notes to consolidated financial statements

1. Summary of Significant Accounting Policies 10. Other Borrowings
2. Business Combinations and Asset Acquisitions 11. Interest Rate Swaps
3. Investment Securities 12. Income Taxes
4. Mortgage-Backed Securities 13. Regulatory Matters
5. Loans and Leases 14. Stock Purchase Rights
6. Loan Servicing Assets 15. Stock Option Plans
7. Deposits 16. Fair Value of Financial Instruments
8. Federal Home Loan Bank Advances 17. Parent Company Financial Information
9. Federal Funds Purchased and Repurchase Agreements 18. Subsequent Event

1. Summary of Significant Accounting Policies
The accounting policies of Charter One Financial, Inc. (“Charter One” or the “Company”), a financial holding company, and Charter One Commercial and Charter One Bank, F.S.B. (collectively, the “Bank”), conform to accounting principles generally accepted in the United States of America and prevailing practices within the banking and thrift industry. A summary of the more significant accounting policies follows:

Nature of Operations – Headquartered in Cleveland, Ohio, Charter One is a financial holding company. Charter One is a Delaware corporation and owns all of the outstanding capital stock of Charter Michigan Bancorp, Inc. and Charter One Commercial. Charter Michigan Bancorp, Inc. owns all of the outstanding capital stock of Charter One Bank, F.S.B., a federally chartered thrift. The Company’s principal line of business is consumer banking which includes retail banking, mortgage banking and other related financial services. Retail banking provides a full range of deposit products, consumer loans, business lending and commercial real estate loans.

  On January 7, 2002, the Company announced that Charter One Bank, F.S.B. filed an application with the Office of the Comptroller of the Currency (“OCC”) to convert to a national bank charter. Charter One Bank, F.S.B. is currently a federal savings bank regulated by the Office of Thrift Supervision (“OTS”). The Company expects the conversion to be effective during the first quarter of 2002.

Basis of Presentation – The Consolidated Financial Statements include the accounts of the Company, the Bank and its subsidiaries. All significant intercompany transactions and balances have been eliminated. Certain items in the Consolidated Financial Statements for 2000 and 1999 have been reclassified to conform to the 2001 presentation.

  The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Securities – Securities consist of mortgage-backed securities, U.S. Government and federal agency obligations, floating-rate notes, corporate bonds, commercial paper and state and local government obligations. Securities are classified as trading, available for sale or held to maturity upon their acquisition. Securities classified as trading on the Consolidated Statements of Financial Condition are carried at estimated fair value with the unrealized holding gain or loss recorded in the Consolidated Statements of Income. Securities classified as available for sale on the Consolidated Statements of Financial Condition are carried at estimated fair value with the unrealized holding gain or loss reflected as a component of shareholders’ equity. Securities classified as held to maturity on the Consolidated Statements of Financial Condition are carried at amortized cost. Premiums and discounts are recognized in interest income over the period to maturity by the level yield method. Realized gains or losses on the sale of debt securities are recorded based on the amortized cost of the specific securities sold.

Loans – Loans intended for sale are carried at estimated market value determined on an aggregate basis. Net unrealized losses are recognized through a valuation allowance by a charge to income. Gains or losses on the sale of loans are determined under the specific identification method.

  Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding unpaid principal balances, net of deferred fees or costs on originated loans or unamortized premiums or discounts on purchased loans. Discounts and premiums are accreted or amortized using the interest method over the remaining period to contractual maturity adjusted for anticipated prepayments. Unamortized net fees or costs are recognized upon early repayment of the loans. Unamortized net fees or costs on loans sold are included in the basis of the loans in calculating gains and losses.

  A loan is considered to be impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. To determine if the impairment criteria have been met, the Bank performs a review of all corporate banking and commercial real estate loans over $1 million that are internally classified as substandard, doubtful or loss. If the impairment criteria have been met, a reserve is calculated according to Statement of Financial Accounting Standards (“SFAS”) No. 114, “Accounting by Creditors for Impairment of a Loan.”

  Loans and leases considered to be nonperforming include nonaccrual loans and leases, accruing loans and leases delinquent more than 90 days, and restructured loans. A loan, including an impaired loan, is classified as nonaccrual when collectability is in doubt (this is generally when the borrower is 90 days past due on contractual principal or interest payments). A loan may be considered impaired but remain on accrual status when the borrower demonstrates (by continuing to make payments) a willingness to keep the loans current. When a loan is placed on nonaccrual status, unpaid interest is reversed and an allowance is established by a charge to interest income equal to all accrued interest. Income is subsequently recognized only to the extent that cash payments are received. Loans are returned to accrual status when, in management’s judgment, the borrower has the ability and intent to make periodic principal and interest payments (this generally requires that the loan be brought current in accordance with its original contractual terms). Loans and leases are classified as accruing loans or leases delinquent more than 90 days when the loan or lease is more than 90 days past due and, in management’s judgment, the borrower has the ability and intent to make periodic interest and principal payments. Loans are classified as restructured when concessions are made to borrowers with respect to the principal balance, interest rate or other terms due to the inability of the borrower to meet the obligation under the original terms. The Bank charges off principal at the earlier of (i) when a total loss of principal has been deemed to have occurred as a result of the book value exceeding the fair value or net realizable value, or (ii) when collection efforts have ceased.

Lease Accounting – The Company classifies leases at the inception of the lease in accordance with SFAS No. 13, “Accounting for Leases.” Estimated residual values are reviewed periodically and reduced if necessary.

  Direct Financing Leases — At lease inception, the present values of future rentals and of the residual are recorded as net investment in direct financing leases. Unearned interest income is amortized to interest income over the lease term to produce a constant percentage return on the investment. Sales commissions and other direct costs incurred in direct financing leases are capitalized and recorded as part of the net investment in leases and are amortized over the lease term.

  Sales-Type-Leases — At the inception of the lease, the present value of future rentals is recorded as an equipment sale. Equipment cost less the present value of the residual is recorded as cost of equipment sold. Accordingly, a dealer profit is recognized at lease inception. The present values of future rentals and of the residual are recorded as net investment in sales-type leases. Unearned income is amortized to interest income over the lease term to produce a constant percentage return on the investment.

  Leveraged Leases — Income on leveraged leases is recognized at a constant rate of return on the outstanding investment in the lease, net of the related deferred tax liability.

Allowance for Loan and Lease Losses – The Company maintains an allowance for loan and lease losses adequate to absorb estimated probable losses inherent in the loan and lease portfolio. The allowance for loan and lease losses consists of specific reserves for individual credits and general reserves for types or portfolios of loans based on historical loan loss experience, adjusted for concentrations and the current economic environment. All outstanding loans, leases, letters of credit and legally binding commitments to provide financing are considered in evaluating the adequacy of the allowance for loan and lease losses. Increases to the allowance for loan and lease losses are made by charges to the provision for loan and lease losses. Loans deemed to be uncollectible are charged against the allowance for loan and lease losses. Recoveries of previously charged-off amounts are credited to the allowance for loan and leases losses.

  In determining the adequacy of the allowance for loan and lease losses, management reviews and evaluates on a quarterly basis the potential credit risk in the loan and lease portfolio. This evaluation process is documented by management and approved by the Company’s Board of Directors. It is performed by senior members of management with many years of banking and lending experience. Management evaluates homogeneous consumer-oriented loans, such as 1-4 family mortgage loans and retail consumer loans, based upon all or a combination of delinquencies, credit scores, loss migration analysis and charge-off experience. Management supplements this analysis by reviewing the geographical lending areas involved and their local economic and political trends, the nature and volume of the portfolio, regulatory examination findings, specific grading systems applied and any other known factors which may impact future credit losses. Nonhomogeneous loans, generally defined as commercial real estate loans, corporate banking loans, and leases are underwritten, approved and risk rated individually at inception. On a monthly basis, management re-evaluates the risk ratings on these nonhomogeneous loans if loan relationships exceed certain dollar thresholds established for the respective portfolios. The Company’s risk rating methodology uses nine grade levels to stratify each portfolio. Many factors are considered when these grades are assigned to individual loans and leases such as current and past delinquency, financial statements of the borrower, current net realizable value of collateral, the general economic environment and the specific economic trends affecting the individual loan or lease. During this evaluation process, individual loans are identified and evaluated for impairment as prescribed under SFAS No. 114, “Accounting by Creditors for Impairment of a Loan.” Impairment losses are recognized when, based upon current information, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impairment is measured either by a loan’s observable market value, fair value of the collateral or the present value of future cash flows discounted at the loan’s effective interest rate. These impairment losses, combined with other probable losses as determined in the loan and lease portfolio evaluation process, are charged to the allowance for loan and lease losses. This data is then presented to the Company’s Reserve Adequacy Committee, comprised of senior members of management and outside directors. The Reserve Adequacy Committee determines the level of provision for loan and lease losses necessary to maintain the allowance for loan and lease losses at an amount considered adequate to absorb probable loan and lease losses inherent in the portfolio. Although management believes that it uses the best information available to determine the adequacy of the allowance for loan and lease losses, future adjustments to the allowance may be necessary and results of operations could be significantly and adversely affected if circumstances differ substantially from the assumptions used in making the determinations.

