FINANCIAL REVIEW AND REPORTS
 
Comerica Incorporated and Subsidiaries
 
         
Performance Graph
    18  
Financial Results and Key Corporate Initiatives
    20  
Overview/Earnings Performance
    21  
Strategic Lines of Business
    33  
Balance Sheet and Capital Funds Analysis
    37  
Risk Management
    44  
Critical Accounting Policies
    62  
Forward-Looking Statements
    67  
Consolidated Financial Statements:
       
Consolidated Balance Sheets
    68  
Consolidated Statements of Income
    69  
Consolidated Statements of Changes in Shareholders’ Equity
    70  
Consolidated Statements of Cash Flows
    71  
Notes to Consolidated Financial Statements
    72  
Report of Management
    131  
Reports of Independent Registered Public Accounting Firm
    132  
Historical Review
    134  


17

 
PERFORMANCE GRAPH
 
 
Comparison of Five Year Cumulative Total Return
Among Comerica Incorporated, Keefe 50-Bank Index, and S&P 500 Index
(Assumes $100 Invested on 12/31/02 and Reinvestment of Dividends)
 
(PERFORMANCE GRAPH)
 
The performance shown on the graph above is not necessarily indicative of future performance.


18

TABLE 1: SELECTED FINANCIAL DATA
 
                                         
    Years Ended December 31  
    2007     2006     2005     2004     2003  
    (dollar amounts in millions, except per share data)  
 
EARNINGS SUMMARY
                                       
Net interest income
  $ 2,003     $ 1,983     $ 1,956     $ 1,811     $ 1,928  
Provision for loan losses
    212       37       (47 )     64       377  
Noninterest income
    888       855       819       808       850  
Noninterest expenses
    1,691       1,674       1,613       1,458       1,452  
Provision for income taxes
    306       345       393       349       291  
Income from continuing operations
    682       782       816       748       658  
Income from discontinued operations, net of tax
    4       111       45       9       3  
Net income
    686       893       861       757       661  
PER SHARE OF COMMON STOCK
                                       
Diluted earnings per common share:
                                       
Income from continuing operations
  $ 4.40     $ 4.81     $ 4.84     $ 4.31     $ 3.73  
Net income
    4.43       5.49       5.11       4.36       3.75  
Cash dividends declared
    2.56       2.36       2.20       2.08       2.00  
Common shareholders’ equity
    34.12       32.70       31.11       29.94       29.20  
Market value
    43.53       58.68       56.76       61.02       56.06  
YEAR-END BALANCES
                                       
Total assets
  $ 62,331     $ 58,001     $ 53,013     $ 51,766     $ 52,592  
Total earning assets
    57,448       54,052       48,646       48,016       48,804  
Total loans
    50,743       47,431       43,247       40,843       40,302  
Total deposits
    44,278       44,927       42,431       40,936       41,463  
Total medium- and long-term debt
    8,821       5,949       3,961       4,286       4,801  
Total common shareholders’ equity
    5,117       5,153       5,068       5,105       5,110  
AVERAGE BALANCES
                                       
Total assets
  $ 58,574     $ 56,579     $ 52,506     $ 50,948     $ 52,980  
Total earning assets
    54,688       52,291       48,232       46,975       48,841  
Total loans
    49,821       47,750       43,816       40,733       42,370  
Total deposits
    41,934       42,074       40,640       40,145       41,519  
Total medium- and long-term debt
    8,197       5,407       4,186       4,540       5,074  
Total common shareholders’ equity
    5,070       5,176       5,097       5,041       5,033  
CREDIT QUALITY
                                       
Allowance for loan losses
  $ 557     $ 493     $ 516     $ 673     $ 803  
Allowance for credit losses on lending- related commitments
    21       26       33       21       33  
Total allowance for credit losses
    578       519       549       694       836  
Total nonperforming assets
    423       232       162       339       538  
Net loan charge-offs
    149       60       110       194       365  
Net credit-related charge-offs
    153       72       116       194       365  
Net loan charge-offs as a percentage of average total loans
    0.30 %     0.13 %     0.25 %     0.48 %     0.86 %
Net credit-related charge-offs as a percentage of average total loans
    0.31       0.15       0.26       0.48       0.86  
Allowance for loan losses as a percentage of total period-end loans
    1.10       1.04       1.19       1.65       1.99  
Allowance for loan losses as a percentage of total nonperforming loans
    138       231       373       215       158  
RATIOS
                                       
Net interest margin
    3.66 %     3.79 %     4.06 %     3.86 %     3.95 %
Return on average assets
    1.17       1.58       1.64       1.49       1.25  
Return on average common shareholders’ equity
    13.52       17.24       16.90       15.03       13.12  
Efficiency ratio
    58.58       58.92       58.01       55.60       53.19  
Dividend payout ratio
    57.79       42.99       43.05       47.71       53.33  
Total payout to shareholders
    142.44       85.79       104.11       96.56       57.60  
Average common shareholders’ equity as a percentage of average assets
    8.66       9.15       9.71       9.90       9.50  
Tier 1 common capital as a percentage of risk-weighted assets
    6.85       7.54       7.78       8.13       8.04  
Tier 1 capital as a percentage of risk-weighted assets
    7.51       8.03       8.38       8.77       8.72  


19

 
2007 FINANCIAL RESULTS AND KEY CORPORATE INITIATIVES
 
Financial Results
 
  •  Reported income from continuing operations of $682 million, or $4.40 per diluted share for 2007, compared to $782 million, or $4.81 per diluted share, for 2006. The most significant item contributing to the $100 million decrease in income from continuing operations in 2007, when compared to 2006, was an increase in the provision for loan losses of $175 million. Net income was $686 million, or $4.43 per diluted share for 2007, compared to $893 million, or $5.49 per diluted share for 2006. Included in net income in 2006 was a $108 million after-tax gain on the sale of the Corporation’s Munder subsidiary
 
  •  Returned 13.52 percent on average common shareholders’ equity and 1.17 percent on average assets
 
  •  Generated growth from December 31, 2006 to December 31, 2007 of $3.3 billion in loans and $1.3 billion in unused commitments to extend credit
 
  •  Generated geographic market growth in average loans (excluding Financial Services Division) of seven percent from 2006 to 2007, including Texas (16 percent), Western (13 percent) and Florida (11 percent), with the Midwest market down one percent
 
  •  Increased total revenue two percent, including four percent growth in noninterest income. Excluding a $47 million Financial Services Division-related lawsuit settlement and a $12 million loss on the sale of the Mexican bank charter in 2006, total revenue growth was three percent and noninterest income growth was eight percent
 
  •  Contained the increase in noninterest expenses to $17 million, or one percent, from 2006. 2007 included incremental expenses related to new banking centers ($23 million), a charge related to the Corporation’s membership in Visa, Inc. (Visa) ($13 million) and costs associated with the previously announced headquarters move to Dallas, Texas ($6 million). 2006 noninterest expense included interest on tax liabilities of $38 million. Interest on tax liabilities was not classified in noninterest expenses in 2007, and instead classified in the “provision for income taxes”. Full-time equivalent employees increased less than one percent from 2006 to 2007, even with the addition of 30 new banking centers during the period
 
  •  Incurred net credit-related charge-offs of 31 basis points as a percent of average total loans in 2007, compared to 15 basis points in 2006; nonperforming assets increased to $423 million, reflecting challenges in the residential real estate development industry in Michigan and California
 
  •  Raised the quarterly cash dividend 8.5 percent, to $0.64 per share, an annual rate of $2.56 per share, for an annual dividend payout ratio of 58 percent
 
  •  Repurchased 10 million shares of outstanding common stock in the open market for $580 million, which combined with dividends, returned 142 percent of earnings to shareholders
 
Key Corporate Initiatives
 
  •  Relocated corporate headquarters to Dallas, Texas, where Comerica already had a major presence, to position the Corporation in a more central location with greater accessibility to all markets. Comerica is now the largest bank headquartered in Texas
 
  •  Continued organic growth focused in high growth markets, including opening 30 new banking centers in 2007; in 2008, Comerica expects to open 32 new banking centers. Since the banking center expansion program began in late 2004, new banking centers have resulted in nearly $1.8 billion in new deposits
 
  •  Continued to refine and develop the enterprise-wide risk management and compliance programs, including improvement of analytics, systems and reporting
 
  •  Managed full-time equivalent staff growth to less than one percent, even with approximately 140 full-time equivalent employees added to support new banking center openings
 
  •  Reduced automotive production exposure from loans, unused commitments and standby letters of credit and financial guarantees from $4.2 billion at December 31, 2006 to $3.7 billion at December 31, 2007


20

 
OVERVIEW/EARNINGS PERFORMANCE
 
Comerica Incorporated (the Corporation) is a financial holding company headquartered in Dallas, Texas. The Corporation’s major business segments are the Business Bank, the Retail Bank and Wealth & Institutional Management. The core businesses are tailored to each of the Corporation’s four primary geographic markets: Midwest, Western, Texas and Florida.
 
The accounting and reporting policies of the Corporation and its subsidiaries conform to U.S. generally accepted accounting principles and prevailing practices within the banking industry. The Corporation’s consolidated financial statements are prepared based on the application of accounting policies, the most significant of which are described on page 72 in Note 1 to the consolidated financial statements. The most critical of these significant accounting policies are discussed in the “Critical Accounting Policies” section on page 62 of this financial review.
 
As a financial institution, the Corporation’s principal activity is lending to and accepting deposits from businesses and individuals. The primary source of revenue is net interest income, which is derived principally from the difference between interest earned on loans and investment securities and interest paid on deposits and other funding sources. The Corporation also provides other products and services that meet the financial needs of customers and which generate noninterest income, the Corporation’s secondary source of revenue. Growth in loans, deposits and noninterest income is affected by many factors, including the economic growth in the markets the Corporation serves, the financial requirements and health of customers and successfully adding new customers and/or increasing the number of products used by current customers. Success in providing products and services depends on the financial needs of customers and the types of products desired.
 
The Corporation sold its stake in Munder Capital Management (Munder) in 2006. This financial review and the consolidated financial statements reflect Munder as a discontinued operation in all periods presented. For detailed information concerning the sale of Munder and the components of discontinued operations, refer to Note 26 to the consolidated financial statements on page 127.
 
The remaining discussion and analysis of the Corporation’s results of operations is based on results from continuing operations.
 
The Corporation generated growth of $3.3 billion in loans and $1.3 billion in unused commitments to extend credit from December 31, 2006 to December 31, 2007. Excluding Financial Services Division, nearly all business lines showed average loan growth in 2007, compared to 2006, including Specialty Businesses, which includes Entertainment, Energy, Leasing, and Technology and Life Sciences (17 percent), Global Corporate Banking (12 percent), Private Banking (11 percent), National Dealer Services (5 percent), Commercial Real Estate (5 percent), Small Business (5 percent) and Middle Market (5 percent). Excluding Financial Services Division, average loans grew in the Texas (16 percent), Western (13 percent) and Florida (11 percent) geographic markets in 2007, compared to 2006, and declined one percent in the Midwest market. Average loans decreased 44 percent in 2007 in the Financial Services Division, where customers deposit large balances (primarily noninterest-bearing) and the Corporation pays certain customer services expenses (included in noninterest expenses on the consolidated statements of income) and/or makes low-rate loans (included in net interest income on the consolidated statements of income) to such customers. Average deposits excluding Financial Services Division increased $1.9 billion, or five percent from 2006. The increase in average deposits excluding Financial Services Division when compared to 2006, resulted primarily from an increase in customer and institutional certificates of deposit. Average Financial Services Division deposits decreased $2.0 billion, or 34 percent, in 2007, compared to 2006. The decrease in average Financial Services Division deposits in 2007, when compared to 2006, resulted from a $1.5 billion decrease in average noninterest-bearing deposits and a $508 million decrease in average interest-bearing deposits. Noninterest-bearing deposits in the Corporation’s Financial Services Division include title and escrow deposits, which benefit from home mortgage financing and refinancing activity. Financial Services Division deposit levels may change with the direction of mortgage activity changes, the desirability of such deposits and competition for deposits. Net interest income increased one percent in 2007, compared to 2006, primarily due to loan growth.
 
Noninterest income, excluding net securities gains, net gain (loss) on sales of businesses and income from lawsuit settlement, increased seven percent in 2007, compared to 2006, resulting primarily from increases in fiduciary income ($19 million), commercial lending fees ($10 million), income from principal investing and warrants ($9 million) and card fees ($8 million).


21

 
The Corporation’s credit staff closely monitors the financial health of lending customers in order to assess ability to repay and to adequately provide for expected losses. Loan quality was impacted by challenges in the residential real estate development industry in Michigan and California and a leveling off of overall credit quality improvement trends in the Texas market and remaining businesses in the Western market. Credit quality trends resulted in an increase in net credit-related charge-offs and nonperforming assets in 2007, compared to 2006. The tools developed in the past several years for evaluating the adequacy of the allowance for loan losses, and the resulting information gained from these processes, continue to help the Corporation monitor and manage credit risk.
 
Noninterest expenses increased one percent in 2007, compared to 2006, primarily due to increases in net occupancy and equipment expense ($18 million), regular salaries ($16 million) and a charge related to the Corporation’s membership in Visa ($13 million), partially offset by a decrease resulting from the prospective change in the classification of interest on tax liabilities to “provision for income taxes” on the consolidated statements of income effective January 1, 2007. Noninterest expenses included $38 million of interest on tax liabilities in 2006. The $18 million increase in net occupancy and equipment expense in 2007 included $9 million from the addition of 30 new banking centers. Full-time equivalent employees increased by less than one percent (approximately 80 employees) from year-end 2006 to year-end 2007, even with approximately 140 full-time equivalent employees added to support new banking center openings.
 
