's financial reporting. This is because these policies apply to areas of relatively greater business importance, to matters for which there is a range of possible outcomes and/or require a more subjective decision-making process on the part of management. For the Corporation, these areas currently include accounting for the allowance for credit losses, pension costs, private equity and venture capital investments, deferred distribution costs and goodwill. Pension assumptions will be evaluated and reset prior to January 1, 2003. Equity markets and interest environments impact these assumptions. Declines in equity markets in recent years and the current low-interest-rate environment will impact pension expense for 2003. The Corporation's pension assumptions for 2002 included a 10 percent long-term rate of return on plan assets and a 7.4 percent discount rate. For each 0.25 percentage point change in the long-term rate of return assumption, pension expense changes by approximately $2 million. For each 0.25 percentage point change in the discount rate assumption, pension expense changes by approximately $4 million. For more information on pension assumptions, refer to Note 15 to the consolidated financial statements included in the Corporation's 2001 annual report. Other Matters In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." The Statement covers legal obligations that are identifiable by the entity upon acquisition and construction, and during the operating life of a long-lived asset. Identified retirement obligations would be recorded as a liability with a corresponding amount capitalized as part of the asset's carrying amount. The capitalized retirement cost asset would be -44-
amortized to expense over the asset's useful life. The Statement is effective January 1, 2003 for calendar year companies. The Corporation does not believe that the impact of adoption of SFAS No. 143 will have a material impact on the Corporation's financial position or results of operations. -45-
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk Net interest income is the predominant source of revenue for the Corporation. Interest rate risk arises primarily through the Corporation's core business activities of extending loans and accepting deposits. The Corporation actively manages its material exposure to interest rate risk. Management attempts to evaluate the effect of movements in interest rates on net interest income and uses interest rate swaps and other instruments to manage its interest rate risk exposure. The primary tool used by the Corporation in determining its exposure to interest rate risk is net interest income simulation analysis. The net interest income simulation analysis performed at the end of each quarter reflects changes to both interest rates and loan, investment and deposit volumes. The measurement of risk exposure at September 30, 2002 for a 200 basis point decline in short-term interest rates identified approximately $108 million, or 4.9%, of forecasted net interest income at risk over the next 12 months. If short-term interest rates rise 200 basis points, forecasted net interest income would be enhanced by approximately $145 million, or 6.6%. Secondarily, the Corporation utilizes a traditional interest sensitivity gap measure and economic value of equity analysis as alternative measures of interest rate risk exposure. At September 30, 2002, all three measures of interest rate risk were within established corporate policy guidelines. For further discussion of interest rate risk, and other market risks, see Note 10 and pages 37-41 of the Corporation's 2001 Annual Report. -46-
ITEM 4. Controls and Procedures (a) Evaluation of Disclosure Controls and Procedures. The Corporation's Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of the Corporation's disclosure controls and procedures (as such term is defined in Rules 13a-14(c) and 15d-14(c) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"). Based on the evaluation, such officers have concluded that, as of the Evaluation Date, the Corporation's disclosure controls and procedures are effective in alerting them on a timely basis to material information relating to the Corporation (including its consolidated subsidiaries) required to be included in the Corporation's periodic filings under the Exchange Act. (b) Changes in Internal Controls. Since the Evaluation Date, there have not been any significant changes in the Corporation's internal controls or in other factors that could significantly affect such controls. -47-
Forward-looking statements This report includes forward-looking statements as that term is used in securities laws. All statements regarding Comerica's expected financial position, strategies and growth prospects and general economic conditions expected to exist in the future are forward-looking statements. The words, "anticipates", "believes", "estimates", "seeks", "plans", "intends" and similar expressions, as they relate to Comerica or its management, are intended to identify forward-looking statements. Although Comerica believes that the expectations reflected in these forward-looking statements are reasonable and has based these expectations on the beliefs and assumptions Comerica has made, such expectations may prove incorrect. Numerous factors, including unknown risks and uncertainties, could cause variances in these projections and their underlying assumptions. Such factors are changes in interest rates, changes in the accounting or tax treatment of any particular item, changes in industries in which Comerica has a concentration of loans, or the political, economic and regulatory stability in countries where Comerica operates, changes in the level of fee income, changes in general economic conditions and related credit and market conditions and the impact of regulatory responses to any of the foregoing. Forward-looking statements speak only as of the date they are made. Comerica does not undertake to update forward-looking statements to reflect facts, circumstances, assumptions or events that occur after the date the forward- looking statements are made. -48-
PART II. OTHER INFORMATION ITEM 1. Legal Proceedings. Several of the Corporation's banking subsidiaries are member banks of Visa U.S.A., Inc. ("Visa"). Several U.S. merchants have filed class action suits against Visa under U.S. federal antitrust law. The Corporation and its subsidiaries are not parties to these suits. However, the Corporation's banking subsidiaries, which are member banks of Visa, may be affected by these suits. The following description of the suits is based primarily on disclosures in the Quarterly Report on Form 10-Q for the period ended June 30, 2002, filed by MasterCard Incorporated ("MasterCard") with the Securities and Exchange Commission on August 14, 2002. Commencing in October 1996, several class action suits were brought by a number of U.S. merchants against MasterCard and Visa. Those suits were later consolidated in the U.S. District Court for the Eastern District of New York. The plaintiffs challenge MasterCard's and Visa's rules requiring merchants who accept their credit cards to accept their debit cards. Plaintiffs claim that MasterCard and Visa unlawfully have tied acceptance of debit cards to acceptance of credit cards and have conspired to monopolize the point-of-sale debit card market. Plaintiffs allege that the plaintiff class has been forced to pay unlawfully high prices for debit and credit card transactions. There are related consumer class actions pending in two state courts that have been stayed pending developments in the merchants' suits. MasterCard and Visa have denied the merchants' allegations. The district court granted the plaintiffs' motion for class certification, a panel of the Second Circuit Court of Appeals affirmed, and on June 6, 2002, the U.S. Supreme Court denied MasterCard's and Visa's petition for a writ of certiorari on the issue of class certification. Recent press reports place the plaintiffs' estimated damage claims at approximately $13.0 billion to $15.0 billion, or more, before mandatory trebling under U.S. federal antitrust law. These figures reflect claims asserted and should not be construed -49-