Loan Fees – Loan origination fees received for loans, net of direct origination costs, are deferred and amortized to interest income over the contractual lives of the loans using the level yield method.
 
Fees received for loan commitments that are expected to be drawn, based on the Bank’s experience with similar commitments, are deferred and amortized over the lives of the loans using the level yield method. Fees for other loan commitments are deferred and amortized over the loan commitment period on a straight-line basis. Unamortized deferred loan fees or costs related to loans paid off are included in income. Unamortized net fees or costs on loans sold are included in the basis of the loans in calculating gains and losses. Amortization of net deferred fees is discontinued for loans that are deemed to be nonperforming.

Loan Servicing Assets – The cost of mortgage loans sold, with servicing rights retained, is allocated between the loans and the servicing rights based on their estimated fair values at time of loan sale. The estimated fair value of loan servicing assets is determined based on expected future cash flows discounted at an interest rate commensurate with the servicing risks involved. In 2001 and 2000, virtually all such recorded assets related to residential mortgage loans. Loan servicing assets are presented in the Consolidated Statements of Financial Condition net of accumulated amortization, which is recorded in proportion to, and over the period of, net servicing income. Capitalized loan servicing assets are stratified based on predominant risk characteristics of underlying loans for the purpose of evaluating impairment. An allowance is then established in the event the recorded value of an individual stratum exceeds fair value.

Derivatives – The Company uses derivatives as a means of managing its interest rate risk profile (defined as the sensitivity of the Company’s earnings and net portfolio value to changes in interest rates). Interest rate swaps are the derivative instruments that Charter One uses as part of its interest rate risk management strategy. Interest rate swap contracts are exchanges of interest payments, based on a common notional amount and maturity date.

  For those derivative instruments that are designated and qualify as hedging instruments, the Company designates the hedging instrument, based upon the exposure being hedged, as either a fair value or cash flow hedge in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended. If it is determined that the derivative instrument is not highly effective as a hedge, hedge accounting is discontinued and the fair value of the derivative instrument is recorded in net income.

Off-Balance-Sheet Financial Instruments – In the ordinary course of business, the Company enters into off-balance-sheet financial instruments consisting of commitments to extend credit, commercial letters of credit, standby letters of credit and commitments to purchase or sell assets. Such financial instruments are recorded in the financial statements when they are funded or the related fees are incurred or received.

Premises and Equipment – Premises and equipment and real estate held for investment are stated at cost less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the useful lives of the related assets.

Real Estate Owned – Real estate owned, including property acquired in settlement of foreclosed loans, is carried at the lower of cost or estimated fair value less estimated cost to sell at the date of foreclosure. Costs relating to the development and improvement of real estate owned are capitalized, whereas costs relating to holding and maintaining the property are charged to expense.

Goodwill – Goodwill represents the purchase price of acquired operations in excess of the fair value of their net identifiable assets at the date of acquisition. For business combinations and branch acquisitions completed prior to June 30, 2001, goodwill was being amortized using the straight-line method over 15 years or less. Amortization of goodwill for past business combinations ceased upon adoption of SFAS No. 142, “Goodwill and Other Intangible Assets” on January 1, 2002. Amortization of goodwill related to branch acquisitions will continue pending further clarification from the Financial Accounting Standards Board (“FASB”). See further discussion in the New Accounting Standards section below.

  For business combinations initiated after June 30, 2001, goodwill is not subject to amortization in accordance with SFAS No. 142. Rather, goodwill will be tested for impairment on an annual basis or when events and circumstances indicate that the value of goodwill has been diminished or impaired.

Income Taxes – Income taxes have been provided using the liability method in accordance with SFAS No. 109, “Accounting for Income Taxes.” The Company files a consolidated federal income tax return.

Consolidated Statements of Cash Flows – For purposes of the Consolidated Statements of Cash Flows, the Company considers all highly liquid investments with a term of three months or less to be cash equivalents. Cash flows from interest rate risk management instruments are classified based on the assets or liabilities hedged.

Stock Dividends – On July 18, 2001, the Board of Directors of the Company approved a 5% stock dividend which was distributed on September 28, 2001 to shareholders of record on September 14, 2001. On July 18, 2000, the Board of Directors of the Company approved a 5% stock dividend which was distributed on September 30, 2000 to shareholders of record on September 14, 2000. On July 21, 1999, the Board of Directors of the Company approved a 5% stock dividend which was distributed on September 30, 1999 to shareholders of record on September 14, 1999.

Earnings Per Share – Basic earnings per share (“EPS”) is based on the weighted average number of common shares outstanding during the year. Diluted EPS is based on the weighted average number of common shares and common share equivalents outstanding during the year. All shares and per share data have been restated to reflect all prior stock dividends.
 
                           
 Year Ended December 31,
(Dollars in thousands,
except per share data) 2001 2000 1999
Basic earnings per share:
                        
 
Income before extraordinary item
  $ 500,714     $ 433,962     $ 335,530  
 
Weighted average common shares outstanding
    221,473,731       224,397,762       234,930,650  
 
Basic earnings per share before extraordinary item
  $ 2.25     $ 1.93     $ 1.43  
Diluted earnings per share:
                        
 
Income before extraordinary item
  $ 500,714     $ 433,962     $ 335,530  
 
Weighted average common shares outstanding
    221,473,731       224,397,762       234,930,650  
 
Add common stock equivalents for shares issuable under stock option plans
    5,558,149       4,073,501       5,244,417  
 
Weighted average common and common equivalent shares outstanding
    227,031,880       228,471,263       240,175,067  
 
Diluted earnings per share before extraordinary item
  $ 2.21     $ 1.90     $ 1.40  

Comprehensive Income – In accordance with SFAS No. 130, “Reporting Comprehensive Income,” reclassification adjustments have been determined for all components of other comprehensive income reported in the Company’s Consolidated Statements of Shareholders’ Equity. Amounts presented within those statements are net of the following reclassification adjustments and related tax expense:
                           
 Year Ended December 31,
(Dollars in thousands) 2001 2000 1999
Other comprehensive income (loss), before tax:
                       
 
Net unrealized holding gain (loss) on securities
  $ 134,533     $ 54,580     $ (144,501 )
 
Reclassification adjustment for (gains) losses included in net income
    (112,804 )     (7,083 )     63,200  
Other comprehensive income (loss), before tax
    21,729       47,497       (81,301 )
Income tax expense (benefit) related to items of other comprehensive income
    7,605       16,624       (28,455 )
 
Other comprehensive income (loss), net of tax
  $ 14,124     $ 30,873     $ (52,846 )

Segments – Charter One has one operating segment, consumer banking, which offers an array of products and services to its customers. Pursuant to its consumer banking strategy, emphasis is placed on building relationships and identifying cross-sell opportunities with its customers, as opposed to building specific lines of business. As a result, Charter One prefers to work as an integrated unit to customize solutions for its customers, with business line emphasis and product offerings changing over time as needs and demands change.

New Accounting Standards – Effective January 1, 2001, the Company adopted SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, which requires that all derivative instruments be reported on the statement of financial condition at fair value and establishes criteria for designation and effectiveness of hedging relationships. At the time of adoption, the Company designated anew certain derivative instruments used for risk management into hedging relationships in accordance with the requirements of the new standard. Derivative instruments used to hedge changes in the fair value of liabilities due to changes in interest rates were designated as fair value hedges. Derivative instruments used to hedge the variability of forecasted cash flows attributable to interest rate risk were designated as cash flow hedges. The cumulative effect of adopting SFAS No. 133 was not material to the Company’s consolidated financial statements.

  In September 2000, the FASB issued SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of FASB Statement No. 125.” SFAS No. 140 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. Those standards are based on consistent application of a financial-components approach that focuses on control. Under that approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. SFAS No. 140 provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. SFAS No. 140 is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. The adoption of SFAS No. 140 did not have a material impact on the Company’s financial condition or results of operations.