A majority of the Corporation’s revenues are generated by the Business Bank business segment, making the Corporation highly sensitive to changes in the business environment in its primary geographic markets. To facilitate better balance among business segments and geographic markets, the Corporation opened 30 new banking centers in 2007 in markets with favorable demographics and plans to continue banking center expansion in these markets. This is expected to provide opportunity for growth across all business segments, especially in the Retail Bank and Wealth & Institutional Management segments, as the Corporation penetrates existing relationships through cross-selling and develops new relationships.
 
For 2008, management expects the following, compared to 2007 from continuing operations (assumes the economy experiences slow growth in 2007 rather than a recession):
 
  •  Mid to high single-digit average loan growth, excluding Financial Services Division loans, with flat growth in the Midwest market, high single-digit growth in the Western market and low double-digit growth in the Texas market
 
  •  Average earning asset growth in excess of average loan growth
 
  •  Average Financial Services Division noninterest-bearing deposits of $1.2 to $1.4 billion. Financial Services Division loans will fluctuate in tandem with the level of noninterest-bearing deposits
 
  •  Based on the federal funds rate declining to 2.00 percent by mid-year 2008, average full year net interest margin between 3.10 and 3.15 percent, including the effects of higher levels of securities, lower value of noninterest-bearing deposits, average loan growth exceeding average deposit growth and the 2008 FAS 91 impact discussed below
 
  •  Average net credit-related charge-offs between 45 and 50 basis points of average loans, with charge-offs in the first half higher than in the second half of 2008. The provision for credit losses is expected to exceed net charge-offs
 
  •  Low single-digit growth in noninterest income
 
  •  Low single-digit decline in noninterest expenses, excluding the provision for credit losses on lending-related commitments and including the 2008 FAS 91 impact discussed below
 
  •  Effective tax rate of about 32 percent
 
  •  Maintain a Tier one common capital ratio comparable to year-end 2007
 
  •  Statement of Financial Accounting Standards No. 91 (FAS 91) - Accounting for Loan Origination Fees and Costs. Beginning in 2008, a change in the application of FAS 91 will result in deferral and amortization (over the loan life) to net interest income of more fees and costs. Based on assumptions for loan growth, loan fees and average loan life, the estimated impact on 2008, compared to 2007, will be to lower the net interest margin by about 3-4 basis points (approximately $20 million), lower noninterest expenses by about 3-4 percent (approximately $60 million) and increase earnings per share by about four cents per quarter


22

TABLE 2: ANALYSIS OF NET INTEREST INCOME-Fully Taxable Equivalent (FTE)
 
                                                                         
    Years Ended December 31
    2007   2006   2005
    Average
      Average
  Average
      Average
  Average
      Average
    Balance   Interest   Rate   Balance   Interest   Rate   Balance   Interest   Rate
    (dollar amounts in millions)
 
Commercial loans(1)(2)(3)
  $ 28,132     $ 2,038       7.25 %   $ 27,341     $ 1,877       6.87 %   $ 24,575     $ 1,381       5.62 %
Real estate construction loans
    4,552       374       8.21       3,905       336       8.61       3,194       231       7.23  
Commercial mortgage loans
    9,771       709       7.26       9,278       675       7.27       8,566       534       6.23  
Residential mortgage loans
    1,814       111       6.13       1,570       95       6.02       1,388       80       5.74  
Consumer loans
    2,367       166       7.00       2,533       181       7.13       2,696       159       5.89  
Lease financing
    1,302       40       3.04       1,314       52       4.00       1,283       49       3.81  
International loans
    1,883       133       7.06       1,809       127       7.01       2,114       126       5.98  
Business loan swap expense(4)
          (67 )                 (124 )                 (2 )      
Total loans(2)(3)(5)
    49,821       3,504       7.03       47,750       3,219       6.74       43,816       2,558       5.84  
                                                                         
Investment securities available-for-sale(6)
    4,447       206       4.56       3,992       174       4.22       3,861       148       3.76  
Federal funds sold and securities purchased under agreements to resell
    164       9       5.28       283       14       5.15       390       12       3.29  
Other short-term investments
    256       14       5.65       266       18       6.69       165       12       7.22  
                                                                         
Total earning assets
    54,688       3,733       6.82       52,291       3,425       6.53       48,232       2,730       5.65  
Cash and due from banks
    1,352                       1,557                       1,721                  
Allowance for loan losses
    (520 )                     (499 )                     (623 )                
Accrued income and other assets
    3,054                       3,230                       3,176                  
                                                                         
Total assets
  $ 58,574                     $ 56,579                     $ 52,506                  
                                                                         
                                                                         
Money market and NOW deposits(1)
  $ 14,937       460       3.08     $ 15,373       443       2.88     $ 17,282       337       1.95  
Savings deposits
    1,389       13       0.93       1,441       11       0.79       1,545       7       0.49  
Customer certificates of deposit
    7,687       342       4.45       6,505       261       4.01       5,418       148       2.73  
Institutional certificates of deposit(4)(7)
    5,563       300       5.39       4,489       235       5.23       511       19       3.72  
Foreign office time deposits(8)
    1,071       52       4.85       1,131       55       4.82       877       37       4.18  
                                                                         
Total interest-bearing deposits
    30,647       1,167       3.81       28,939       1,005       3.47       25,633       548       2.14  
Short-term borrowings
    2,080       105       5.06       2,654       130       4.89       1,451       52       3.59  
Medium- and long-term debt(4)(7)
    8,197       455       5.55       5,407       304       5.63       4,186       170       4.05  
                                                                         
Total interest-bearing sources
    40,924       1,727       4.22       37,000       1,439       3.89       31,270       770       2.46  
                                                                         
Noninterest-bearing deposits(1)
    11,287                       13,135                       15,007                  
Accrued expenses and other liabilities
    1,293                       1,268                       1,132                  
Shareholders’ equity
    5,070                       5,176                       5,097                  
                                                                         
Total liabilities and shareholders’ equity
  $ 58,574                     $ 56,579                     $ 52,506                  
                                                                         
Net interest income/rate spread (FTE)
          $ 2,006       2.60             $ 1,986       2.64             $ 1,960       3.19  
                                                                         
FTE adjustment(9)
          $ 3                     $ 3                     $ 4          
                                                                         
Impact of net noninterest-bearing sources of funds
                    1.06                       1.15                       0.87  
                                                                         
Net interest margin (as a percentage of average earning assets) (FTE)(2)(3)
                    3.66 %                     3.79 %                     4.06 %
                                                                         
                                                                       
(1) FSD balances included above:
                                                                       
Loans (primarily low-rate)
  $ 1,318     $ 9       0.69 %   $ 2,363     $ 13       0.57 %   $ 1,893     $ 8       0.45 %
Interest-bearing deposits
    1,202       47       3.91       1,710       66       3.86       2,600       76       2.91  
Noninterest-bearing deposits
    2,836                       4,374                       5,851                  
(2) Impact of FSD loans (primarily low-rate) on the following:
                                                                       
Commercial loans
                    (0.32 )%                     (0.59 )%                     (0.43 )%
Total loans
                    (0.18 )                     (0.32 )                     (0.24 )
Net interest margin (FTE) (assuming loans were funded by noninterest-bearing deposits)
                    (0.08 )                     (0.16 )                     (0.15 )
(3) Impact of 2005 warrant accounting change on the following:
                                                                       
Commercial loans
                                                          $ 20       0.08 %
Total loans
                                                            20       0.05  
Net interest margin (FTE)
                                                            20       0.04  
(4) The gain or loss attributable to the effective portion of cash flow hedges of loans is shown in “Business loan swap expense”. The gain or loss attributable to the effective portion of fair value hedges of institutional certificates of deposits and medium- and long-term debt, which totaled a net gain of $12 million in 2007, is included in the related interest expense line items.
(5) Nonaccrual loans are included in average balances reported and are used to calculate rates.
(6) Average rate based on average historical cost.
 
(7) Institutional certificates of deposit and medium- and long-term debt average balances have been adjusted to reflect the gain or loss attributable to the risk hedged by risk management swaps that qualify as a fair value hedge.
(8) Includes substantially all deposits by foreign domiciled depositors; deposits are primarily in excess of $100,000.
(9) The FTE adjustment is computed using a federal income tax rate of 35%.


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TABLE 3: RATE-VOLUME ANALYSIS-Fully Taxable Equivalent (FTE)
 
                                                 
    2007/2006     2006/2005  
    Increase
    Increase
    Net
    Increase
    Increase
    Net
 
    (Decrease)
    (Decrease)
    Increase
    (Decrease)
    (Decrease)
    Increase
 
    Due to Rate     Due to Volume*     (Decrease)     Due to Rate     Due to Volume*     (Decrease)  
    (in millions)  
 
Interest income (FTE):
                                               
Loans:
                                               
Commercial loans
  $ 104     $ 57     $ 161     $ 306     $ 190     $ 496  
Real estate construction loans
    (16 )     54       38       44       61       105  
Commercial mortgage loans
    (1 )     35       34       89       52       141  
Residential mortgage loans
    1       15       16       4       11       15  
Consumer loans
    (3 )     (12 )     (15 )     34       (12 )     22  
Lease financing
    (12 )           (12 )     2       1       3  
International loans
    1       5       6       22       (21 )     1  
Business loan swap expense
    57             57       (122 )           (122 )
                                                 
Total loans
    131       154       285       379       282       661  
Investment securities available-for-sale
    11       21       32       20       6       26  
Federal funds and securities purchased under agreements to resell
    1       (6 )     (5 )     8       (6 )     2  
Other short-term investments
    (3 )     (1 )     (4 )     1       5       6  
                                                 
Total interest income (FTE)
    140       168       308       408       287       695  
Interest expense:
                                               
Interest-bearing deposits:
                                               
Money market and NOW accounts
    30       (13 )     17       161       (55 )     106  
Savings deposits
    2             2       5       (1 )     4  
Certificates of deposit
    29       52       81       69       44       113  
Institutional certificates of deposit
    7       58       65       8       208       216  
Foreign office time deposits
          (3 )     (3 )     6       12       18  
                                                 
Total interest-bearing deposits
    68       94       162       249       208       457  
Short-term borrowings
    5       (30 )     (25 )     19       59       78  
Medium- and long-term debt
    (4 )     155       151       66       68       134  
                                                 
Total interest expense
    69       219       288       334       335       669  
                                                 
Net interest income (FTE)
  $ 71     $ (51 )   $ 20     $ 74     $ (48 )   $ 26  
                                                 
 
 
* Rate/volume variances are allocated to variances due to volume.
 
 
Net Interest Income
 
Net interest income is the difference between interest and yield-related fees earned on assets and interest paid on liabilities. Adjustments are made to the yields on tax-exempt assets in order to present tax-exempt income and fully taxable income on a comparable basis. Gains and losses related to the effective portion of risk management interest rate swaps that qualify as hedges are included with the interest income or expense of the hedged item when classified in net interest income. Net interest income on a fully taxable equivalent (FTE) basis comprised 69 percent of total revenues in 2007, compared to 70 percent in 2006 and 71 percent in 2005. Table 2 on page 23 of


24

this financial review provides an analysis of net interest income for the years ended December 31, 2007, 2006 and 2005. The rate-volume analysis in Table 3 above details the components of the change in net interest income on a FTE basis for 2007 compared to 2006 and 2006 compared to 2005.
 
Net interest income (FTE) was $2.0 billion in 2007, an increase of $20 million, or one percent, from 2006. The net interest margin (FTE), which is net interest income (FTE) expressed as a percentage of average earning assets, decreased to 3.66 percent in 2007, from 3.79 percent in 2006. The increase in net interest income in 2007 was due to loan growth, which was partially offset by a decline in noninterest-bearing deposits (primarily in the Financial Services Division) and competitive environments for both loan and deposit pricing. The decrease in net interest margin (FTE) was due to loan growth, a competitive loan and deposit pricing environment and changes in the funding mix, including a continued shift in funding sources toward higher-cost funds. Partially offsetting these decreases were maturities of interest rate swaps that carried negative spreads, which provided a 10 basis point improvement to the net interest margin in 2007, compared to 2006. Average earning assets increased $2.4 billion, or five percent, to $54.7 billion in 2007, compared to 2006, primarily as a result of a $2.1 billion increase in average loans and a $455 million increase in average investment securities available-for-sale. Average Financial Services Division loans (primarily low-rate) decreased $1.0 billion, and average Financial Services Division noninterest-bearing deposits decreased $1.5 billion in 2007, compared to 2006.
 
The Corporation expects, on average, net interest margin in 2008 to be between 3.10 and 3.15 percent for the full year, based on the federal funds rate declining to 2.00 percent by mid-year 2008 and including the effects of higher levels of securities, lower value of noninterest-bearing deposits, average loan growth exceeding average deposit growth and the 2008 FAS 91 impact discussed in the 2008 guidance provided on page 22 of this financial review.
 
Net interest income and net interest margin are impacted by the operations of the Corporation’s Financial Services Division. Financial Services Division customers deposit large balances (primarily noninterest-bearing) and the Corporation pays certain customer services expenses (included in “noninterest expenses” on the consolidated statements of income) and/or makes low-rate loans (included in “net interest income” on the consolidated statements of income) to such customers. Footnote (1) to Table 2 on page 23 of this financial review displays average Financial Services Division loans and deposits, with related interest income/expense and average rates. As shown in Footnote (2) to Table 2 on page 23 of this financial review, the impact of Financial Services Division loans (primarily low-rate) on net interest margin (assuming the loans were funded by Financial Services Division noninterest-bearing deposits) was a decrease of 8 basis points in 2007, compared to a decrease of 16 basis points in 2006.
 