as an acknowledgement of the reliability of the figures presented. Trial is currently scheduled for April 2003. The Corporation and its subsidiaries are not parties to these suits and therefore will not be directly liable for any amount related to these suits. However, if a judgment is entered against Visa, then Visa may seek to assess the associations' member banks, including the Corporation's banking subsidiaries, to obtain funds to satisfy the judgment. In addition, because a judgment against the associations could adversely affect the business operations of the member banks, they may be compelled by business necessity to assist Visa to satisfy the judgment. The outcome of these suits, the amount of any possible judgment against the associations, and the effects on the associations' member banks, including the Corporation's banking subsidiaries, resulting from these suits, cannot be determined at this time. In addition to the above, the Corporation and its subsidiaries are subject to various pending or threatened legal proceedings, arising out of the normal course of business. In view of the inherent difficulty of predicting the outcome of such matters, the Corporation cannot state what the eventual outcome of these matters will be. However, the Corporation believes, based on current knowledge and after consultation with counsel, that the outcome of such matters will not have a material adverse effect on the Corporation's consolidated financial condition or results of operations. ITEM 5. Other Information. As previously announced, Eugene A. Miller retired as Chairman of the Board of Directors of Comerica on October 1, 2002. In order to ensure a stable transition, Mr. Miller will continue to make himself available to Comerica and will continue to receive certain benefits in accordance with a Supplemental Benefit Agreement entered into between Comerica and Mr. Miller as of September 19, 2002 and filed as an exhibit hereto. -50-
ITEM 6. Exhibits and Reports on Form 8-K (a) Exhibits 3.1 Amended and Restated Bylaws of Comerica Incorporated (10.1*) Supplemental Benefit Agreement dated September 19, 2002, between Comerica Incorporated and Eugene A. Miller (11) Statement re: Computation of Net Income Per Common Share (99.1) Chairman, President and CEO Certification of Periodic Report (99.2) CFO Certification of Periodic Report * Management compensation arrangement (b) Reports on Form 8-K A report on Form 8-K, dated August 13, 2002, was filed under report items number 7 and 9, announcing and including the certified sworn statements made by the Corporation's principal executive officer and principal financial officer regarding facts and circumstances relating to the Corporation's filings under the Securities Exchange Act of 1934, pursuant to Securities and Exchange Commission Order No. 4-460. -51-
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. COMERICA INCORPORATED (Registrant) /s/ Elizabeth S. Acton ----------------------------------------- Elizabeth S. Acton Chief Financial Officer /s/ Marvin J. Elenbaas ----------------------------------------- Marvin J. Elenbaas Senior Vice President and Controller (Principal Accounting Officer) Date: November 13, 2002 -52-
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Ralph W. Babb, Jr., Chairman, President and Chief Executive Officer of Comerica Incorporated (the "Registrant"), certify that: 1. I have reviewed this quarterly report on Form 10-Q of the Registrant for the period ended September 30, 2002 (the "Quarterly Report"); 2. Based on my knowledge, this Quarterly Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Quarterly Report; 3. Based on my knowledge, the financial statements, and other financial information included in this Quarterly Report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this Quarterly Report; 4. The Registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this Quarterly Report is being prepared; b) evaluated the effectiveness of the Registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this Quarterly Report (the "Evaluation Date"); and c) presented in this Quarterly Report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The Registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the Registrant's auditors and the audit committee of Registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Registrant's ability to record, process, summarize and report financial data and have identified for the Registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal controls; and 6. The Registrant's other certifying officers and I have indicated in this Quarterly Report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal -53-
controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 12, 2002 /s/ Ralph W. Babb, Jr. --------------------------------------- Ralph W. Babb, Jr. Chairman, President and Chief Executive Officer -54-
CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Elizabeth S. Acton, Chief Financial Officer of Comerica Incorporated (the "Registrant"), certify that: 1. I have reviewed this quarterly report on Form 10-Q of the Registrant for the period ended September 30, 2002 (the "Quarterly Report"); 2. Based on my knowledge, this Quarterly Report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this Quarterly Report; 3. Based on my knowledge, the financial statements, and other financial information included in this Quarterly Report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this Quarterly Report; 4. The Registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the Registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this Quarterly Report is being prepared; b) evaluated the effectiveness of the Registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this Quarterly Report (the "Evaluation Date"); and c) presented in this Quarterly Report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The Registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the Registrant's auditors and the audit committee of Registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the Registrant's ability to record, process, summarize and report financial data and have identified for the Registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant's internal controls; and 6. The Registrant's other certifying officers and I have indicated in this Quarterly Report whether or not there were significant changes in internal -55-
controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 12, 2002 /s/ Elizabeth S. Acton ------------------------ Elizabeth S. Acton Chief Financial Officer -56-
10-Q EXHIBIT INDEX EXHIBIT NO. DESCRIPTION EX-3.1 Amended and Restated Bylaws of Comerica Incorporated EX-(10.1*) Supplemental Benefit Agreement dated September 19, 2002, between Comerica Incorporated and Eugene A. Miller EX-(11) Statement re: Computation of Net Income Per Common Share EX-99.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 EX-99.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002