  In July 2001, the FASB issued SFAS No. 141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets.” These statements change the accounting for business combinations and goodwill. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Use of the pooling-of-interests method is prohibited. SFAS No. 142 changes the accounting for goodwill and certain intangible assets from an amortization method to an impairment-only approach. Any goodwill arising from the result of business combinations initiated after June 30, 2001 is not amortized. On an annual basis, and when there is reason to suspect that their values have been diminished or impaired, goodwill and certain intangible assets must be tested for impairment and write-downs may be necessary. Additionally, amortization of goodwill recorded for past business combinations will cease upon adoption of SFAS No. 142 on January 1, 2002. The Company’s amortization of goodwill related to these past business combinations was $3.0 million after tax, or $.01 per diluted share in 2001.
 
  In October 2001, the FASB decided to undertake a limited-scope project to reconsider part of the guidance in SFAS No. 72, “Accounting for Certain Acquisitions of Banking or Thrift Institutions.” In particular, the Board decided to reconsider whether the acquisition of a branch is a business combination and if goodwill recorded in connection with a branch acquisition (“Statement 72 Goodwill”) should continue to be amortized. Currently, Statement 72 Goodwill is excluded from the scope of SFAS No. 142. The Company’s amortization of goodwill related to branch acquisitions was $7.5 million after tax, or $.04 per diluted share in 2001. Pending further clarification from the FASB, the Company anticipates its amortization of goodwill related to branch acquisitions will be $10.0 million after tax, or $.04 per diluted share in 2002.

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2. Business Combinations and Asset Acquisitions
The tables below set forth the Company’s business combinations and asset acquisitions during the past three years.

Business Combinations
                                                 
Assets at Common Method
Date Date of Shares Cash of Goodwill
(Dollars in thousands) Completed Merger Issued Consideration Accounting Recorded
Alliance Bancorp(1)
    July 2, 2001     $ 2,019,000       6,887,605     $ 50,234       Purchase     $ 138,814  
St. Paul Bancorp, Inc. 
     October 1, 1999       6,200,000       39,892,023       —       Pooling       —  

(1)  The results of this acquisition have been included in the consolidated financial statements since July 2, 2001. Pro forma results of operations for this acquisition, had the acquisition occurred as of January 1, 2001 and January 1, 2000, is not significant and accordingly, is not provided.

Branch Purchases
                                         
Date Deposits Loans Goodwill
(Dollars in thousands) Branches Completed Assumed Acquired Recorded
Superior Federal Bank, F.S.B
    17       November 19, 2001     $ 1,022,023     $ 3,370     $ 55,984  
Chittenden Corporation
    14       November 5, 1999     $ 357,500     $ 84,700     $ 43,600  

The following tables reconcile merger-related charges in 2000 and 1999 between cash, noncash and accrual activity. The Company did not have any non-cash merger-related charges in 2000.
                                             
2000 2000 2000 2000
Period 2000 Total Accrual Ending
(Dollars in thousands) Cost Accrual Expense Charges Accrual
Cash:
                                       
 
Direct severance and termination costs
  $ 256     $ 20,454     $ 20,710     $ (29,227 )   $ 10,186  
 
Premises and equipment
    1,149       480       1,629       (70 )     503  
 
Professional fees
    5,472       —       5,472       (34 )     19  
 
Conversion and other
    1,680       —       1,680       (971 )     324  
   
Total merger- related charges
  $ 8,557     $ 20,934     $ 29,491     $ (30,302 )   $ 11,032  
                                               
1999 1999 1999 1999
Period 1999 Total Accrual Ending
(Dollars in thousands) Cost Accrual Expense Charges Accrual
Cash:
                                       
 
Direct severance and termination costs
  $ 23,293     $ 16,403     $ 39,696     $ (11,411 )   $ 18,959  
 
Premises and equipment
    3,757       65       3,822       (3,797 )     93  
 
Professional fees
    14,872       75       14,947       (3,462 )     53  
 
Conversion and other
    2,257       —       2,257       (6,504 )     1,295  
   
Total cash
    44,179       16,543       60,722       (25,174 )     20,400  
Non-cash:
                                       
 
Write-off of discontinued assets
    2,572       —       2,572       —       —  
 
Conversion and other
    232       —       232       —       —  
   
Total non-cash
    2,804       —       2,804       —       —  
     
Total merger- related charges
  $ 46,983     $ 16,543     $ 63,526     $ (25,174 )   $ 20,400  

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3. Investment Securities
Investment securities at December 31, 2001, 2000 and 1999, are as follows:
                                       
December 31, 2001
Gross Gross
Amortized Unrealized Unrealized Fair
(Dollars in thousands) Cost Gains Losses Value
Available for Sale
                                
 
U.S. Treasury and agency securities
  $ 30,344     $ 586     $ 1     $ 30,929  
 
Securities of U.S. states and political subdivisions
    8       —       —       8  
 
Other
    101,899       830       4,354       98,375  
   
Total investment securities available for sale
    132,251       1,416       4,355       129,312  
Held to Maturity
                                
 
Securities of U.S. states and political subdivisions
    5,839       194       2       6,031  
 
Other
    435       1       —       436  
   
Total investment securities held to maturity
    6,274       195       2       6,467  
     
Total
  $ 138,525     $ 1,611     $ 4,357     $ 135,779  
 
                                       
December 31, 2000
Gross Gross
Amortized Unrealized Unrealized Fair
(Dollars in thousands) Cost Gains Losses Value
Available for Sale
                                
 
U.S. Treasury and agency securities
  $ 334,065     $ 252     $ 417     $ 333,900  
 
Securities of U.S. states and political subdivisions
    11       —       —       11  
 
Other
    102,032       710       9,952       92,790  
   
Total investment securities available for sale
    436,108       962       10,369       426,701  
Held to Maturity
                                
 
U.S. Treasury and agency securities
    15,000       3       —       15,003  
 
Securities of U.S. states and political subdivisions
    7,074       160       6       7,228  
 
Other
    440       —       —       440  
   
Total investment securities held to maturity
    22,514       163       6       22,671  
     
Total
  $ 458,622     $ 1,125     $ 10,375     $ 449,372  
                                       
December 31, 1999
Gross Gross
Amortized Unrealized Unrealized Fair
(Dollars in thousands) Cost Gains Losses Value
Trading
                                
 
Other
  $ 13,380     $ —     $ —     $ 13,380  
   
Total investment securities held for trading
    13,380       —       —       13,380  
Available for Sale
                                
 
U.S. Treasury and agency securities
    342,570       5,479       8,362       339,687  
 
Securities of U.S. states and political subdivisions
    294       1       —       295  
 
Other
    141,001       5,250       3,538       142,713  
   
Total investment securities available for sale
    483,865       10,730       11,900       482,695  
Held to Maturity
                                
 
U.S. Treasury and agency securities
    17,058       —       292       16,766  
 
Securities of U.S. states and political subdivisions
    8,279       75       53       8,301  
 
Other
    20,669       —       1,326       19,343  
   
Total investment securities held to maturity
    46,006       75       1,671       44,410  
     
Total
  $ 543,251     $ 10,805     $ 13,571     $ 540,485  

The Company did not have any investment securities held for trading at December 31, 2001 and 2000. The weighted average interest rate on investment securities was 8.21%, 7.40%, and 7.26% at December 31, 2001, 2000 and 1999, respectively.

  Investment securities by contractual maturity as of December 31, 2001 are shown below:
                                                   
Due After One But
Due Within One Year Within Five Years
Amortized Fair Amortized Fair
Cost Value Yield Cost Value Yield
U.S. Treasury and agency securities
  $ 10,003     $ 10,095       5.99 %   $ 3,544     $ 3,655       4.49 %
Securities of U.S. states and political subdivisions
    235       243       5.84       2,477       2,569       5.09  
Other
    403       403       —       526       527       7.92  
 
Total
  $ 10,641     $ 10,741       5.76     $ 6,547     $ 6,751       4.99  
                                                   
Due After Five But
Within Ten Years Due After Ten Years
Amortized Fair Amortized Fair
Cost Value Yield Cost Value Yield
U.S. Treasury and agency securities
  $ 743     $ 837       8.52 %   $ 16,054     $ 16,342       7.10 %
Securities of U.S. states and political subdivisions
    3,135       3,227       5.22       —       —       —  
Other
    26       26       6.80       101,379       97,855       8.94  
 
Total
  $ 3,904     $ 4,090       5.86     $ 117,433     $ 114,197       8.68  

Gains on sales were $3.2 million, $11.2 million and $5.3 million for the years ended December 31, 2001, 2000 and 1999, respectively. Losses on sales were $9.8 million for the year ended December 31, 1999. No losses on sales were realized during the years ended December 31, 2001 and 2000, respectively.