The Corporation implements various asset and liability management tactics to manage net interest income exposure to interest rate risk. Refer to the “Interest Rate Risk” section on page 54 of this financial review for additional information regarding the Corporation’s asset and liability management policies.
 
In 2006, net interest income (FTE) was $2.0 billion, an increase of $26 million, or one percent, from 2005. The net interest margin (FTE) decreased to 3.79 percent in 2006, from 4.06 percent in 2005. The increase in net interest income in 2006 was due to strong loan growth, which was nearly offset by a decline in noninterest-bearing deposits (primarily in the Financial Services Division), competitive environments for both loan and deposit pricing and the impact of warrant accounting change discussed in Note 1 to the consolidated financial statements on page 72, which resulted in a $20 million increase in net interest income in 2005. A greater contribution from noninterest-bearing deposits in a higher rate environment also benefited net interest income in 2006. The decrease in net interest margin (FTE) was due to the 2005 warrant accounting change, which increased the 2005 net interest margin by four basis points, the changes in average Financial Services Division loans and noninterest-bearing deposits discussed below, competitive loan and deposit pricing, a change in the interest-bearing deposit mix toward higher-cost deposits and the margin impact of loan growth funded with non-core deposits and purchased funds. Average earning assets increased $4.1 billion, or eight percent, to $52.3 billion in 2006, compared to 2005, primarily as a result of a $3.9 billion increase in average loans and a $131 million increase in average investment securities available-for-sale. Average Financial Services Division loans (primarily low-rate) increased $470 million, and average Financial Services Division noninterest-bearing deposits decreased $1.5 billion in 2006, compared to 2005.


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Provision for Credit Losses
 
The provision for credit losses includes both the provision for loan losses and the provision for credit losses on lending-related commitments. The provision for loan losses reflects management’s evaluation of the adequacy of the allowance for loan losses. The allowance for loan losses represents management’s assessment of probable losses inherent in the Corporation’s loan portfolio. The provision for credit losses on lending-related commitments, a component of “noninterest expenses” on the consolidated statements of income, reflects management’s assessment of the adequacy of the allowance for credit losses on lending-related commitments. The allowance for credit losses on lending-related commitments, which is included in “accrued expenses and other liabilities” on the consolidated balance sheets, covers probable credit-related losses inherent in credit-related commitments, including letters of credit and financial guarantees. The Corporation performs an in-depth quarterly credit quality review to determine the adequacy of both allowances. For a further discussion of both the allowance for loan losses and the allowance for credit losses on lending-related commitments, refer to the “Credit Risk” section of this financial review on page 44, and the “Critical Accounting Policies” section on page 62 of this financial review.
 
The provision for loan losses was $212 million in 2007, compared to $37 million in 2006 and a negative provision of $47 million in 2005. The $175 million increase in the provision for loan losses in 2007, compared to 2006, resulted primarily from challenges in the residential real estate development industry in Michigan and California and a leveling off of overall credit quality improvement trends in the Texas market and the remaining businesses of the Western market. These credit trends reflect economic conditions in the Corporation’s three largest geographic markets. While the economic conditions in Michigan deteriorated over the last year, the economic conditions in Texas continued to experience growth at a rate somewhat faster than the national economy, while those in California, other than real estate, grew at a rate equal to the nation as a whole. The average 2007 Michigan Business Activity index compiled by the Corporation was slightly lower than the average for 2006. However, intense restructuring efforts in the Michigan-based automotive sector created a significant drag on the state economy that spilled over to other sectors, with the residential real estate development industry one of the most affected. Forward-looking indicators suggest that current economic conditions in Michigan will deteriorate at about the same pace as in 2007 and that growth in California and Texas will be slower than it was last year. The increase in the provision for loan losses in 2006, when compared to 2005, was primarily the result of loan growth, challenges in the automotive industry and the Michigan residential real estate development industry, and a leveling off of credit quality improvement trends.
 
The provision for credit losses on lending-related commitments was a negative provision of $1 million in 2007, compared to charges of $5 million and $18 million in 2006 and 2005, respectively. The $6 million decrease in the provision for credit losses on lending-related commitments in 2007 was primarily the result of a decrease in specific reserves related to unused commitments extended to two large customers in the automotive industry. These reserves declined due to sales of commitments and improved market values for the remaining commitments. The decrease in 2006 was primarily due to reduced reserve needs resulting from improved market values for unfunded commitments to certain customers in the automotive industry. An analysis of the changes in the allowance for credit losses on lending-related commitments is presented on page 45 of this financial review.
 
Net loan charge-offs in 2007 were $149 million, or 0.30 percent of average total loans, compared to $60 million, or 0.13 percent, in 2006 and $110 million, or 0.25 percent, in 2005. The $89 million increase from 2006 resulted primarily from increases in Midwest residential real estate development ($43 million), Midwest middle market lending ($34 million) and Western residential real estate development ($16 million). Total net credit-related charge-offs, which includes net charge-offs on both loans and lending-related commitments, were $153 million, or 0.31 percent of average total loans, in 2007, compared to $72 million, or 0.15 percent, in 2006 and $116 million, or 0.26 percent, in 2005. Of the $81 million increase in net credit-related charge-offs in 2007, compared to 2006, net credit-related charge-offs in the Business Bank business segment increased $80 million. By geographic market, net credit-related charge-offs in the Midwest and Western markets increased $62 million and $27 million in 2007 compared to 2006. Net credit-related charge-offs in 2006 were impacted by a decision to sell a $74 million portfolio of loans related to manufactured housing. These loans were transferred to held-for-sale in the fourth quarter 2006, which required a charge-off of $9 million to adjust the loans to estimated fair value. An analysis of the changes in the allowance for loan losses, including charge-offs and recoveries by loan category, is presented in Table 8 on page 45 of this financial review. An analysis of the changes in the allowance for credit losses on lending-related commitments is presented on page 45 of this financial review.


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Management expects full-year 2008 average net credit-related charge-offs between 45 and 50 basis points of average loans, with charge-offs in the first half higher than in the second half of 2008. The provision for credit losses is expected to exceed net charge-offs.
 
Noninterest Income
 
                         
    Years Ended December 31  
    2007     2006     2005  
    (in millions)  
 
Service charges on deposit accounts
  $ 221     $ 218     $ 218  
Fiduciary income
    199       180       174  
Commercial lending fees
    75       65       63  
Letter of credit fees
    63       64       70  
Foreign exchange income
    40       38       37  
Brokerage fees
    43       40       36  
Card fees
    54       46       39  
Bank-owned life insurance
    36       40       38  
Net income from principal investing and warrants
    19       10       17  
Net securities gains
    7              
Net gain (loss) on sales of businesses
    3       (12 )     1  
Income from lawsuit settlement
          47        
Other noninterest income
    128       119       126  
                         
Total noninterest income
  $ 888     $ 855     $ 819  
                         
 
Noninterest income increased $33 million, or four percent, to $888 million in 2007, compared to $855 million in 2006, and increased $36 million, or five percent, in 2006, compared to $819 million in 2005. Excluding net securities gains, net gain (loss) on sales of businesses and income from lawsuit settlement, noninterest income increased seven percent in 2007 and less than one percent in 2006. An analysis of increases and decreases by individual line item is presented below.
 
Service charges on deposit accounts increased $3 million, or one percent, to $221 million in 2007, compared to $218 million in both 2006 and 2005.
 
Fiduciary income increased $19 million, or 11 percent, in 2007 and increased $6 million, or four percent, in 2006. Personal and institutional trust fees are the two major components of fiduciary income. These fees are based on services provided and assets managed. Fluctuations in the market values of the underlying assets managed, which include both equity and fixed income securities, impact fiduciary income. The increase in 2007 and 2006 was due to net new business and market appreciation.
 
Commercial lending fees increased $10 million, or 16 percent, in 2007, compared to an increase of $2 million, or two percent, in 2006. The increases in 2007 and 2006 were primarily due to higher commercial loan commitment and participation fees.
 
Letter of credit fees decreased $1 million, or two percent, in 2007, compared to a decrease of $6 million, or eight percent, in 2006. The 2007 decrease in letter of credit fees was principally due to competitive pricing pressures and lower demand resulting from the recent challenges in the residential real estate market. Of the 2006 decline, $3 million reflected the impact, in 2005, of an adjustment of deferred fee amortization to more closely align the amortization periods with actual terms of the letters of credit.
 
Foreign exchange income increased $2 million, or five percent, to $40 million in 2007, compared to $38 million and $37 million in 2006 and 2005, respectively. The increase in 2007 was primarily due to the impact of exchange rate changes on the Canadian dollar denominated net assets held at the Corporation’s Canadian branch.
 
Brokerage fees of $43 million increased $3 million, or nine percent, in 2007, compared to $40 million and $36 million in 2006 and 2005, respectively. Brokerage fees include commissions from retail broker transactions


27

and mutual fund sales and are subject to changes in the level of market activity. The increase in 2007 was primarily due to increased customer investments in money market mutual funds. The increase in 2006 was primarily due to increased transaction volumes as a result of improved market conditions.
 
Card fees, which consist primarily of interchange fees earned on debit and commercial cards, increased $8 million, or 16 percent, to $54 million, compared to $46 million in 2006, and increased $7 million, or 17 percent, compared to $39 million in 2005. Growth in both 2007 and 2006 resulted primarily from an increase in transaction volume caused by the continued shift to electronic banking, new customer accounts and new products.
 
Bank-owned life insurance income decreased $4 million, to $36 million in 2007, compared to an increase of $2 million, to $40 million in 2006. The decrease in 2007 resulted primarily from a decrease in death benefits received and decreased earnings, as a result of interest rate changes.
 
Net income from principal investing and warrants increased $9 million to $19 million in 2007, compared to $10 million in 2006 and $17 million in 2005. The $9 million increase in 2007 included a $5 million increase in warrant income and $4 million of additional income generated from the Corporation’s indirect private equity investments.
 
Net securities gains were $7 million in 2007, none of which were individually significant, and were minimal in both 2006 and 2005.
 
The net gain (loss) on sales of businesses in 2007 included a net gain of $1 million on the sale of an insurance subsidiary and a $2 million adjustment to reduce the loss on the 2006 sale of the Corporation’s Mexican bank charter, while 2006 included a net loss of $12 million on the sale of the Mexican bank charter.
 
The income from lawsuit settlement of $47 million in 2006 resulted from a payment received to settle a Financial Services Division-related lawsuit in the fourth quarter 2006.
 
Other noninterest income increased $9 million, or eight percent, in 2007, compared to a decrease of $7 million, or five percent, in 2006. The following table illustrates fluctuations in certain categories included in “other noninterest income” on the consolidated statements of income.
 
                         
    Years Ended December 31  
    2007     2006     2005  
    (in millions)  
 
Other noninterest income
                       
Risk management hedge gains (losses) from interest rate and foreign exchange contracts
  $ 3     $ (1 )   $ 3  
Amortization of low income housing investments
    (33 )     (29 )     (25 )
Gain on sale of SBA loans
    14       12       16  
Deferred compensation asset returns*
    7       3        
 
 
Compensation deferred by the Corporation’s officers is invested in stocks and bonds to reflect the investment selections of the officers. Income earned on these assets is reported in noninterest income and the offsetting increase in the liability is reported in salaries expense.
 
 
Management expects low single-digit growth in noninterest income in 2008 from 2007 levels.


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Noninterest Expenses
 
                         
    Years Ended December 31  
    2007     2006     2005  
    (in millions)  
 
Salaries
  $ 844     $ 823     $ 786  
Employee benefits
    193       184       178  
                         
Total salaries and employee benefits
    1,037       1,007       964  
Net occupancy expense
    138       125       118  
Equipment expense
    60       55       53  
Outside processing fee expense
    91       85       77  
Software expense
    63       56       49  
Customer services
    43       47       69  
Litigation and operational losses
    18       11       14  
Provision for credit losses on lending-related commitments
    (1 )     5       18  
Other noninterest expenses
    242       283       251  
                         
Total noninterest expenses
  $ 1,691     $ 1,674     $ 1,613  
                         
 
Noninterest expenses increased $17 million, or one percent, to $1,691 million in 2007, compared to $1,674 million in 2006, and increased $61 million, or four percent, in 2006, from $1,613 million in 2005. Increases in regular salaries ($16 million), net occupancy and equipment expenses ($18 million), employee benefits ($9 million), and a $13 million charge in 2007 related to the Corporation’s membership in Visa, were substantially offset by a decrease due to the prospective change in classification of interest on tax liabilities to “provision for income taxes” in 2007 ($38 million). For further discussion of interest on tax liabilities, refer to Note 1 to the consolidated financial statements on page 72 and to the section in this financial review entitled “Income Taxes and Tax-Related Items.” In addition, noninterest expenses included approximately $6 million of costs related to the 2007 relocation of the Corporation’s headquarters to Dallas, Texas, reflected in salaries and other noninterest expenses. An analysis of increases and decreases by individual line item is presented below.
 
The following table summarizes the various components of salaries and employee benefits expense.
 