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4. Mortgage-Backed Securities

Mortgage-backed securities at December 31, 2001, 2000 and 1999, are as follows:
                                         
December 31, 2001
Gross Gross
Amortized Unrealized Unrealized Fair
(Dollars in thousands) Cost Gains Losses Value
Available for Sale
                                
 
Participation certificates:
                               
   
U.S. government and agency issues
  $ 6,914,397     $ 58,000     $ 21,972     $ 6,950,425  
 
Collateralized mortgage obligations:
                               
   
U.S. government and agency issues
    508,093       10,168       10       518,251  
   
Private issues
    545,998       16,245       407       561,836  
     
Total mortgage- backed securities available for sale
    7,968,488       84,413       22,389       8,030,512  
Held to Maturity
                                
 
Participation certificates:
                               
   
U.S. government and agency issues
    475,622       19,871       4       495,489  
   
Private issues
    90,203       973       171       91,005  
 
Collateralized mortgage obligations:
                               
   
U.S. government and agency issues
    185,944       10,187       80       196,051  
   
Private issues
    232,135       8,212       234       240,113  
     
Total mortgage- backed securities held to maturity
    983,904       39,243       489       1,022,658  
       
Total
  $ 8,952,392     $ 123,656     $ 22,878     $ 9,053,170  
                                         
December 31, 2000
Gross Gross
Amortized Unrealized Unrealized Fair
(Dollars in thousands) Cost Gains Losses Value
Available for Sale
                                
 
Participation certificates:
                               
   
U.S. government and agency issues
  $ 3,012,369     $ 39,162     $ 3,959     $ 3,047,572  
 
Collateralized mortgage obligations:
                               
   
U.S. government and agency issues
    519,746       4,970       722       523,994  
   
Private issues
    507,395       9,840       1,605       515,630  
     
Total mortgage-backed securities available for sale
    4,039,510       53,972       6,286       4,087,196  
Held to Maturity
                                
 
Participation certificates:
                               
   
U.S. government and agency issues
    672,638       12,600       308       684,930  
   
Private issues
    128,407       518       1,787       127,138  
 
Collateralized mortgage obligations:
                               
   
U.S. government and agency issues
    268,575       9,139       439       277,275  
   
Private issues
    436,555       7,351       1,724       442,182  
     
Total mortgage-backed securities held to maturity
    1,506,175       29,608       4,258       1,531,525  
       
Total
  $ 5,545,685     $ 83,580     $ 10,544     $ 5,618,721  
                                         
December 31, 1999
Gross Gross
Amortized Unrealized Unrealized Fair
(Dollars in thousands) Cost Gains Losses Value
Available for Sale
                                
 
Participation certificates:
                               
   
U.S. government and agency issues
  $ 3,145,128     $ 4,797     $ 29,055     $ 3,120,870  
 
Collateralized mortgage obligations:
                               
   
U.S. government and agency issues
    530,123       15,015       865       544,273  
   
Private issues
    525,345       8,702       6,056       527,991  
     
Total mortgage-backed securities available for sale
    4,200,596       28,514       35,976       4,193,134  
Held to Maturity
                                
 
Participation certificates:
                               
   
U.S. government and agency issues
    848,038       4,859       7,128       845,769  
   
Private issues
    162,485       545       4,315       158,715  
 
Collateralized mortgage obligations:
                               
   
U.S. government and agency issues
    304,772       11,781       1,907       314,646  
   
Private issues
    591,951       3,436       5,204       590,183  
     
Total mortgage-backed securities held to maturity
    1,907,246       20,621       18,554       1,909,313  
       
Total
  $ 6,107,842     $ 49,135     $ 54,530     $ 6,102,447  

Sales of mortgage-backed securities resulted in gains of $109.6 million in 2001, $19.7 million in 2000 and $12.4 million in 1999. Losses on sales were $23.9 million in 2000 and $71.1 million in 1999. No losses on sales were realized in 2001.

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5. Loans and Leases
Loans and leases consist of the following:
                                                                                           
At December 31,
2001 2000 1999 1998 1997
% of % of % of % of % of
(Dollars in thousands) Amount Total Amount Total Amount Total Amount Total Amount Total
Real estate mortgage loans:
                                                                               
 
Permanent:
                                                                               
   
One-to-four family
  $ 9,317,810       36.7 %   $ 10,413,005       43.5 %   $ 11,365,545       51.1 %   $ 13,311,870       60.6 %   $ 12,471,500       65.1 %
   
Multifamily
    989,169       3.9       1,064,796       4.4       1,224,348       5.5       1,027,320       4.7       1,203,277       6.3  
   
Commercial
    1,076,493       4.2       769,589       3.2       624,517       2.8       663,448       3.0       627,816       3.3  
     
Total permanent
    11,383,472       44.8       12,247,390       51.1       13,214,410       59.4       15,002,638       68.3       14,302,593       74.7  
 
Construction:
                                                                               
   
One-to-four family
    666,982       2.6       611,317       2.6       486,512       2.2       453,762       2.1       342,915       1.7  
   
Multifamily
    359,848       1.4       90,129       .4       75,171       .3       45,064       .2       36,234       .2  
   
Commercial
    313,725       1.3       163,544       .6       92,993       .4       73,641       .3       48,716       .3  
     
Total construction
    1,340,555       5.3       864,990       3.6       654,676       2.9       572,467       2.6       427,865       2.2  
       
Total real estate mortgage loans
    12,724,027       50.1       13,112,380       54.7       13,869,086       62.3       15,575,105       70.9       14,730,458       76.9  
Retail consumer loans
    4,808,390       18.9       4,583,770       19.1       3,745,633       16.8       2,841,225       12.9       1,943,287       10.1  
Automobile loans
    4,244,070       16.7       3,046,038       12.7       2,413,531       10.8       2,011,968       9.2       1,624,612       8.5  
Consumer finance loans
    1,027,392       4.0       974,852       4.1       700,259       3.2       443,301       2.0       127,420       .7  
Leases
    1,994,524       7.9       1,778,021       7.4       1,137,895       5.1       734,152       3.3       439,004       2.3  
Corporate banking loans
    1,043,714       4.1       802,379       3.4       679,397       3.0       575,042       2.6       512,595       2.7  
         
Total loans and leases held for investment
    25,842,117       101.7       24,297,440       101.4       22,545,801       101.2       22,180,793       100.9       19,377,376       101.2  
Less:
                                                                               
   
Loans in process
    387,264       1.5       345,341       1.4       259,680       1.2       163,277       .8       143,750       .8  
   
Unamortized net discounts (premiums)
    20,527       —       (6,763 )     —       (7,430 )     —       (14,282 )     (.1)       (5,292 )     —  
   
Allowance for loan and lease losses
    255,478       1.0       189,616       .8       186,400       .8       184,989       .8       181,554       .9  
   
Net deferred loan costs
    (86,007 )     (.3)       (83,388 )     (.4)       (91,133 )     (.4)       (66,927 )     (.3)       (35,368 )     (.2)  
   
Automobile dealer reserve
    (131,216 )     (.5)       (97,538 )     (.4)       (78,578 )     (.4)       (65,214 )     (.3)       (55,613 )     (.3)  
       
Total net items
    446,046       1.7       347,268       1.4       268,939       1.2       201,843       .9       229,031       1.2  
 
Loans and leases held for investment, net
  $ 25,396,071       100.0 %   $ 23,950,172       100.0 %   $ 22,276,862       100.0 %   $ 21,978,950       100.0 %   $ 19,148,345       100.0 %
Loans held for sale
  $ 332,629             $ 58,002             $ 35,988             $ 240,461             $ 361,175          
Loan servicing portfolio
  $ 13,846,807             $ 10,379,644             $ 10,798,563             $ 9,916,922             $ 10,140,387          

As of December 31, 2001, there was no concentration of loans or leases in any type of industry which exceeded 10% of the Bank’s total loans and leases that is not included as a loan or lease category in the table above.

  The following table reflects the principal payments contractually due (assuming no prepayments) on the Bank’s construction portfolio, net of loans in process, and corporate banking loan portfolio at December 31, 2001. Management expects prepayments will cause actual maturities to be shorter.
                                   
Principal Payments Contractually Due in the Year(s)
Ended December 31,
2003- 2007 and
(Dollars in thousands) 2002 2006 Thereafter Total
Construction loans
  $ 672,739     $ 265,839     $ 6,490     $ 945,068  
Corporate banking loans
    260,146       476,119       307,449       1,043,714  
 
Total(1)
  $ 932,885     $ 741,958     $ 313,939     $ 1,988,782  
(1)  Of the $1.1 billion of loans due after December 31, 2002, 41% are fixed rate and 59% are adjustable rate.

The Company normally has outstanding a number of commitments to extend credit. At December 31, 2001, there were outstanding commitments to originate $2.6 billion of mortgage loans and other loans and leases, all at market rates. Terms of the commitments extend up to nine months, but are generally less than two months. At December 31, 2001, there were also outstanding unfunded consumer lines of credit of $3.7 billion and corporate banking lines of credit of $404.4 million. Substantially all of the consumer loans, including consumer lines of credit, are secured by equity in the borrowers’ residences. The Company does not expect all of these lines to be used by the borrowers. Outstanding letters of credit totaled $106.4 million as of December 31, 2001.

  The Bank is engaged in equipment leasing through a subsidiary, ICX Corporation (“ICX”). The equipment leased by ICX is for commercial and industrial use only, with primary lease concentrations to Fortune 1000 companies for large capital equipment acquisitions. A lessee is evaluated from a credit perspective using the same underwriting standards and procedures as for a borrower. A lessee is expected to be able to make the rental payments based on its business’ cash flow and the strength of its balance sheet. Leases are usually not evaluated as collateral-based transactions and, therefore, the lessee’s overall financial strength is the most important credit evaluation factor.

  A summary of the investment in leases, before the allowance for lease losses, is as follows:
                   
 December 31,
(Dollars in thousands) 2001 2000
Direct financing leases
  $ 1,277,979     $ 1,186,961  
Sales-type leases
    49,793       54,369  
Leveraged leases
    666,752       536,691  
 
Total lease financings
  $ 1,994,524     $ 1,778,021  

The components of the investment in lease financings, before the allowance for lease losses, are as follows:
                   
 December 31,
(Dollars in thousands) 2001 2000
Total future minimum lease rentals
  $ 1,512,225     $ 1,400,651  
Estimated residual value of leased equipment
    1,076,772       972,822  
Initial direct costs
    11,397       10,768  
Less unearned income on minimum lease rentals and estimated residual value of leased equipment
    605,870       606,220  
 
Total lease financings
  $ 1,994,524     $ 1,778,021  

At December 31, 2001, future minimum lease rentals on direct financing, sales-type and leveraged leases are as follows: $258.1 million in 2002; $224.2 million in 2003; $186.2 million in 2004; $153.1 million in 2005; $124.4 million in 2006; and $566.2 million thereafter.

Allowance for Loan and Lease Losses – Changes in the allowance for loan and lease losses are as follows:
                           
 Year Ended December 31,
(Dollars in thousands) 2001 2000 1999
Balance, beginning of year
  $ 189,616     $ 186,400     $ 184,989  
 
Provision
    100,766       54,205       35,237  
 
Acquired through business combination
    33,782       —       3,603  
 
Charge-offs
    (78,459 )     (60,331 )     (45,484 )
 
Recoveries
    9,773       9,342       8,055  
Balance, end of year
  $ 255,478     $ 189,616     $ 186,400  

The total investment in impaired loans was $12.3 million and $23.0 million at December 31, 2001 and 2000, respectively. These loans were subject to allowances for loan and lease losses of $3.8 million and $12.9 million as of December 31, 2001 and 2000, respectively.

  The average recorded investment in impaired loans was $10.9 million, $21.3 million, and $17.6 million for the years ended December 31, 2001, 2000, and 1999, respectively. Interest income recognized was $.7 million, $.6 million and $1.4 million for the years ended December 31, 2001, 2000, and 1999, respectively. The interest income potential based upon the original terms of the contracts for these impaired loans was $1.0 million, $2.1 million, and $1.8 million for 2001, 2000 and 1999, respectively.

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6. Loan Servicing Assets
Activity in loan servicing assets is summarized as follows:
                 
Year Ended December 31,
(Dollars in thousands) 2001 2000
Beginning balance
  $ 121,735     $ 118,792  
Amount capitalized
    61,897       42,860  
Sales
    —       (36,576 )
Amortization
    (19,178 )     (13,341 )
Net change in valuation allowance
    (24,614 )     10,000  
Ending balance
  $ 139,840     $ 121,735  

Loans serviced for others were $13.8 billion and $10.4 billion at December 31, 2001 and 2000, respectively. At December 31, 2001, the fair value of loan servicing assets approximated book value. At December 31, 2000, the fair value of loan servicing assets was $138.3 million.

  The Bank securitized residential mortgage and consumer loans of $6.7 billion and $4.0 billion in 2001 and 2000, respectively, in which the Bank retained servicing. The residential mortgage and consumer loans were exchanged for government agency mortgage-backed securities. The Bank did not retain any credit enhancing residual interests, nor is the Bank subject to any significant recourse obligations. The Company does not hold any interests in or sponsor any special-purpose entities.

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7. Deposits
Deposits consist of the following:
                                                     
December 31,
2001 2000 1999
Weighted Weighted Weighted
Average Average Average
(Dollars in thousands) Amount Rate Amount Rate Amount Rate
Checking accounts:
                                               
 
Interest-bearing
  $ 5,973,545       2.45 %   $ 2,547,726       2.68 %   $ 2,066,453       2.05 %
 
Noninterest-bearing
    1,856,481       —       1,394,186       —       1,263,290       —  
Money market and savings accounts
    6,737,160       2.26       5,486,158       3.30       5,235,562       2.70  
Certificates of deposit
    10,556,123       4.43       10,177,601       5.99       10,508,670       5.31  
   
Total deposits, net
  $ 25,123,309       3.05     $ 19,605,671       4.38     $ 19,073,975       3.89  
Including the effect of interest rate swaps
            2.88               4.35               3.79  
 
A summary of all certificates of deposit by maturity follows:
           
(Dollars in thousands) December 31, 2001
Within 12 months
  $ 8,118,917  
Over 12 months to 36 months
    1,123,640  
Over 36 months
    1,313,566  
 
Total
  $ 10,556,123  
A summary of retail certificates of deposit with balances of $100,000 or more by maturity follows:
           
(Dollars in thousands) December 31, 2001
Three months or less
  $ 356,070  
Over three months to six months
    729,021  
Over six months to twelve months
    742,362  
Over twelve months
    170,814  
 
Total
  $ 1,998,267  

Investment securities and mortgage-backed securities with a par value of $573.0 million, $594.6 million and $546.2 million at December 31, 2001, 2000, and 1999, respectively, are pledged to secure public deposits and for other purposes required or permitted by law.

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8. Federal Home Loan Bank Advances
Federal Home Loan Bank (“FHLB”) advances at December 31, 2001 are secured by the Company’s investment in the stock of the FHLB, as well as $12.6 billion in certain real estate loans and $2.4 billion in mortgage-backed securities. FHLB advances are comprised of the following:
                                   
 December 31,
2001 2000
Weighted Weighted
Average Average
(Dollars in thousands) Amount Rate Amount Rate
Fixed rate advances
  $ 8,218,827       5.19 %   $ 9,011,799       5.81 %
Variable rate advances
    424,477       1.75       624,478       6.59  
 
Total advances
    8,643,304       5.02       9,636,277       5.86  
Plus amortized premium on advances
    13,934       —       —       —  
 
Total advances, net
  $ 8,657,238       4.95     $ 9,636,277       5.86  
Including the effect of interest rate swaps
            5.02 %             5.86 %

Scheduled repayments of FHLB advances are as follows:
                                     
December 31, 2001
Fixed Rate Advances Variable Rate Advances
Weighted Weighted
Average Average
(Dollars in thousands) Amount Rate Amount Rate
Maturing in:
                               
 
2002
  $ 1,100,000       3.04 %   $ 14,873       2.05 %
 
2003
    1,105,000       4.66       —       —  
 
2004
    125,000       5.64       —       —  
 
2005
    2,265,200       6.23       —       —  
 
2006
    500,112       4.98       —       —  
 
Thereafter
    3,123,515       5.39       409,604       1.74  
   
Total advances, net
  $ 8,218,827       5.19 %   $ 424,477       1.75 %

At December 31, 2001, certain fixed rate agreements are convertible to LIBOR at the counterparty’s option beginning in 2002. If the counterparty exercises its option, the Company can prepay the advance in full or part on the effective conversion date or on the quarterly repricing date.

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9. Federal Funds Purchased and Repurchase Agreements
The Company enters into federal funds purchased and repurchase agreements. The agreements to repurchase assets correspond with sales of the Company’s securities which are treated as financings for financial statement purposes. The securities subject to repurchase agreements were delivered to the FHLB or brokers arranging the transactions who hold the collateral until maturity of the agreements.

  Federal funds purchased and repurchase agreements consist of the following:
                                 
 December 31,
 2001  2000
Weighted Weighted
Average Average
(Dollars in thousands) Amount Rate Amount Rate
Due within 30 days
  $ 203,259       1.67 %   $ 262,326       5.64 %

At December 31, 2001, there were no amounts at risk with any counterparties exceeding 10% of shareholders’ equity. The amount at risk is equal to the excess of the carrying value (or market value if greater) of the securities sold under agreements to repurchase over the amount of the repurchase liability.