                         
    Years Ended December 31  
    2007     2006     2005  
    (in millions)  
 
Salaries
                       
Regular salaries (including contract labor)
  $ 635     $ 619     $ 582  
Severance
    4       8       6  
Incentives
    138       134       155  
Deferred compensation plan costs
    8       5        
Share-based compensation
    59       57       43  
                         
Total salaries
    844       823       786  
Employee benefits
                       
Pension expense
    36       39       31  
Other employee benefits
    157       145       147  
                         
Total employee benefits
    193       184       178  
                         
Total salaries and employee benefits
  $ 1,037     $ 1,007     $ 964  
                         
 
Salaries expense increased $21 million, or three percent, in 2007, compared to an increase of $37 million, or five percent, in 2006. The increase in 2007 was primarily due to increases in regular salaries of $16 million and incentive compensation of $4 million. The increase in regular salaries in 2007 was primarily the result of annual merit increases of approximately $18 million, partially offset by a decline in contract labor costs associated with technology-related projects. In addition, staff size increased approximately 80 full-time equivalent employees


29

from year-end 2006 to year-end 2007, including approximately 140 full-time equivalent employees added in new banking centers. The increase in incentive compensation was primarily due to increased incentives tied to peer-based comparisons of corporate results. Severance included $2 million in 2007 related to the relocation of the Corporation’s headquarters to Dallas, Texas. The increase in 2006 was primarily due to increases in regular salaries of $37 million and shared-based compensation of $14 million. The increase in regular salaries in 2006 was primarily the result of annual merit increases of approximately $17 million and increased contract labor costs associated with technology-related projects. In addition, staff size from continuing operations increased approximately 65 full-time equivalent employees from year-end 2005 to year-end 2006. Shared-based compensation expense increased in 2006 primarily as a result of adopting the requisite service period provisions of SFAS 123 (revised 2004) (SFAS 123(R)), “Shared-Based Payment,” effective January 1, 2006, as discussed in Notes 1 and 15 to the consolidated financial statements on pages 72 and 95, respectively. These increases were partially offset by a $16 million decline in incentives.
 
Employee benefits expense increased $9 million, or five percent, in 2007, compared to an increase of $6 million, or three percent, in 2006. The increase in 2007 resulted primarily from an increase in defined contribution plan expense, mostly from a change in the Corporation’s core matching contribution rate effective January 1, 2007. The increase in 2006 resulted primarily from an increase in pension expense. For a further discussion of pension and defined contribution plan expense, refer to the “Critical Accounting Policies” on page 62 of this financial review and Note 16 to the consolidated financial statements on page 97.
 
Net occupancy and equipment expense increased $18 million, or ten percent, to $198 million in 2007, compared to an increase of $9 million, or six percent, in 2006. Net occupancy and equipment expense increased $9 million and $7 million in 2007 and 2006, respectively, due to the addition of 30 new banking centers in 2007, 25 in 2006 and 18 in 2005.
 
Outside processing fee expense increased $6 million, or seven percent, to $91 million in 2007, from $85 million in 2006, compared to an increase of $8 million, or 10 percent, in 2006. The 2007 increase is from higher volume in activity-based processing charges, in part related to outsourcing. The 2006 increase in outside processing fees resulted primarily from the outsourcing of certain trust and retirement services processing and a new electronic bill payment service marketed to corporate customers in 2006.
 
Software expense increased $7 million, or 12 percent, in 2007, compared to an increase of $7 million, or 15 percent in 2006. The increases in both 2007 and 2006 were primarily due to increased investments in technology and the implementation of several systems, including tools for a sales tracking system in the banking centers, anti-money laundering initiatives and a corporate banking portal, increasing both amortization and maintenance costs.
 
Customer services expense decreased $4 million, or seven percent, to $43 million in 2007, from $47 million in 2006, and decreased $22 million, or 33 percent, in 2006, from $69 million in 2005. Customer services expense represents compensation provided to customers, and is one method to attract and retain title and escrow deposits in the Financial Services Division. The amount of customer services expense varies from period to period as a result of changes in the level of noninterest-bearing deposits and low-rate loans in the Financial Services Division and the earnings credit allowances provided on these deposits, as well as a competitive environment.
 
Litigation and operational losses increased $7 million, or 55 percent, to $18 million in 2007, from $11 million in 2006, and decreased $3 million, or 17 percent, in 2006, compared to $14 million in 2005. Litigation and operational losses include traditionally defined operating losses, such as fraud or processing problems, as well as uninsured losses and litigation losses. These expenses are subject to fluctuation due to timing of authorized and actual litigation settlements as well as insurance settlements. The increase in 2007 reflected $13 million to record an estimated liability related to membership in Visa, partially offset by a litigation-related insurance settlement of $8 million received in the second quarter 2007. Members of the Visa card association participate in a loss sharing arrangement to allocate financial responsibilities arising from any potential adverse resolution of certain antitrust lawsuits challenging the practices of the association. The Corporation believes that its share of the proceeds from an expected initial public offering of Visa, anticipated in early 2008, will exceed its share of recorded losses.
 
The provision for credit losses on lending-related commitments was a negative provision of $1 million in 2007, compared to provisions of $5 million and $18 million in 2006 and 2005, respectively. For additional


30

information on the provision for credit losses on lending-related commitments, refer to Notes 1 and 20 to the consolidated financial statements on pages 72 and 107, respectively, and the “Provision for Credit Losses” section on page 26 of this financial review.
 
Other noninterest expenses decreased $41 million, or 14 percent, in 2007, compared to an increase of $32 million, or 13 percent, in 2006. The decrease in 2007 was primarily the result of the prospective change in classification of interest on tax liabilities to “provision for income taxes” in 2007. The following table illustrates the fluctuations in certain categories included in “other noninterest expenses” on the consolidated statements of income. For a further discussion of interest on tax liabilities, refer to “Income Taxes and Tax-Related Items” below.
 
                         
    Years Ended December 31  
    2007     2006     2005  
    (in millions)  
 
Other noninterest expenses
                       
Interest on tax liabilities
  $ N/A     $ 38     $ 11  
Charitable Foundation Contribution
    2       10       10  
Other real estate expenses
    7       4       12  
 
 
N/A- Not Applicable
 
Management expects a low single-digit decline in noninterest expenses in 2008 compared to 2007 levels, excluding the provision for credit losses on lending-related commitments and including the impact of a 2008 change in the application of FAS 91 discussed in the 2008 guidance provided on page 22 of this financial review.
 
The Corporation’s efficiency ratio (total noninterest expenses as a percentage of total revenue (FTE) excluding net securities gains) decreased to 58.58 percent in 2007, compared to 58.92 percent in 2006 and 58.01 percent in 2005. The efficiency ratio declined in 2007 primarily due to increased income levels and increased in 2006 primarily due to higher expense levels.
 
Income Taxes And Tax-Related Items
 
The provision for income taxes was $306 million in 2007, compared to $345 million in 2006 and $393 million in 2005. The provision for income tax in 2007 included a $9 million reduction ($6 million after-tax) of interest resulting from a settlement with the Internal Revenue Service (IRS) on a refund claim. The provision for income taxes in 2006 was impacted by the completion of an IRS audit of federal tax returns for years 1996 through 2000, the settlement of various refund claims and an adjustment to tax reserves. In the first quarter 2006, tax reserves, which include the provision for income taxes and interest expense on tax liabilities (included in “other noninterest expenses” in 2006 and 2005) were adjusted to reflect the resolution of those tax years and to reflect an updated assessment of reserves on certain types of structured lease transactions and a series of loans to foreign borrowers. Interest on tax liabilities was also reduced by $6 million in the second quarter 2006, upon settlement of various refund claims with the IRS. As previously disclosed in quarterly and annual SEC filings under the heading “Tax Contingency,” the IRS disallowed the benefits related to a series of loans to foreign borrowers. The Corporation has had ongoing discussions with the IRS related to the disallowance. In the fourth quarter 2006, based on settlements discussed, the Corporation recorded a charge to its tax reserves for the disallowed loan benefits. The following table summarizes the impact of the items described above on the Corporation’s consolidated statement of income for the year ended December 31, 2006.
 
                         
    Year Ended December 31, 2006  
    Interest on Tax Liabilities     Provision for
 
    Pre-tax     After-tax     Income Taxes  
    (in millions)  
 
Completion of IRS audit of the Corporation’s federal income tax returns for 1996-2000
  $ 24     $ 15     $ (16 )
Settlement of various refund claims
    (6 )     (4 )     (2 )
Adjustment to tax reserves on a series of loans to foreign borrowers
    14       9       22  
                         
Total tax-related items
  $ 32     $ 20     $ 4  
                         


31

The effective tax rate, computed by dividing the provision for income taxes by income from continuing operations before income taxes, was 31.0 percent in 2007, 30.6 percent in 2006 and 32.5 percent in 2005. Changes in the effective tax rate in 2007 from 2006, and 2006 from 2005, are disclosed in Note 17 to the consolidated financial statements on page 103. The Corporation had a net deferred tax liability of $146 million at December 31, 2007. Included in net deferred taxes at December 31, 2007 were deferred tax assets of $514 million, net of a $2 million valuation allowance established for certain state deferred tax assets. A valuation allowance is provided when it is “more-likely-than-not” that some portion of the deferred tax asset will not be realized. Deferred tax assets are evaluated for realization based on available evidence and assumptions made regarding future events. In the event that the future taxable income does not occur in the manner anticipated, other initiatives could be undertaken to preclude the need to recognize a valuation allowance against the deferred tax asset.
 
On January 1, 2007, the Corporation adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109,” (FIN 48). As a result, the Corporation recognized an increase in the liability for unrecognized tax benefits of approximately $18 million at January 1, 2007, accounted for as a change in accounting principle via a decrease to the opening balance of retained earnings ($13 million net of tax). Prior disclosures on the change in unrecognized tax benefits resulting from the adoption of FIN 48 were adjusted to address an uncertain tax position that was incorrectly assessed at the time of adoption. The facts and circumstances surrounding this uncertain tax position were unchanged since January 1, 2007. For further discussion of FIN 48 refer to Note 17 to the consolidated financial statements on page 103.
 
In July, 2007, the State of Michigan replaced its current Single Business Tax (SBT) with a new Michigan Business Tax (MBT). Financial institutions are subject to an industry-specific tax which is based on net capital, effective January 1, 2008. Management believes the MBT will have an immaterial effect on the Corporation’s financial condition and results of operations when compared to the SBT. Both the SBT and MBT, when effective, are recorded in “Other noninterest expenses” on the consolidated statements of income.
 
Management expects an effective tax rate for the full-year 2008 of about 32 percent.
 
Income From Discontinued Operations, Net Of Tax
 
Income from discontinued operations, net of tax, was $4 million in 2007, compared to $111 million in 2006 and $45 million in 2005. Income from discontinued operations in 2007 reflected an adjustment to the initial gain recorded on the sale of the Corporation’s Munder subsidiary in 2006. Included in 2006 was a $108 million after-tax gain on the sale of Munder in the fourth quarter 2006. The Munder sale agreement included an interest-bearing contingent note with an initial principal amount of $70 million, which will be realized if the Corporation’s client-related revenues earned by Munder remain consistent with 2006 levels of approximately $17 million per year for the five years following the closing of the transaction (2007-2011). Future gains related to the contingent note are expected to be recognized periodically as targets for the Corporation’s client-related revenues earned by Munder are achieved. The potential future gains are expected to be recorded between 2008 and the fourth quarter of 2011, unless fully earned prior to that time. Included in 2005 was a $32 million after-tax gain in the fourth quarter 2005 that resulted from Munder’s sale of its minority interest in Framlington Group Limited (Framlington) (a London, England based investment manager). For further information on discontinued operations, refer to Note 26 to the consolidated financial statements on page 127.


32

 
STRATEGIC LINES OF BUSINESS
 
Business Segments
 
The Corporation’s operations are strategically aligned into three major business segments: the Business Bank, the Retail Bank and Wealth & Institutional Management. These business segments are differentiated based upon the products and services provided. In addition to the three major business segments, the Finance Division is also reported as a segment. The Other category includes discontinued operations and items not directly associated with these business segments or the Finance Division. Note 24 to the consolidated financial statements on page 119 describes the business activities of each business segment and the methodologies which form the basis for these results, and presents financial results of these business segments for the years ended December 31, 2007, 2006 and 2005.
 
The following table presents net income (loss) by business segment.
 
                                                 
    Years Ended December 31  
    2007     2006     2005  
    (dollar amounts in millions)  
 
Business Bank
  $ 503       75 %   $ 589       74 %   $ 658       74 %
Retail Bank
    99       15       144       18       174       19  
Wealth & Institutional Management
    70       10       61       8       63       7  
                                                 
      672       100 %     794       100 %     895       100 %
Finance
    4               (18 )             (71 )        
Other*
    10               117               37          
                                                 
Total
  $ 686             $ 893             $ 861          
                                                 
 
 
Includes discontinued operations and items not directly associated with the three major business segments or the Finance Division.
 
 
The Business Bank’s net income decreased $86 million, or 15 percent, to $503 million in 2007, compared to a decrease of $69 million, or 11 percent, to $589 million in 2006. Net interest income (FTE) was $1.3 billion in 2007, an increase of $11 million, or one percent, compared to 2006. The increase in net interest income (FTE) was primarily due to a $2.7 billion increase in average loan balances (excluding Financial Services Division) and a $524 million increase in average deposit balances (excluding Financial Services Division), partially offset by a decline in loan and deposit spreads. The provision for loan losses increased $164 million in 2007, from $14 million in 2006, primarily due to an increase in reserves in 2007 for the residential real estate development business, a reserve related to a single customer in the Technology and Life Sciences business line and credit improvements recognized in 2006, partially offset by a decrease in reserves related to the automotive industry in 2007. Excluding a $47 million Financial Services Division-related lawsuit settlement recorded in 2006 and a $12 million loss on the sale of the Mexican bank charter in 2006, noninterest income increased $21 million from 2006. The increase was primarily due to net securities gains of $7 million in 2007 and increases in commercial lending fees ($7 million) and card fees ($4 million) in 2007, when compared to 2006. Noninterest expenses of $708 million for 2007 decreased $33 million from 2006, primarily due to a $16 million decrease in allocated net corporate overhead expense, an $8 million decrease in provision for credit losses on lending-related commitments, and $8 million in legal fees recorded in 2006 related to the Financial Services Division-related lawsuit settlement noted previously. The corporate overhead allocation rates used were six percent and seven percent in 2007 and 2006, respectively. The one percentage point decrease in rate in 2007, when compared to 2006, resulted mostly from income tax related items.
 