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10. Other Borrowings
Other borrowings consist of the following:
                   
 December 31,
(Dollars in thousands) 2001 2000
Senior notes, due February 15, 2004, interest payable at 7.125% (net of unamortized discount of $.6 million in 2001 and $.8 million in 2000)
  $ 94,524     $ 94,284  
Zero coupon bonds of $151 million at December 31, 2001 and $156 million at December 31, 2000, due February 2005, with yield to maturity of 11.37%
    106,162       98,028  
Installment obligations without recourse
    85,482       73,660  
Variable-rate bonds, due December 1, 2015, interest payable semi-annually at 4.75% with a ceiling of 9.50%
    10,000       10,000  
Other
    8,242       8,836  
 
Total
  $ 304,410     $ 284,808  

The zero coupon bonds are collateralized by mortgage-backed securities with a par value of $202.3 million and $186.2 million at December 31, 2001 and 2000, respectively.

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11. Interest Rate Swaps
The Company uses interest rate swaps as a means of managing its interest rate risk profile (defined as the sensitivity of the Company’s earnings and net portfolio value to changes in interest rates). The Company utilizes fixed receipt callable interest rate swaps to convert certain longer-term callable certificates of deposit into short-term variable instruments. Under these agreements Charter One has agreed to receive interest from the counterparty on a notional amount at a fixed rate defined in the agreement, and to pay interest at a floating rate indexed to LIBOR. Such interest rate swaps are designated and qualify as fair value hedges under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended. The Company assumed no ineffectiveness in the respective hedging relationships. Any gain or loss on the interest rate swap was offset by a gain or loss on the certificates of deposit during the period of change in fair values.

  The Company also utilizes fixed payment interest rate swaps to convert certain floating-rate FHLB advances into fixed-rate instruments. Under these agreements, Charter One has agreed to pay interest to the counterparty on a notional principal amount at a fixed rate defined in the agreement, and receive interest at a floating rate indexed to LIBOR. The amounts of interest exchanged are calculated on the basis of notional principal amounts. Such interest rate swaps are designated and qualify as cash flow hedges under SFAS No. 133. The Company assumed no ineffectiveness in the respective hedging relationships. Any gain or loss on the interest rate swap was offset by the expected future cash flows on the FHLB advances during the period of change in fair values.

  Information on the interest rate swaps, by maturity date, is as follows:
                                                   
 December 31,
 2001  2000
Receiving Paying Receiving Paying
Notional Interest Interest Notional Interest Interest
(Dollars in thousands) Amount Rate Rate Amount Rate Rate
Fixed Payment and Variable Receipt
                                               
2002
  $ 25,000       3.73 %     6.44 %   $ 25,000       6.94 %     6.44 %
2003
    409,605       1.94       3.55       —       —       —  
 
Total
  $ 434,605       2.04 %(1)     3.71 %   $ 25,000       6.94 %(1)     6.44 %
Variable Payment and Fixed Receipt
                                               
2001
  $ —       —       —     $ 420,000       6.38 %     6.73 %
2002
    —       —       —       155,000       7.03       6.73  
2003
    255,000       4.08       2.14       120,000       6.14       6.68  
2004
    —       —       —       478,000       6.84       6.75  
2005
    —       —       —       445,000       7.89       6.68  
2006
    930,000       5.80       2.12       70,000       7.07       6.59  
2007
    10,000       7.25       2.36       10,000       7.25       6.71  
2009
    —       —       —       65,000       7.32       6.53  
2010
    10,000       7.40       2.06       10,000       7.50       6.65  
2011
    45,000       6.33       1.94       —       —       —  
 
Total
  $ 1,250,000       5.49 %     2.12 % (1)   $ 1,773,000       7.00 %     6.71 % (1)
(1)  Rates are based on LIBOR.
The fair value of the Company’s interest rate swap contracts is estimated as the difference in the present value of future cash flows between the Company’s existing agreements and current market rate agreements of the same duration. Information on the fair values of the interest rate swaps is as follows:
                     
 December 31,
(Dollars in thousands) 2001 2000
Unrealized gain (loss):
               
 
Fair value hedges
  $ 23,376     $ 20,980  
 
Cash flow hedges
    (3,584 )     (258 )
   
Total fair value
  $ 19,792     $ 20,722  

The net benefit of interest rate swaps included in interest expense is as follows:
                             
 Year Ended December 31,
(Dollars in thousands) 2001 2000 1999
Interest (income) expense:
                       
 
Deposits
  $ (21,774 )   $ (8,879 )   $ (9,886 )
 
FHLB advances
    1,241       —       86  
 
Federal funds purchased and repurchase agreements
    —       —       (236 )
 
Mortgage loans
    —       —       273  
   
Total
  $ (20,533 )   $ (8,879 )   $ (9,763 )

The Company is exposed to credit loss in the event of nonperformance by the swap counterparties; however, the Company does not currently anticipate nonperformance by the counterparties.

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12. Income Taxes
The provision for income taxes consists of the following components:
                           
 Year Ended December 31,
(Dollars in thousands) 2001 2000 1999
Current
  $ 46,396     $ 33,463     $ 62,158  
Deferred
    186,502       170,321       98,449  
 
Total
  $ 232,898     $ 203,784     $ 160,607  

A reconciliation from tax at the statutory rate to the income tax provision is as follows:
                                                     
 Year Ended December 31,
 2001  2000  1999
(Dollars in thousands) Amount Rate Amount Rate Amount Rate
Tax at statutory rate
  $ 257,057       35.0 %   $ 223,211       35.0 %   $ 173,648       35.0 %
Decrease due to:
                                               
 
Bank owned life insurance
    (13,615 )     (1.9 )     (13,429 )     (2.1 )     (9,191 )     (1.9 )
 
General business credits
    (3,443 )     (.5 )     (2,500 )     (.4 )     (1,821 )     (.3 )
 
Other
    (7,101 )     (.9 )     (3,498 )     (.5 )     (2,029 )     (.4 )
   
Income tax provision
  $ 232,898       31.7 %   $ 203,784       32.0 %   $ 160,607       32.4 %
 
Significant components of the deferred tax assets and liabilities are as follows:
                               
 Year Ended December 31,
(Dollars in thousands) 2001 2000 1999
Deferred tax assets:
                       
 
Book allowance for loan losses
  $ 84,466     $ 62,581     $ 61,847  
 
Accrued and deferred compensation
    1,936       3,267       3,176  
 
Net unrealized loss on securities
    —       —       3,774  
 
Alternative minimum tax credit
    47,638       53,728       22,850  
 
Other
    27,886       53,170       51,317  
   
Total deferred tax assets
    161,926       172,746       142,964  
Deferred tax liabilities:
                       
 
Leasing activities, net
    557,246       386,053       225,459  
 
FHLB stock dividend
    58,018       45,307       32,709  
 
Deferred loan costs
    28,731       29,136       33,656  
 
Tax allowance for loan losses
    2,285       3,640       5,081  
 
Net unrealized gain on securities
    20,586       12,825       —  
 
Other
    10,099       44,346       7,700  
   
Total deferred tax liabilities
    676,965       521,307       304,605  
     
Net deferred tax liability
  $ (515,039 )   $ (348,561 )   $ (161,641 )

In 2001 and 2000, Charter One recaptured excess bad debt reserves of $3.8 million and $4.1 million, respectively, resulting in payments of $1.3 million and $1.4 million which were previously accrued. The pre-1988 reserve provisions are subject only to recapture requirements in the case of certain excess distributions to, and redemptions of, shareholders or if the Bank no longer qualifies as a “bank”. Tax bad debt deductions accumulated prior to 1988 by the Bank are approximately $321.3 million. No deferred income taxes have been provided on these bad debt deductions and no recapture of these amounts is anticipated.

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13. Regulatory Matters
Federal Reserve Board (“FRB”) regulations require depository institutions to maintain certain minimum reserve balances. These reserves, which consisted of vault cash and deposits at the Federal Reserve Bank, totaled $78.5 million and $54.9 million at December 31, 2001 and 2000, respectively.

  The Bank may not declare or pay cash dividends on its shares of common stock if the payment would cause shareholders’ equity to be reduced below applicable regulatory capital maintenance requirements, or if such declaration and payment would otherwise violate regulatory requirements. At December 31, 2001, approximately $62.8 million of the Company’s retained earnings was available to pay dividends to shareholders or to be used for other corporate purposes.

  As a financial holding company, Charter One is subject to regulation by the FRB under the Bank Holding Company Act of 1956 as amended, and the regulations of the FRB, including various capital requirements. Charter One Commercial and Charter One Bank, F.S.B. are subject to various regulatory capital requirements administered by the Federal Deposit Insurance Corporation (“FDIC”) and the OTS, respectively. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly discretionary, actions by each regulator that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, specific capital guidelines must be met that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The institution’s capital classification is also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

  Quantitative measures established by regulation to ensure capital adequacy require Charter One and Charter One Commercial to individually maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital to risk-weighted assets, and Tier 1 capital to average assets. Charter One Bank, F.S.B. is required to maintain minimum amounts and ratios (also set forth in the table below) of total and Tier 1 capital to risk-weighted assets, of core capital to adjusted tangible assets, and of tangible capital to tangible assets. The actual regulatory capital ratios calculated for Charter One, Charter One Commercial and Charter One Bank, F.S.B., along with the capital amounts and ratios for capital adequacy purposes and the amounts required to be categorized as well capitalized under the regulatory framework for prompt corrective action are as follows:
                                                   
December 31, 2001
To Be “Well
Capitalized”
Under Prompt
For Capital Corrective
Actual Adequacy Purposes Action Provisions
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
Charter One:
                                                
 
Total capital to risk-weighted assets
  $ 2,773,390       10.23 %   $ 2,168,434       ³8.00 %   $ 2,710,542       ³10.00 %
 
Tier 1 capital to risk-weighted assets
    2,517,875       9.29       1,084,217       ³4.00       1,626,325       ³6.00  
 
Tier 1 capital to average assets
    2,517,875       6.81       1,479,451       ³4.00       1,849,313       ³5.00  
Charter One Commercial:
                                                
 
Total capital to risk-weighted assets
    39,729       46.21       6,877       ³8.00       8,597       ³10.00  
 
Tier 1 capital to risk-weighted assets
    39,729       46.21       3,439       ³4.00       5,158       ³6.00  
 
Tier 1 capital to average assets
    39,729       13.72       11,579       ³4.00       14,474       ³5.00  
Charter One Bank, F.S.B.:
                                                
 
Total capital to risk-weighted assets
    2,659,977       10.01       2,125,856       ³8.00       2,657,320       ³10.00  
 
Tier 1 capital to risk-weighted assets
    1,910,830       7.19       N/A       N/A       1,594,392       ³6.00  
 
Core capital to adjusted tangible assets
    1,932,552       5.12       1,509,358       ³4.00       1,886,698       ³5.00  
 
Tangible capital to tangible assets
    1,932,552       5.12       566,009       ³1.50       N/A       N/A  
 
                                                   
December 31, 2000
To Be “Well
Capitalized”
Under Prompt
For Capital Corrective
Actual Adequacy Purposes Action Provisions
(Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio
Charter One:
                                                
 
Total capital to risk-weighted assets
  $ 2,448,962       10.29 %   $ 1,906,468       ³8.00 %   $ 2,380,585       ³10.00 %
 
Tier 1 capital to risk-weighted assets
    2,259,030       9.49       952,234       ³4.00       1,428,351       ³6.00  
 
Tier 1 capital to average assets
    2,259,030       6.89       1,310,915       ³4.00       1,638,643       ³5.00  
Charter One Commercial:
                                                
 
Total capital to risk-weighted assets
    30,213       30.56       7,910       ³8.00       9,887       ³10.00  
 
Tier 1 capital to risk-weighted assets
    30,213       30.56       3,955       ³4.00       5,932       ³6.00  
 
Tier 1 capital to average assets
    30,213       8.67       13,941       ³4.00       17,427       ³5.00  
Charter One Bank, F.S.B.:
                                                
 
Total capital to risk-weighted assets
    2,376,443       10.23       1,858,583       ³8.00       2,323,229       ³10.00  
 
Tier 1 capital to risk-weighted assets
    1,673,360       7.20       N/A       N/A       1,393,938       ³6.00  
 
Core capital to adjusted tangible assets
    1,687,568       5.15       1,310,207       ³4.00       1,637,759       ³5.00  
 
Tangible capital to tangible assets
    1,687,300       5.15       491,324       ³1.50       N/A       N/A  

Management believes that, as of December 31, 2001, Charter One, Charter One Commercial and Charter One Bank, F.S.B., individually met the capital adequacy requirements to which they were subject. Events beyond management’s control, such as fluctuations in interest rates or a downturn in the economy in areas in which the institution’s loans and securities are concentrated could adversely affect future earnings and, consequently, the institution’s ability to meet its future capital requirements.

  As discussed in Note 1 to the Notes to Consolidated Financial Statements, the Company announced on January 7, 2002, that Charter One Bank, F.S.B. filed an application with the OCC to convert to a national bank charter. The Company expects the conversion to be effective during the first quarter of 2002, at which time Charter One Bank will be subject to various regulatory capital requirements administered by the OCC.

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14. Stock Purchase Rights
On October 20, 1999, the Board of Directors of the Company approved an amendment and restatement of the Company’s stockholder rights plan, extending the plan that was adopted in 1989 and scheduled to expire on November 20, 1999. Under the Amended and Restated Stockholder Protection Rights Agreement, each share of the Company’s common stock outstanding entitles the shareholder to one stock purchase right. Each right will entitle its holder to purchase one one-hundredth of a share of a new series of preferred stock (Series A Preferred Stock), at a price of $100.00 (subject to adjustment) (the “Exercise Price”) and will generally become exercisable if any person or group (1) acquires 20% or more of the Company’s common stock or (2) commences a tender or exchange offer to acquire 20% or more of the Company’s common stock. Upon announcement that any person or group has acquired 20% or more of the Company’s common stock (“Acquiring Person”), rights owned by the Acquiring Person will become void and each other right will “flip-in,” entitling its holder to purchase for the Exercise Price either Series A Preferred Stock or, at the option of the Company, common stock, having a market value of twice the Exercise Price. In addition, after any person has become an Acquiring Person, the Company may not consolidate or merge with any person or sell 50% or more of its assets or earning power to any person if at the time of such merger or sale the Acquiring Person controls the Company’s Board of Directors and, in the case of a merger, will receive different treatment than the other shareholders, unless provision is made such that each right would thereafter entitle its holder to buy, for the Exercise Price, the number of shares of common stock of such other person having a market value of twice the Exercise Price.

  The rights may be redeemed by the Company for $.01 per right at any time prior to an acquisition of 20% or more of the common stock of the Company. The rights will expire on October 20, 2009 or before that date under certain circumstances, including in connection with the acquisition of the Company in a merger before any person has acquired more than 20% of the Company’s common stock.

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15. Stock Option Plans
At December 31, 2001, the Company has several stock option plans under which 9.1 million shares of common stock are reserved for grant to officers, key employees and directors. The plans provide that option prices will not be less than the fair market value of the stock at the grant date. The date on which the options are first exercisable is determined by the Stock Option Committee of the Board of Directors (the “Committee”). The options expire no later than 10 years from the grant date. The Company applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for its stock option plans. Had compensation cost of the Company’s stock option plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS No. 123, “Accounting for Stock-Based Compensation,” the Company’s net income and earnings per share would have been reduced to the pro forma amounts indicated below (per share data has been restated to reflect all stock dividends as of December 31, 2001):
                           
 Year Ended December 31,
(Dollars in thousands, except per share data) 2001 2000 1999
Net income:
                       
 
As reported
  $ 500,714     $ 433,962     $ 333,976  
 
Pro forma
    474,945       409,818       310,549  
Basic earnings per share:
                       
 
As reported
    2.25       1.93       1.42  
 
Pro forma
    2.14       1.83       1.32  
Diluted earnings per share:
                       
 
As reported
    2.21       1.90       1.39  
 
Pro forma
    2.09       1.79       1.29  

The fair value of each option grant was estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions used for grants in 2001, 2000 and 1999:
                         
 Year Ended December 31,
2001 2000 1999
Dividend yield
    2.00 %     2.00 %     2.00 %
Volatility
    34.40- 43.66 %     43.00- 45.41 %     32.66- 33.65 %
Risk-free interest rate
    4.42-5.55 %     5.20-6.78 %     4.91-6.49 %
Life of grant
    7 years       7 years       7 years  

The estimated weighted-average grant-date fair value (based on the above option-pricing model and assumptions) for options granted in 2001, 2000, and 1999 was $10.68, $8.45, and $9.84, respectively.

  The following is an analysis of the stock option activity for each of the years in the three-year period ended December 31, 2001 and the stock options outstanding at the end of the respective periods. Amounts have been restated to reflect all prior stock dividends.
                 