The Retail Bank’s net income decreased $45 million, or 31 percent, to $99 million in 2007, compared to a decrease of $30 million, or 18 percent, to $144 million in 2006. Net interest income (FTE) of $627 million decreased $10 million, or two percent, in 2007, primarily due to decreases in loan and deposit spreads, partially offset by the benefit of a $349 million increase in average deposit balances. The provision for loan losses increased $18 million in 2007 primarily due to increases in credit-related reserves for Small Business Administration (SBA) loans and Small Business lending. Noninterest income of $220 million increased $10 million from 2006, primarily due to a $3 million increase in card fees and a $2 million increase in income from the sale of SBA loans. Noninterest expenses of


33

$655 million for 2007 increased $47 million from 2006, partially due to increases in salaries and employee benefits expense ($17 million), net occupancy expenses ($9 million) primarily related to the addition of new banking centers, outside processing fees ($5 million) and a charge related to the Corporation’s membership in Visa ($13 million). Partially offsetting these increases was an $8 million decrease in allocated net corporate overhead expenses. Refer to the Business Bank discussion above for an explanation of the decrease in allocated net corporate overhead expenses. The Corporation opened 30 new banking centers in 2007 and 25 new banking centers in 2006, contributing $56 million to noninterest expenses in 2007, an increase of $23 million compared to 2006.
 
Wealth & Institutional Management’s net income increased $9 million, or 14 percent, to $70 million in 2007, compared to a decrease of $2 million, or three percent, to $61 million in 2006. Net interest income (FTE) of $145 million decreased $2 million, or two percent, in 2007, compared to 2006, as decreases in loan spreads and average deposit balances were partially offset by an increase in average loan balances of $403 million from 2006. The provision for loan losses decreased $4 million, primarily due to an improvement from one large customer in the Midwest market. Noninterest income of $283 million increased $24 million, or 10 percent, in 2007, primarily due to a $19 million increase in fiduciary income and a $3 million increase in brokerage fees. Noninterest expenses of $322 million increased $9 million from 2006, primarily due to a $7 million increase in salaries and employee benefits expense and a $3 million increase in outside processing fee expense, partially offset by a $4 million decrease in allocated net corporate overhead expenses. Refer to the Business Bank discussion above for an explanation of the decrease in allocated net corporate overhead expenses.
 
Net income in the Finance Division was $4 million in 2007, compared to a net loss of $18 million in 2006. Contributing to the increase in net income was a $31 million increase in net interest income (FTE), primarily due to the rising rate environment in the first three quarters of the year, during which time interest income received from the lending-related business units increased faster than the longer-term value attributed to deposits generated by the business units, and the maturity of swaps with negative spreads, partially offset by an increase in wholesale funding.
 
Net income in the Other category was $10 million for 2007, compared to $117 million for 2006. Income from discontinued operations, net of tax, was $4 million in 2007, compared to $111 million for 2006. Discontinued operations in 2006 included a $108 million after-tax gain on the sale of the Corporation’s Munder subsidiary. Noninterest income increased $12 million from 2006, primarily due to a $4 million increase in net income from principal investing and warrants and a $4 million increase in deferred compensation asset returns. The remaining difference is due to timing differences between when corporate overhead expenses are reflected as a consolidated expense and when the expenses are allocated to the business segments.
 
Geographic Market Segments
 
The Corporation’s management accounting system also produces market segment results for the Corporation’s four primary geographic markets: Midwest, Western, Texas and Florida. In addition to the four primary geographic markets, Other Markets and International are also reported as market segments. The Finance & Other Businesses category includes discontinued operations. Note 24 to the consolidated financial statements on page 119 presents a description of each of these market segments as well as the financial results for the years ended December 31, 2007, 2006 and 2005.


34

 
The following table presents net income (loss) by market segment.
 
                                                 
    Years Ended December 31  
    2007     2006     2005  
    (dollar amounts in millions)  
 
Midwest
  $ 277       42 %   $ 319       41 %   $ 351       39 %
Western
    170       25       273       34       338       38  
Texas
    79       12       82       10       89       10  
Florida
    7       1       14       2       15       2  
Other Markets
    89       13       72       9       62       7  
International
    50       7       34       4       40       4  
                                                 
      672       100 %     794       100 %     895       100 %
Finance & Other Businesses*
    14               99               (34 )        
                                                 
Total
  $ 686             $ 893             $ 861          
                                                 
 
 
 *  Includes discontinued operations and items not directly associated with the market segments.
 
 
The Midwest market’s net income decreased $42 million, or 14 percent, to $277 million in 2007, compared to a decrease of $32 million, or nine percent, to $319 million in 2006. Net interest income (FTE) of $863 million decreased $45 million from 2006, primarily due to a decrease in loan spreads. The provision for loan losses increased $11 million, primarily due to an increase in residential real estate development reserves in 2007, compared to 2006, partially offset by a decrease in reserves related to the automotive industry in 2007. Noninterest income of $471 million increased $19 million from 2006 due to a $10 million increase in fiduciary income, a $6 million increase in card fees and a $3 million increase in brokerage fees. Noninterest expenses of $821 million increased $10 million from 2006, primarily due to a $10 million charge related to the Corporation’s membership in Visa allocated to the Midwest market in 2007, a $5 million increase in salaries and employee benefits expense and a $4 million increase in litigation and operational losses, partially offset by a $5 million decrease in allocated net corporate overhead expenses. Refer to the Business Bank discussion above for an explanation of the decrease in allocated net corporate overhead expenses. The Corporation opened two new banking centers and consolidated five banking centers in Michigan in 2007. In addition, 22 banking centers in Michigan were refurbished in 2007.
 
The Western market’s net income decreased $103 million, or 38 percent, to $170 million in 2007, compared to a decrease of $65 million, or 19 percent, to $273 million in 2006. Net interest income (FTE) of $706 million increased $5 million, or one percent, in 2007. The increase in net interest income (FTE) was primarily due to a $1.7 billion increase in average loan balances (excluding Financial Services Division) and an $823 million increase in average deposit balances (excluding Financial Services Division), partially offset by a decrease in net interest income from the Financial Services Division and declining loan and deposit spreads. Average low-rate Financial Services Division loan balances declined $1.0 billion in 2007 and average Financial Services Division deposits declined $2.1 billion. The provision for loan losses increased $140 million, primarily due to an increase in credit risk in the California residential real estate development industry in 2007, compared to overall credit improvements in 2006. Noninterest income was $131 million in 2007, a decrease of $29 million from 2006, primarily due to a $47 million Financial Services Division-related lawsuit settlement in 2006, partially offset by a $5 million increase in customer derivative income and a $2 million increase in income from the sale of SBA loans. Noninterest expenses of $455 million increased $5 million, primarily due to a $12 million increase in expenses related to the addition of new banking centers, mostly salaries and employee benefits expense and net occupancy expense. These increases were partially offset by an $8 million decrease in legal fees related to the Financial Services Division-related lawsuit settlement and an $8 million decrease in allocated net corporate overhead expenses. Refer to the Business Bank discussion above for an explanation of the decrease in allocated net corporate overhead expenses. The Corporation opened 16 new banking centers in the Western market in 2007. In addition, two banking centers in the Western market were relocated and two were refurbished in 2007.
 
The Texas market’s net income decreased $3 million, or three percent, to $79 million in 2007, compared to a decrease of $7 million, to $82 million in 2006. Net interest income (FTE) of $279 million increased $18 million, or seven percent, in 2007, compared to 2006. The increase in net interest income (FTE) was primarily due to an increase in average loan and deposit balances, partially offset by a decrease in loan spreads. The provision for loan losses increased $10 million, primarily due to credit improvements recognized in 2006. Noninterest income of


35

$86 million increased $10 million from 2006, primarily due to a $4 million increase in commercial lending fees and increases in various other fee categories. Noninterest expenses of $235 million increased $19 million from 2006, partially due to a $9 million increase in salaries and employee benefits expense and a $2 million increase in net occupancy expense, primarily related to the addition of new banking centers. These increases were partially offset by a $3 million decrease in allocated net corporate overhead expenses. Refer to the Business Bank discussion above for an explanation of the decrease in allocated net corporate overhead expenses. The Corporation opened 12 new banking centers in the Texas market in 2007, which resulted in a $7 million increase in noninterest expenses. In addition, one banking center in the Texas market was relocated and three were refurbished in 2007.
 
The Florida market’s net income decreased $7 million, or 46 percent, to $7 million in 2007, compared to a decrease of $1 million, to $14 million in 2006. Net interest income (FTE) of $47 million increased $4 million, or nine percent, from 2006, primarily due to a $164 million increase in average loan balances. The provision for loan losses increased $8 million, primarily due to an increase in residential real estate development industry reserves in 2007, compared to 2006. Noninterest income of $14 million was unchanged from 2006. Noninterest expenses of $39 million increased $5 million from the comparable period in the prior year, partially due to a $2 million increase in salaries and employee benefit expenses.
 
The Other Markets’ net income increased $17 million to $89 million in 2007, compared to 2006. Net interest income (FTE) of $136 million increased $18 million from 2006, primarily due to a $443 million increase in average loan balances and a $133 million increase in average deposit balances. The provision for loan losses increased $10 million, primarily due to an increase in residential real estate development industry reserves in 2007. Noninterest income of $54 million increased $2 million in 2007 compared to 2006. Noninterest expenses of $92 million decreased $9 million from the comparable period in the prior year, primarily due to an $8 million decrease in the provision for credit losses on lending-related commitments.
 
The International market’s net income increased $16 million, to $50 million in 2007, compared to 2006. Net interest income (FTE) of $67 million decreased $1 million from the comparable period in the prior year. The provision for loan losses was negative in both 2007 and 2006, due to credit improvements. Noninterest income of $38 million increased $18 million from 2006, primarily due to a $12 million loss on the sale of the Mexican bank charter in the third quarter 2006 and a $4 million increase in net securities gains in 2007. Noninterest expenses of $43 million decreased $7 million in 2007 compared to 2006, reflecting a decrease in salaries and employee benefit expenses and nominal decreases in other expense categories.
 
Net income for the Finance & Other Business segment was $14 million in 2007, compared to $99 million for 2006. Income from discontinued operations, net of tax, was $4 million in 2007, compared to $111 million for 2006. Discontinued operations in 2006 included a $108 million after-tax gain on the sale of the Corporation’s Munder subsidiary. Net interest income (FTE) increased $21 million, primarily due to the rising rate environment in the first three quarters of the year, during which time interest income received from the lending-related business units increased faster than the longer-term value attributed to deposits generated by the business units, and the maturity of swaps with negative spreads, partially offset by an increase in wholesale funding. Noninterest income increased $13 million, primarily due to a $4 million increase in net income from principal investing and warrants and a $4 million increase in deferred compensation asset returns. The remaining difference is due to timing differences between when corporate overhead expenses are reflected as a consolidated expense and when the expenses are allocated to the business segments.
 
The following table lists the Corporation’s banking centers by geographic market segments.
 
                         
    December 31  
    2007     2006     2005  
 
Midwest (Michigan)
    237       240       250  
Western:
                       
California
    83       70       58  
Arizona
    8       5       3  
                         
      91       75       61  
Texas
    79       68       61  
Florida
    9       9       6  
International
    1       1       5  
                         
Total
    417       393       383  
                         


36

BALANCE SHEET AND CAPITAL FUNDS ANALYSIS
 
Total assets were $62.3 billion at December 31, 2007, an increase of $4.3 billion from $58.0 billion at December 31, 2006. On an average basis, total assets increased to $58.6 billion in 2007, from $56.6 billion in 2006, an increase of $2.0 billion, resulting primarily from a $2.4 billion increase in earning assets. The Corporation also recorded a $140 million decrease in average deposits, a $574 million decrease in average short-term borrowings and a $2.8 billion increase in average medium- and long-term debt in 2007, compared to 2006.
 
TABLE 4: ANALYSIS OF INVESTMENT SECURITIES AND LOANS
 
                                         
    December 31  
    2007     2006     2005     2004     2003  
    (in millions)  
 
Investment securities available-for-sale:
                                       
U.S. Treasury and other Government agency securities
  $ 36     $ 46     $ 124     $ 192     $ 188  
Government-sponsored enterprise securities
    6,165       3,497       3,954       3,564       4,121  
State and municipal securities
    3       4       4       7       11  
Other securities
    92       115       158       180       169  
                                         
Total investment securities available-for-sale
  $ 6,296     $ 3,662     $ 4,240     $ 3,943     $ 4,489  
                                         
Commercial loans
  $ 28,223     $ 26,265     $ 23,545     $ 22,039     $ 21,579  
Real estate construction loans:
                                       
Commercial Real Estate business line
    4,089       3,449       2,831       2,461       2,754  
Other business lines
    727       754       651       592       643  
                                         
Total real estate construction loans
    4,816       4,203       3,482       3,053       3,397  
Commercial mortgage loans:
                                       
Commercial Real Estate business line
    1,377       1,534       1,450       1,556       1,655  
Other business lines
    8,671       8,125       7,417       6,680       6,223  
                                         
Total commercial mortgage loans
    10,048       9,659       8,867       8,236       7,878  
Residential mortgage loans
    1,915       1,677       1,485       1,294       1,228  
Consumer loans:
                                       
Home equity
    1,616       1,591       1,775       1,837       1,647  
Other consumer
    848       832       922       914       963  
                                         
Total consumer loans
    2,464       2,423       2,697       2,751       2,610  
Lease financing
    1,351       1,353       1,295       1,265       1,301  
International loans:
                                       
Government and official institutions
                3       4       12  
Banks and other financial institutions
    27       47       46       11       45  
Commercial and industrial
    1,899       1,804       1,827       2,190       2,252  
                                         
Total international loans
    1,926       1,851       1,876       2,205       2,309  
                                         
Total loans
  $ 50,743     $ 47,431     $ 43,247     $ 40,843     $ 40,302  
                                         


37

TABLE 5: LOAN MATURITIES AND INTEREST RATE SENSITIVITY
 
                                 
    December 31, 2007  
    Loans Maturing  
          After One
             
    Within
    But Within
    After
       
    One Year*     Five Years     Five Years     Total  
    (in millions)  
 
Commercial loans
  $ 21,608     $ 5,561     $ 1,054     $ 28,223  
Real estate construction loans
    3,813       792       211       4,816  
Commercial mortgage loans
    3,953       4,482       1,613       10,048  
International loans
    1,777       115       34       1,926  
                                 
Total
  $ 31,151     $ 10,950     $ 2,912     $ 45,013  
                                 
Sensitivity of Loans to Changes in Interest Rates:
                               
Predetermined (fixed) interest rates
          $ 4,347     $ 2,330          
Floating interest rates
            6,603       582          
                                 
Total
          $ 10,950     $ 2,912          
                                 
 
 
* Includes demand loans, loans having no stated repayment schedule or maturity and overdrafts.
 
 
Earning Assets
 
Total earning assets increased to $57.4 billion at December 31, 2007, from $54.1 billion at December 31, 2006. The Corporation’s average earning assets balances are reflected in Table 2 on page 23.
 
The following table details the Corporation’s average loan portfolio by loan type, business line and geographic market.
 
                                 
    Years Ended December 31  
                      Percent
 
    2007     2006     Change     Change  
    (dollar amounts in millions)  
 
Average Loans By Loan Type:
                               
Commercial loans:
                               
Excluding Financial Services Division
  $ 26,814     $ 24,978     $ 1,836       7 %
Financial Services Division*
    1,318       2,363       (1,045 )     (44 )
                                 
Total commercial loans
    28,132       27,341       791       3  
Real estate construction loans:
                               
Commercial real estate business line
    3,799       3,184       615       19  
Other business lines
    753       721       32       4  
                                 
Total real estate construction loans
    4,552       3,905       647       17  
Commercial mortgage loans:
                               
Commercial real estate business line
    1,390       1,504       (114 )     (8 )
Other business lines
    8,381       7,774       607       8  
                                 
Total commercial mortgage loans
    9,771       9,278       493       5  
Residential mortgage loans
    1,814       1,570       244       16  
Consumer loans:
                               
Home equity
    1,580       1,705       (125 )     (7 )
Other consumer
    787       828       (41 )     (5 )
                                 
Total consumer loans
    2,367       2,533       (166 )     (7 )
Lease financing
    1,302       1,314       (12 )     (1 )
International loans
    1,883       1,809       74       4  
                                 
Total loans
  $ 49,821     $ 47,750     $ 2,071       4 %
                                 


38

                                 
    Years Ended December 31  
                      Percent
 
    2007     2006     Change     Change  
    (dollar amounts in millions)  
 
Average Loans By Business Line:
                               
Middle Market
  $ 16,185     $ 15,386     $ 799       5 %
Commercial Real Estate
    6,717       6,397       320       5  
Global Corporate Banking
    5,471       4,871       600       12  
National Dealer Services
    5,187       4,937       250       5  
Specialty Businesses:
                               
Excluding Financial Services Division
    4,843       4,127       716       17  
Financial Services Division*
    1,318       2,363       (1,045 )     (44 )
                                 
Total Specialty Businesses
    6,161       6,490       (329 )     (5 )
                                 
Total Business Bank
    39,721       38,081       1,640       4  
Small Business
    4,023       3,828       195       5  
Personal Financial Services
    2,111       2,256       (145 )     (6 )
                                 
Total Retail Bank
    6,134       6,084       50       1  
Private Banking
    3,937       3,534       403       11  
                                 
Total Wealth & Institutional Management
    3,937       3,534       403       11  
Finance/Other
    29       51       (22 )     (44 )
                                 
Total loans
  $ 49,821     $ 47,750     $ 2,071       4 %
                                 
Average Loans By Geographic Market:
                               
Midwest
  $ 18,598     $ 18,737     $ (139 )     (1 )%
Western:
                               
Excluding Financial Services Division
    15,212       13,519       1,693       13  
Financial Services Division*
    1,318       2,363       (1,045 )     (44 )
                                 
Total Western
    16,530       15,882       648       4  
Texas
    6,827       5,911       916       16  
Florida
    1,672       1,508       164       11  
Other Markets
    4,041       3,598       443       12  
International
    2,124       2,063       61       3  
Finance/Other
    29       51       (22 )     (44 )
                                 
Total loans
  $ 49,821     $ 47,750     $ 2,071       4 %
                                 
 
 
* Financial Services Division includes primarily low-rate loans
 
 
Total loans were $50.7 billion at December 31, 2007, an increase of $3.3 billion from $47.4 billion at December 31, 2006. Total loans, on an average basis, increased $2.0 billion, or four percent, ($3.1 billion, or seven percent, excluding Financial Services Division loans), to $49.8 billion in 2007, from $47.8 billion in 2006. Within average loans, most business lines and geographic markets showed growth. The Corporation continues to make progress toward the goal of achieving more geographic balance, with markets outside of the Midwest comprising 62 percent of average total loans (excluding Financial Services Division loans and loans in the Finance & Other Businesses category) in 2007, compared to 59 percent in 2006.
 
Average commercial real estate loans, consisting of real estate construction and commercial mortgage loans, increased $1.1 billion, or nine percent, to $14.3 billion in 2007, from $13.2 billion in 2006. Commercial mortgage loans are loans where the primary collateral is a lien on any real property. Real property is generally considered primary collateral if the value of that collateral represents more than 50 percent of the commitment at loan approval. Average loans to borrowers in the Commercial Real Estate business line, which include loans to residential real estate developers, represented $5.2 billion, or 36 percent, of average total commercial real estate loans in 2007, compared to $4.7 billion, or 36 percent, of average total commercial real estate loans in 2006. The increase in average commercial real estate loans to borrowers in the Commercial Real Estate business line in 2007 largely included draws on previously approved lines of credit for residential real estate and commercial

39

development projects and new loans for commercial development projects. The remaining $9.1 billion and $8.5 billion of commercial real estate loans in other business lines in 2007 and 2006, respectively, were primarily owner-occupied commercial mortgages. In addition to the $14.3 billion of average 2007 commercial real estate loans discussed above, the Commercial Real Estate business line also had $1.5 billion of average 2007 loans not classified as commercial real estate on the consolidated balance sheet. Refer to page 52 under Commercial Real Estate Lending in the Risk Management section for more information.
 
Average residential mortgage loans increased $244 million, or 16 percent, from 2006, and primarily include mortgages originated and retained for certain relationship customers.
 
Average home equity loans decreased $125 million, or seven percent, from 2006, as a result of a decrease in draws on commitments extended.
 
Loans classified as Shared National Credit (SNC) loans totaled $10.9 billion (approximately 1,090 borrowers) at December 31, 2007, compared to $8.8 billion (approximately 1,000 borrowers) at December 31, 2006. SNC loans are facilities greater than $20 million shared by three or more federally supervised financial institutions which are reviewed by regulatory authorities at the agent bank level. The Corporation generally seeks to obtain ancillary business at origination of the SNC relationship, or within two years thereafter. These loans, diversified by both line of business and geography, comprised approximately 21 percent and 19 percent of total loans at December 31, 2007 and 2006, respectively.
 
Management currently expects average loan growth for 2008 to be in the mid to high single-digit range, excluding Financial Services Division loans, with flat growth in the Midwest market, high single-digit growth in the Western market and low double-digit growth in the Texas market, compared to 2007.
 
TABLE 6: ANALYSIS OF INVESTMENT SECURITIES PORTFOLIO
(Fully Taxable Equivalent)
 
                                                                                         
    December 31, 2007  
                                                                Weighted
 
    Maturity*     Average
 
    Within 1 Year     1 - 5 Years     5 - 10 Years     After 10 Years     Total     Maturity
 
    Amount     Yield     Amount     Yield     Amount     Yield     Amount     Yield     Amount     Yield     Yrs./Mos.  
    (dollar amounts in millions)  
 
Available-for-sale
                                                                                       
U.S. Treasury and other Government agency securities
  $ 35       4.40 %   $       %   $       %   $ 1       7.07 %   $ 36       4.51 %     0/10  
Government-sponsored enterprise securities
    21       4.08       262       3.73       1,478       4.03       4,404       5.27       6,165       4.90       12/0  
State and municipal securities
                2       9.52       1       9.85                   3       9.51       2/9  
Other securities
                                                                                       
Other bonds, notes and debentures
    45       4.67       1       6.73                               46       4.70       0/2  
Other investments**
                                        46             46              
                                                                                         
Total investment securities available-for-sale
  $ 101       4.47 %   $ 265       3.77 %   $ 1,479       4.03 %   $ 4,451       5.27 %   $ 6,296       4.90 %     11/10  
                                                                                         
 
 
Based on final contractual maturity.
 
** Balances are excluded from the calculation of total yield.
 
 
Investment securities available-for-sale increased $2.6 billion to $6.3 billion at December 31, 2007, from $3.7 billion at December 31, 2006. Average investment securities available-for-sale increased $455 million to $4.4 billion in 2007, compared to $4.0 billion in 2006, primarily due to a $470 million increase in average U.S. Treasury, Government agency, and Government-sponsored enterprise securities. Changes in U.S. Treasury, Government agency, and Government-sponsored enterprise securities resulted from balance sheet management


40

decisions to reduce interest rate sensitivity. Average other securities decreased $15 million to $131 million in 2007, and consisted largely of money market and other fund investments at December 31, 2007.
 
Short-term investments include federal funds sold and securities purchased under agreements to resell, and other short-term investments. Federal funds sold offer supplemental earning opportunities and serve correspondent banks. Average federal funds sold and securities purchased under agreements to resell declined $119 million to $164 million during 2007, compared to 2006. Other short-term investments include interest-bearing deposits with banks, trading securities, and loans held-for-sale. Interest-bearing deposits with banks are investments with banks in developed countries or foreign banks’ international banking facilities located in the United States. Loans held-for-sale typically represent residential mortgage loans, student loans and Small Business Administration loans that have been originated and which management has decided to sell. Average other short-term investments decreased $10 million to $256 million during 2007, compared to 2006. Short-term investments, other than loans held-for-sale, provide a range of maturities less than one year and are mostly used to manage short-term investment requirements of the Corporation.
 
TABLE 7: INTERNATIONAL CROSS-BORDER OUTSTANDINGS
(year-end outstandings exceeding 1% of total assets)
 
                                 
    December 31  
    Government
    Banks and
             
    and Official
    Other Financial
    Commercial
       
    Institutions     Institutions     and Industrial     Total  
    (in millions)  
 
Mexico
                               
2007
  $     $ 4     $ 911     $ 915  
2006
                922       922  
2005
    3             905       908  
Canada
                               
2006
  $     $ 653     $ 68     $ 721  
 
Risk management practices minimize risk inherent in international lending arrangements. These practices include structuring bilateral agreements or participating in bank facilities, which secure repayment from sources external to the borrower’s country. Accordingly, such international outstandings are excluded from the cross-border risk of that country. Mexico, with cross-border outstandings of $915 million, or 1.47 percent of total assets at December 31, 2007, was the only country with outstandings exceeding 1.00 percent of total assets at year-end 2007. There were no countries with cross-border outstandings between 0.75 and 1.00 percent of total assets at year-end 2007. Additional information on the Corporation’s Mexican cross-border risk is provided in Table 7 above.


41

Deposits And Borrowed Funds
 
The Corporation’s average deposits and borrowed funds balances are detailed in the following table.
 