Weighted Average
Number of Exercise Price of
Option Shares Option Shares
Outstanding at January 1, 1999
    18,592,315       $13.58  
Granted
    3,849,020       23.99  
Exercised
    (2,316,488 )     8.84  
Forfeited
    (367,732 )     23.18  
Outstanding at December 31, 1999
    19,757,115       15.99  
Granted
    4,193,258       17.32  
Exercised
    (2,246,472 )     10.79  
Forfeited
    (807,945 )     20.85  
Outstanding at December 31, 2000
    20,895,956       16.63  
Granted
    7,792,756       25.95  
Acquired through acquisition
    1,034,488       17.54  
Exercised
    (2,936,151 )     11.85  
Forfeited
    (604,489 )     20.36  
Outstanding at December 31, 2001
    26,182,560       19.89  

Financial data pertaining to outstanding stock options were as follows:
                                         
December 31, 2001
Weighted
Average
Weighted Exercise Price
Average Average Number of of Exercisable
Ranges of Number of Remaining Exercise Price of Exercisable Option
Exercise Prices Option Shares Years Option Shares Option Shares Shares
$ 2.54 -  9.98
    2,049,530       1.5       $ 6.44       2,049,530       $ 6.44  
10.07 - 14.04
    3,597,619       4.1       11.20       3,597,619       11.20  
15.14 - 20.00
    5,648,320       7.1       17.31       2,063,228       17.71  
20.24 - 24.58
    6,900,793       6.6       23.45       3,584,347       22.99  
25.21 - 25.99
    3,849,517       9.0       25.23       75,396       25.83  
26.07 - 30.59
    4,136,781       9.8       26.69       143,175       27.26  
      26,182,560       6.8       19.89       11,513,295       15.48  

The Committee may also award restricted shares of common stock to officers and key employees. The terms of the grants are determined by the Committee at the date of the award. As of December 31, 2001, no awards of restricted shares of common stock had been made.

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16. Fair Value of Financial Instruments
The estimated fair values of financial instruments have been determined by the Company using available market information and appropriate valuation methodologies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.

Cash, Cash Equivalents, Accrued Interest Receivable and Payable and Advance Payments by Borrowers for Taxes and Insurance – The carrying amount as reported in the Consolidated Statements of Financial Condition is a reasonable estimate of fair value.

Mortgage-Backed and Investment Securities – Fair values are based on quoted market prices, dealer quotes and prices obtained from independent pricing services.

Loans and Leases – The fair value is estimated by discounting the future cash flows using the current market rates for loans and leases of similar maturities with adjustments for market and credit risks.

Federal Home Loan Bank Stock – The fair value is estimated to be the carrying value which is par. All transactions in the capital stock of the FHLB are executed at par.

Deposits – The fair value of demand deposits, savings accounts and money market deposit accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimated using rates currently offered for advances of similar remaining maturities.
 
Federal Home Loan Bank Advances, Federal Funds Purchased and Repurchase Agreements and Other Borrowings – Rates currently available to the Bank for borrowings with similar terms and remaining maturities are used to estimate fair value of existing borrowings and capital securities.

Forward Commitments – Quoted market prices are utilized to determine fair value disclosures when such prices are available.

  The fair value estimates presented herein are based on pertinent information available to management as of December 31, 2001 and 2000. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since that date and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.
                                     
 December 31, 2001  December 31, 2000
Carrying Fair Carrying Fair
(Dollars in thousands) Value Value Value Value
Assets:
                               
 
Cash and cash equivalents
  $ 516,520     $ 516,520     $ 531,257     $ 531,257  
 
Investment securities
    135,586       135,779       449,215       449,372  
 
Mortgage-backed securities
    9,014,416       9,053,170       5,593,371       5,618,721  
 
Loans and leases, net
    25,728,700       26,102,123       24,008,174       23,953,841  
 
Federal Home Loan Bank stock
    617,836       617,836       568,377       568,377  
 
Accrued interest receivable
    162,065       162,065       165,990       165,990  
Liabilities:
                               
 
Deposits:
                               
   
Checking, money market and savings accounts
    14,567,186       14,567,186       9,428,070       9,428,070  
   
Certificates of deposit
    10,556,123       10,695,580       10,177,601       10,213,966  
 
Federal Home Loan Bank advances
    8,657,238       9,017,975       9,636,277       9,582,491  
 
Federal funds purchased and repurchase agreements
    203,259       203,259       262,326       262,326  
 
Other borrowings
    304,410       323,957       284,808       322,212  
 
Advance payments by borrowers for taxes and insurance
    54,103       54,103       60,761       60,761  
 
Accrued interest payable
    57,704       57,704       54,499       54,499  
Off-Balance-Sheet Items:
                               
 
Forward commitments to purchase/ sell/originate loans or mortgage-backed securities
            4,397               843  

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17. Parent Company Financial Information
The summarized financial statements of Charter One (parent company only) as of December 31, 2001 and 2000 and for the three years ended December 31, 2001 are as follows:

Statements of Financial Condition

                       
 December 31,
(Dollars in thousands) 2001 2000
Assets:
                
 
Deposits with subsidiaries
  $ 55,043     $ 81,655  
 
Cash equivalents
    138       131  
 
Investment in subsidiaries, at equity
    2,401,473       1,941,579  
 
Securities and other
    570,318       530,770  
   
Total assets
  $ 3,026,972     $ 2,554,135  
Liabilities:
                
 
Other borrowings
  $ 94,524     $ 94,284  
 
Accrued expenses and other liabilities
    3,948       3,647  
   
Total liabilities
    98,472       97,931  
Shareholders’ Equity:
                
 
Common stock and additional paid-in capital
    2,094,016       1,747,359  
 
Retained earnings
    811,093       786,793  
 
Treasury stock, at cost
    (14,586 )     (100,545 )
 
Borrowings of employee investment and stock ownership plan
    —       (1,256 )
 
Accumulated other comprehensive income
    37,977       23,853  
   
Total shareholders’ equity
    2,928,500       2,456,204  
     
Total liabilities and shareholders’ equity
  $ 3,026,972     $ 2,554,135  

Statements of Income
                             
 Year Ended December 31,
(Dollars in thousands) 2001 2000 1999
Income:
                        
 
Dividends from subsidiaries
  $ 407,300     $ 1,022,400     $ 145,000  
 
Interest and dividends on securities
    39,382       17,914       1,347  
 
Other income
    1,064       1,238       982  
   
Total income
    447,746       1,041,552       147,329  
Expenses:
                        
 
Interest expense
    7,015       7,022       1,766  
 
Administrative expenses
    6,566       5,663       7,787  
   
Total expenses
    13,581       12,685       9,553  
Income before undistributed net earnings of subsidiaries
    434,165       1,028,867       137,776  
Equity in undistributed net earnings (loss) of subsidiaries
    66,549       (594,905 )     196,200  
   
Net income
  $ 500,714     $ 433,962     $ 333,976  
 
Statements of Cash Flows
                               
 Year Ended December 31,
(Dollars in thousands) 2001 2000 1999
Cash Flows from Operating Activities:
                        
 
Net income
  $ 500,714     $ 433,962     $ 333,976  
 
Adjustments to reconcile net income to net cash provided by operating activities:
                       
   
Equity in undistributed net (earnings) loss of subsidiaries
    (66,549 )     594,905       (196,200 )
   
Other
    (219,564 )     (35,980 )     54,621  
     
Net cash provided by operating activities
    214,601       992,887       192,397  
Cash Flows from Investing Activities:
                        
 
Payments for investments in and advances to subsidiaries
    —       (530,000 )     —  
 
Repayment of investments in and advances to subsidiaries
    —       27,000       —  
 
Purchases of securities
    (1,000 )     —       —  
 
Maturity of securities
    —       —       1,000  
     
Net cash provided by (used in) investing activities
    (1,000 )     (503,000 )     1,000  
Cash Flows from Financing Activities:
                        
 
Proceeds from long-term borrowings
    —       —       95,104  
 
Proceeds from issuance of common stock
    49,443       30,209       24,093  
 
Payment of dividends on common stock
    (167,052 )     (144,659 )     (134,328 )
 
Net purchases of treasury stock
    (122,597 )     (293,763 )     (160,381 )
     
Net cash used in financing activities
    (240,206 )     (408,213 )     (175,512 )
Increase (decrease) in deposits with subsidiaries and cash equivalents
  $ (26,605 )   $ 81,674     $ 17,885  

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18. Subsequent Event
On January 11, 2002, the Boards of Directors of the Company and Charter National Bancorp, Inc. announced a definitive agreement pursuant to which the Company will acquire Charter National in a cash-out merger. Charter Bank, the principal subsidiary of Charter National, is a state-chartered commercial bank headquartered in Wyandotte, Michigan with approximately $300 million in assets, $250 million in deposits, and eight branch offices located south of Detroit, Michigan. The merger, which will be accounted for as a purchase, is expected to close in the second or third quarter of 2002. The transaction is subject to required bank regulatory approvals and approval by Charter National shareholders.
 
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