                                 
    Years Ended December 31  
                      Percent
 
    2007     2006     Change     Change  
    (in millions)  
 
Money market and NOW deposits:
                               
Excluding Financial Services Division
  $ 13,735     $ 13,663     $ 72       1 %
Financial Services Division
    1,202       1,710       (508 )     (30 )
                                 
Total money market and NOW deposits
    14,937       15,373       (436 )     (3 )
Savings deposits
    1,389       1,441       (52 )     (4 )
Customer certificates of deposit
    7,687       6,505       1,182       18  
Institutional certificates of deposit
    5,563       4,489       1,074       24  
Foreign office time deposits
    1,071       1,131       (60 )     (5 )
                                 
Total interest-bearing deposits
    30,647       28,939       1,708       6  
Noninterest-bearing deposits:
                               
Excluding Financial Services Division
    8,451       8,761       (310 )     (4 )
Financial Services Division
    2,836       4,374       (1,538 )     (35 )
                                 
Total noninterest-bearing deposits
    11,287       13,135       (1,848 )     (14 )
                                 
Total deposits
  $ 41,934     $ 42,074     $ (140 )     %
                                 
Short-term borrowings
  $ 2,080     $ 2,654     $ (574 )     (22 )%
Medium- and long-term debt
    8,197       5,407       2,790       52  
                                 
Total borrowed funds
  $ 10,277     $ 8,061     $ 2,216       27 %
                                 
 
Average deposits were $41.9 billion during 2007, a decrease of $140 million, or less than one percent, from 2006. Excluding Financial Services Division, average deposits increased of $1.9 billion, or five percent, from 2006. The $1.7 billion, or six percent, increase in average interest-bearing deposits in 2007, when compared to 2006, resulted primarily from an increase in average customer and institutional certificates of deposit. Institutional certificates of deposit represent certificates of deposit issued to institutional investors in denominations in excess of $100,000 and are an alternative to other sources of purchased funds. The increases in certificates of deposit were partially offset by decreases in average money market, NOW and savings deposits reflecting movement toward higher cost deposits as customers sought higher returns. Average noninterest-bearing deposits decreased $1.8 billion, or 14 percent, from 2006. Noninterest-bearing deposits include title and escrow deposits in the Corporation’s Financial Services Division, which benefit from home mortgage financing and refinancing activity. Financial Services Division deposit levels may change with the direction of mortgage activity changes, and the desirability of and competition for such deposits. Average Financial Services Division noninterest-bearing deposits decreased $1.5 billion, to $2.8 billion in 2007.
 
Average short-term borrowings decreased $574 million, to $2.1 billion in 2007, compared to $2.7 billion in 2006. Short-term borrowings include federal funds purchased, securities sold under agreements to repurchase and treasury tax and loan notes.
 
The Corporation uses medium-term debt (both domestic and European) and long-term debt to provide funding to support earning assets while providing liquidity that mirrors the estimated duration of deposits. Long-term subordinated notes further help maintain the Corporation’s and subsidiary banks’ total capital ratios at a level that qualifies for the lowest FDIC risk-based insurance premium. Medium- and long-term debt increased, on an average basis, by $2.8 billion. Further information on medium- and long-term debt is provided in Note 11 to the consolidated financial statements on page 89.


42

Capital
 
Common shareholders’ equity was $5.1 billion at December 31, 2007, compared to $5.2 billion at December 31, 2006. The following table presents a summary of changes in common shareholders’ equity in 2007:
 
                 
   
(in millions)
 
 
Balance at December 31, 2006
          $ 5,153  
FSP 13-2 transition adjustment, net of tax
            (46 )
FIN 48 transition adjustment, net of tax
            (6 )
                 
Balance at January 1, 2007
            5,101  
Retention of earnings (net income less cash dividends declared)
            293  
Change in accumulated other comprehensive income (loss):
               
Investment securities available-for-sale
  $ 52          
Cash flow hedges
    50          
Defined benefit and other postretirement plans adjustment
    45          
                 
Total change in accumulated other comprehensive income (loss)
            147  
Repurchase of approximately 10 million common shares
            (580 )
Net issuance of common stock under employee stock plans
            97  
Recognition of share-based compensation expense
            59  
                 
Balance at December 31, 2007
          $ 5,117  
                 
 
Further information on the change in accumulated other comprehensive income (loss) is provided in Note 13 to the consolidated financial statements on page 92.
 
The Corporation declared common dividends totaling $393 million, or $2.56 per share, on net income applicable to common stock of $686 million. The dividend payout ratio calculated on a per share basis was 58 percent in 2007 and 43 percent in 2006 and 2005.
 
The Corporation assesses capital adequacy against the risk inherent in the balance sheet, recognizing that unexpected loss is the common denominator of risk and that common equity has the greatest capacity to absorb unexpected loss. Appropriate capitalization is therefore defined through the use of a target capital range. The Corporation targets to maintain a Tier 1 common capital ratio of between 6.5 percent and 7.5 percent and a Tier 1 capital ratio of between 7.25 percent and 8.25 percent. The Tier 1 common capital ratio is the regulatory Tier 1 capital ratio excluding preferred equity. Based on an interim decision issued by the banking regulators issued in 2006, the after-tax charge associated with a recent accounting standard (SFAS 158) on pension and post-retirement plan accounting was excluded from the calculation of regulatory capital ratios. Therefore, for the purposes of calculating regulatory capital ratios, shareholders’ equity was increased by $170 million and $215 million on December 31, 2007 and 2006, respectively. Refer to Note 19 on page 106 for further discussion of regulatory capital requirements and capital ratio calculations.
 
When capital exceeds necessary levels, the Corporation’s common stock can be repurchased as a way to return excess capital to shareholders. Repurchasing common stock offers a flexible way to control capital levels by adjusting the capital deployed in reaction to core balance sheet growth. In November 2006 and again in November 2007, the Board of Directors of the Corporation (the Board) authorized the purchase of up to 10 million shares of Comerica Incorporated outstanding common stock in the open market. In addition to limits that result from the Board authorizations, the share repurchase program is constrained by holding company liquidity and capital levels relative to internal targets and regulatory minimums. The Corporation repurchased 10.0 million shares in the open market in 2007 for $580 million, compared to 6.6 million shares in 2006 for $383 million. Comerica Incorporated common stock available for repurchase under Board authority totaled 12.6 million shares at December 31, 2007. Share repurchases combined with dividends returned 142 percent of earnings to shareholders in 2007. Refer to Note 12 to the consolidated financial statements on page 91 for additional information on the Corporation’s share repurchase program.
 
At December 31, 2007, the Corporation and its U.S. banking subsidiaries exceeded the capital ratios required for an institution to be considered “well capitalized” by the standards developed under the Federal Deposit Insurance Corporation Improvement Act of 1991.


43

 
RISK MANAGEMENT
 
The Corporation assumes various types of risk in the normal course of business. Management classifies the risk exposures into five areas: (1) credit, (2) market and liquidity, (3) operational, (4) compliance and (5) business risks and considers credit risk as the most significant risk. The Corporation employs and is continuously enhancing various risk management processes to identify, measure, monitor and control these risks, as described below.
 
The Corporation continues to enhance its risk management capabilities with additional processes, tools and systems designed to provide management with deeper insight into the Corporation’s various risks, enhance the Corporation’s ability to control those risks and ensure that appropriate compensation is received for the risks taken.
 
Specialized risk managers, along with the risk management committees in credit, market and liquidity, and operational and compliance are responsible for the day-to-day management of those respective risks. The Corporation’s Enterprise-Wide Risk Management Committee is responsible for establishing the governance over the risk management process as well as providing oversight in managing the Corporation’s aggregate risk position. The Enterprise-Wide Risk Management Committee is principally made up of the various managers from the different risk areas and business units and has reporting responsibility to the Enterprise Risk Committee of the Board.
 
Credit Risk
 
Credit risk represents the risk of loss due to failure of a customer or counterparty to meet its financial obligations in accordance with contractual terms. The Corporation manages credit risk through underwriting, periodically reviewing and approving its credit exposures using Board committee approved credit policies and guidelines. Additionally, the Corporation manages credit risk through loan sales and loan portfolio diversification, limiting exposure to any single industry, customer or guarantor, and selling participations and/or syndicating to third parties credit exposures above those levels it deems prudent.
 
During 2007, the Corporation continued its focus on the credit components of the previously described enterprise-wide risk management processes. A two-factor risk rating system was initiated in 2005 and was extended to all portfolios in 2006. Enhancements to the analytics related to capital modeling, migration, credit loss forecasting, stress testing analysis and validation and testing continued in 2007. The evaluation of the Corporation’s loan portfolios with the new tools is anticipated to provide improved measurement of the potential risks within the loan portfolios.


44

TABLE 8: ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
 
                                         
    Years Ended December 31  
    2007     2006     2005     2004     2003  
    (dollar amounts in millions)  
 
Balance at beginning of year
  $ 493     $ 516     $ 673     $ 803     $ 791  
Loan charge-offs:
                                       
Domestic
                                       
Commercial
    89       44       91       201       302  
Real estate construction
                                       
Commercial Real Estate business line
    37             2       2       1  
Other business lines
    5                         1  
                                         
Total real estate construction
    42             2       2       2  
Commercial mortgage
                                       
Commercial Real Estate business line
    15       4       4       4       4  
Other business lines
    37       13       13       19       18  
                                         
Total commercial mortgage
    52       17       17       23       22  
Residential mortgage
                1       1        
Consumer
    13       23       15       14       11  
Lease financing
          10       37       13       4  
International
          4       11       14       67  
                                         
Total loan charge-offs
    196       98       174       268       408  
Recoveries:
                                       
Domestic
                                       
Commercial
    27       27       55       52       28  
Real estate construction
                             
Commercial mortgage
    4       4       3       3       1  
Residential mortgage
                             
Consumer
    4       3       5       2       3  
Lease financing
    4                   1        
International
    8       4       1       16       11  
                                         
Total recoveries
    47       38       64       74       43  
                                         
Net loan charge-offs
    149       60       110       194       365  
Provision for loan losses
    212       37       (47 )     64       377  
Foreign currency translation adjustment
    1                          
                                         
Balance at end of year
  $ 557     $ 493     $ 516     $ 673     $ 803  
                                         
Allowance for loan losses as a percentage of total loans at end of year
    1.10 %     1.04 %     1.19 %     1.65 %     1.99 %
Net loans charged-off during the year as a percentage of average loans outstanding during the year
    0.30       0.13       0.25       0.48       0.86  
 
The following table provides an analysis of the changes in the allowance for credit losses on lending-related commitments.
 
                                         
    Years Ended December 31  
    2007     2006     2005     2004     2003  
    (dollar amounts in millions)  
 
Balance at beginning of year
  $   26     $   33     $   21     $ 33     $   35  
Less: Charge-offs on lending-related commitments *
    4       12       6              
Add: Provision for credit losses on lending-relatedcommitments
    (1 )     5       18       (12 )     (2 )
                                         
Balance at end of year
  $ 21     $ 26     $ 33     $ 21     $ 33  
                                         
 
 
Charge-offs result from the sale of unfunded lending-related commitments.
 


45

Allowance for Credit Losses
 
The allowance for credit losses includes both the allowance for loan losses and the allowance for credit losses on lending-related commitments. The allowance for loan losses represents management’s assessment of probable losses inherent in the Corporation’s loan portfolio. The allowance for loan losses provides for probable losses that have been identified with specific customer relationships and for probable losses believed to be inherent in the loan portfolio, but that have not been specifically identified. Internal risk ratings are assigned to each business loan at the time of approval and are subject to subsequent periodic reviews by the Corporation’s senior management. The Corporation performs a detailed credit quality review quarterly on both large business and certain large personal purpose consumer and residential mortgage loans that have deteriorated below certain levels of credit risk and may allocate a specific portion of the allowance to such loans based upon this review. The Corporation defines business loans as those belonging to the commercial, real estate construction, commercial mortgage, lease financing and international loan portfolios. A portion of the allowance is allocated to the remaining business loans by applying estimated loss ratios, based on numerous factors identified below, to the loans within each risk rating. In addition, a portion of the allowance is allocated to these remaining loans based on industry specific risks inherent in certain portfolios that have experienced above average losses, including portfolio exposures to technology-related industries, Michigan and California residential real estate development and Small Business Administration loans. Furthermore, a portion of the allowance is allocated to these remaining loans based on industry specific risks inherent in certain portfolios that have not yet manifested themselves in the risk ratings, including portfolio exposures to the automotive industry and California residential real estate development. The portion of the allowance allocated to all other consumer and residential mortgage loans is determined by applying estimated loss ratios to various segments of the loan portfolio. Estimated loss ratios for all portfolios incorporate factors such as recent charge-off experience, current economic conditions and trends, and trends with respect to past due and nonaccrual amounts, and are supported by underlying analysis, including information on migration and loss given default studies from each of the three largest domestic geographic markets (Midwest, Western and Texas), as well as mapping to bond tables. The allowance for credit losses on lending-related commitments, included in “accrued expenses and other liabilities” on the consolidated balance sheets, provides for probable credit losses inherent in lending-related commitments, including unused commitments to extend credit, letters of credit and financial guarantees. Lending-related commitments for which it is probable that the commitment will be drawn (or sold) are reserved with the same estimated loss rates as loans, or with specific reserves. In general, the probability of draw for letters of credit is considered certain once the credit becomes a watch list credit. Non-watch list letters of credits and all unfunded commitments have a lower probability of draw, to which standard loan loss rates are applied.
 
The total allowance for loan losses was $557 million at December 31, 2007, compared to $493 million at December 31, 2006. The increase resulted mostly from an increase in individual and industry reserves for customers in the real estate industry, primarily Michigan and California residential real estate development. This increase was partially offset by reductions in the industry reserves for customers in the automotive, air transportation, contractor and entertainment industries. An analysis of the changes in the allowance for loan losses is presented in Table 8 on page 45 of this financial review. The allowance for credit losses on lending-related commitments was $21 million at December 31, 2007, compared to $26 million at December 31, 2006, a decrease of $5 million, resulting primarily from a decrease in specific reserves related to unused commitments extended to two large customers in the automotive industry that were previously reserved at quoted prices and now are reserved using standard unfunded commitment methodology. An analysis of the changes in the allowance for credit losses on lending-related commitments is presented on page 45 of this financial review.


46

TABLE 9: ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
 
                                                                                 
    December 31  
    2007     2006     2005     2004     2003  
    Amount     %     Amount     %     Amount     %     Amount     %     Amount     %  
    (dollar amounts in millions)  
 
Domestic
                                                                               
Commercial
  $ 288       55 %   $ 320       55 %   $ 336       55 %   $ 442       54 %   $ 510       54 %
Real estate construction
    128       9       29       9       21       8       27       8       35       8  
Commercial mortgage
    92       20       80       20       74       21       88       20       104       20  
Residential mortgage
    2       4       2       4       1       3       2       3       5       3  
Consumer
    21       5       22       5       25       6       26       7       28       6  
Lease financing
    15       3       27       3       29       3       45       3       27       3  
International
    11       4       13       4       30       4       43       5       94       6  
                                                                                 
Total
  $ 557       100 %   $ 493       100 %   $ 516       100 %   $ 673       100 %   $ 803       100 %
                                                                                 
 
 
Amount — allocated allowance
 
% — loans outstanding as a percentage of total loans
 
 
Actual loss ratios experienced in the future may vary from those projected. The uncertainty occurs because factors may exist which affect the determination of probable losses inherent in the loan portfolio that are not necessarily captured by the application of estimated loss ratios or identified industry-specific risks. A portion of the allowance is maintained to capture these probable losses and reflects management’s view that the allowance should recognize the margin for error inherent in the process of estimating expected loan losses. Factors that were considered in the evaluation of the adequacy of the Corporation’s allowance include the inherent imprecision in the risk rating system and the risk associated with new customer relationships. The allowance associated with the margin for inherent imprecision covers probable loan losses as a result of an inaccuracy in assigning risk ratings or stale ratings which may not have been updated for recent negative trends in particular credits. The allowance due to new business migration risk is based on an evaluation of the risk of rating downgrades associated with loans that do not have a full year of payment history.
 
The total allowance is available to absorb losses from any segment within the portfolio. Unanticipated economic events, including political, economic and regulatory instability in countries where the Corporation has loans, could cause changes in the credit characteristics of the portfolio and result in an unanticipated increase in the allowance. Inclusion of other industry specific portfolio exposures in the allowance, as well as significant increases in the current portfolio exposures, could also increase the amount of the allowance. Any of these events, or some combination thereof, may result in the need for additional provision for loan losses in order to maintain an allowance that complies with credit risk and accounting policies.
 
The allowance as a percentage of total loans, nonperforming loans and as a multiple of annual net loan charge-offs is provided in the following table.
 
                         
    Years Ended December 31  
    2007     2006     2005  
 
Allowance for loan losses as a percentage of total loans at end of year
    1.10 %     1.04 %     1.19 %
Allowance for loan losses as a percentage of total nonperforming loans at end of year
    138       231       373  
Allowance for loan losses as a multiple of total net loan charge-offs for the year
    3.7       8.2       4.7  
 
The allowance for loan losses as a percentage of total period-end loans increased to 1.10 percent at December 31, 2007, from 1.04 percent at December 31, 2006. The allowance for loan losses as a percentage of nonperforming loans decreased to 138 percent at December 31, 2007, from 231 percent at December 31, 2006. The allowance for loan losses as a multiple of net loan charge-offs decreased to 3.7 times for the year ended December 31, 2007, compared to 8.2 times for the prior year, as a result of higher levels of net loan


47

charge-offs in 2007. While certain ratios declined, the ratios do not reflect a change in the methodology of developing the allowance based on the underlying loan portfolios.
 
TABLE 10: SUMMARY OF NONPERFORMING ASSETS AND PAST DUE LOANS
 
                                         
    December 31  
    2007     2006     2005     2004     2003  
    (dollar amounts in millions)  
 
NONPERFORMING ASSETS
                                       
Nonaccrual loans:
                                       
Commercial
  $ 75     $ 97     $ 65     $ 161     $ 295  
Real estate construction:
                                       
Commercial Real Estate business line
    161       18       3       31       21  
Other business lines
    6       2             3       3  
                                         
Total real estate construction
    167       20       3       34       24  
Commercial mortgage:
                                       
Commercial Real Estate business line
    66       18       6       6       3  
Other business lines
    75       54       29       58       84  
                                         
Total commercial mortgage
    141       72       35       64       87  
Residential mortgage
    1       1       2       1       2  
Consumer
    3       4       2       1       7  
Lease financing
          8       13       15       24  
International
    4       12       18       36       68  
                                         
Total nonaccrual loans
    391       214       138       312       507  
Reduced-rate loans
    13                          
                                         
Total nonperforming loans
    404       214       138       312       507  
Foreclosed property
    19       18       24       27       30  
Nonaccrual debt securities
                            1  
                                         
Total nonperforming assets
  $ 423     $ 232     $ 162     $ 339     $ 538  
                                         
Nonperforming loans as a percentage of total loans
    0.80 %     0.45 %     0.32 %     0.76 %     1.26 %
Nonperforming assets as a percentage of total loans, foreclosed property and nonaccrual debt securities
    0.83       0.49       0.37       0.83       1.33  
Allowance for loan losses as a percentage of total nonperforming loans
    138       231       373       215       158  
Loans past due 90 days or more and still accruing
  $ 54     $ 14     $ 16     $ 15     $ 32  
 
Nonperforming Assets
 
Nonperforming assets include loans and loans held-for-sale on nonaccrual status, loans which have been renegotiated to less than market rates due to a serious weakening of the borrower’s financial condition, real estate which has been acquired through foreclosure and is awaiting disposition and debt securities on nonaccrual status.
 
Consumer loans, except for certain large personal purpose consumer and residential mortgage loans, are charged-off no later than 180 days past due, and earlier, if deemed uncollectible. Loans, other than consumer loans, and debt securities are generally placed on nonaccrual status when management determines that principal or interest may not be fully collectible, but no later than 90 days past due on principal or interest, unless the loan or debt security is fully collateralized and in the process of collection. Loan amounts in excess of probable future cash collections are charged-off to an amount that management ultimately expects to collect. Interest previously accrued but not collected on nonaccrual loans is charged against current income at the time the loan is placed on nonaccrual. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable. Loans that have been restructured to yield a rate that was equal to or greater


48

than the rate charged for new loans with comparable risk and have met the requirements for a return to accrual status are not included in nonperforming assets. However, such loans may be required to be evaluated for impairment. Refer to Note 4 of the consolidated financial statements on page 83 for a further discussion of impaired loans.
 
Nonperforming assets increased $191 million, or 82 percent, to $423 million at December 31, 2007, from $232 million at December 31, 2006. Table 10 above shows changes in individual categories. The $177 million increase in nonaccrual loans at December 31, 2007 from year-end 2006 levels resulted primarily from a $147 million increase in nonaccrual real estate construction loans and a $69 million increase in nonaccrual commercial mortgage loans, partially offset by a $22 million decrease in nonaccrual commercial loans, an $8 million decrease in nonaccrual international loans and an $8 million decrease in nonaccrual lease financing loans. An analysis of nonaccrual loans at December 31, 2007, based primarily on the Standard Industrial Classification (SIC) code, is presented on page 51 of this financial review. Loans past due 90 days or more and still on accrual status increased $40 million, to $54 million at December 31, 2007, from $14 million at December 31, 2006. Nonperforming assets as a percentage of total loans, foreclosed property and nonaccrual debt securities was 0.83 percent and 0.49 percent at December 31, 2007 and 2006, respectively.
 
The following table presents a summary of changes in nonaccrual loans.
 
                 
    2007     2006  
    (in millions)  
 
Balance at January 1
  $ 214     $ 138  
Loans transferred to nonaccrual(1)
    455       176  
Nonaccrual business loan gross charge-offs(2)
    (183 )     (72 )
Loans transferred to accrual status(1)
    (13 )      
Nonaccrual business loans sold(3)
    (15 )     (9 )
Payments/Other(4)
    (67 )     (19 )
                 
Balance at December 31
  $ 391     $ 214  
                 
                 
               
(1) Based on an analysis of nonaccrual loans with book balances greater than $2 million.
               
                 
(2) Analysis of gross loan charge-offs:
               
                 
Nonaccrual business loans
  $ 183     $ 72  
Performing watch list loans (as defined below)
          3  
Consumer and residential mortgage loans
    13       23  
                 
Total gross loan charge-offs
  $ 196     $ 98  
                 
                 
(3) Analysis of loans sold:
               
                 
Nonaccrual business loans
  $ 15     $ 9  
Performing watch list loans (as defined below)
    13       77  
                 
Total loans sold
  $ 28     $ 86  
                 
 
(4) Includes net changes related to nonaccrual loans with balances less than $2 million, other than business loan gross charge-offs and nonaccrual loans sold, and payments on nonaccrual loans with book balances greater than $2 million.
 


49

The following table presents the number of nonaccrual loan relationships greater than $2 million and balance by size of relationship at December 31, 2007.
 
                 
    Number of
       
Nonaccrual Relationship Size
  Relationships     Balance  
    (dollar amounts in millions)  
 
$2 million — $5 million
    20     $ 66  
$5 million — $10 million
    11       71  
$10 million — $25 million
    7       116  
Greater than $25 million
    2       54  
                 
Total loan relationships greater than $2 million at December 31, 2007
    40     $ 307  
                 
 
There were 58 loan relationships with balances greater than $2 million, totaling $455 million that were transferred to nonaccrual status in 2007, an increase of $279 million, when compared to $176 million in 2006. Of the transfers to nonaccrual with balances greater than $2 million in 2007, $286 million were from the Midwest market and $132 million were from the Western market. There were 11 loan relationships greater than $10 million transferred to nonaccrual in 2007. The 11 loan relationships totaled $236 million and were to companies in the real estate ($188 million) and retail trade ($48 million) industries.
 
The Corporation sold $15 million of nonaccrual business loans in 2007. These loans were to customers in the real estate, automotive production and airline transportation industries. In addition, the Corporation sold $82 million of unused commitments in 2007, including $60 million with customers in the automotive industry. The losses associated with the sale of the unused commitments were charged to the “provision for credit losses on lending-related commitments” on the consolidated statements of income.
 
Nonaccrual loan payments/other, as shown in the table above, increased $48 million in 2007, when compared to 2006. The increase was mostly due to an increase in payments received on nonaccrual loans greater than $2 million in 2007, compared to 2006.
 
The following table presents a summary of total internally classified watch list loans (generally consistent with regulatory defined special mention, substandard and doubtful loans) at December 31, 2007. Of the $3.5 billion of watch list loans, $1.1 billion, or 31 percent were in the Commercial Real Estate business line. Consistent with the increase in nonaccrual loans from December 31, 2006 to December 31, 2007, total watch list loans increased both in dollars and as a percentage of the total loan portfolio.
 
                 
    December 31
    2007   2006
    (dollar amounts in millions)
 
Total watch list loans
  $ 3,464     $ 2,411  
As a percentage of total loans
    6.8 %     5.1 %


50

The following table presents a summary of nonaccrual loans at December 31, 2007 and loan relationships transferred to nonaccrual and net loan charge-offs during the year ended December 31, 2007, based primarily on the Standard Industrial Classification (SIC) industry categories.
 
                                                 
    December 31,
    Year Ended December 31, 2007  
    2007     Loans
    Net Loan
 
    Nonaccrual
    Transferred to
    Charge-Offs
 
Industry Category
  Loans     Nonaccrual(1)     (Recoveries)  
    (dollar amounts in millions)  
 
Real estate
  $ 232       59 %   $ 280       62 %   $ 63       42 %
Retail trade
    47       12       61       14       38       26  
Services
    41       10       48       10       22       15  
Automotive
    16       4                   (2 )     (1 )
Manufacturing
    13       3       13       3       2       1  
Wholesale trade
    10       3       14       3       4       3  
Contractors
    8       2       13       3       4       2  
Transportation
    6       2       6       1       5       3  
Churches
    6       2       9       2       3       2  
Finance
    2       1       6       1       9       6  
Entertainment
    1                         (6 )     (4 )
Other(2)
    9       2       5       1       7       5  
                                                 
Total
  $ 391       100 %   $ 455       100 %   $ 149       100 %
                                                 
 
 
(1) Based on an analysis of nonaccrual loan relationships with book balances greater than $2 million.
 
(2) Consumer nonaccrual loans and net charge-offs are included in the “Other” category.
 
 
SNC nonaccrual loans comprised six percent and less than one percent of total nonaccrual loans at December 31, 2007 and 2006, respectively. As a percentage of total loans, SNC loans represented approximately 21 percent and 19 percent at December 31, 2007 and 2006, respectively. SNC loan net charge-offs were $2 million in both 2007 and 2006. For further discussion of the Corporation’s SNC relationships, refer to the “Earning Assets” section of this financial review on page 38.
 
The following table indicates the percentage of nonaccrual loan value to contractual value, which exhibits the degree to which loans reported as nonaccrual have been partially charged-off.
 
                 
    December 31  
    2007     2006  
    (dollar amounts in millions)  
 
Carrying value of nonaccrual loans
  $ 391     $ 214  
Contractual value of nonaccrual loans
    549       300  
Carrying value as a percentage of contractual value
    71 %     71 %
 
Concentration of Credit
 
Loans to borrowers in the automotive industry represented the largest significant industry concentration at December 31, 2007 and 2006. Loans to automotive dealers and to borrowers involved with automotive production are reported as automotive, since management believes these loans have similar economic characteristics that might cause them to react similarly to changes in economic conditions. This aggregation involves the exercise of judgment. Included in automotive production are: (a) original equipment manufacturers and Tier 1 and Tier 2 suppliers that produce components used in vehicles and whose primary revenue source is automotive-related (“primary” defined as greater than 50%) and (b) other manufacturers that produce components used in vehicles and whose primary revenue source is automotive-related. Loans less than $1 million and loans recorded in the Small Business division were excluded from the definition. Foreign ownership consists of North American affiliates of foreign automakers and suppliers.


51

A summary of loans outstanding and total exposure from loans, unused commitments and standby letters of credit and financial guarantees to companies related to the automotive industry follows:
 
                                                 
    December 31  
    2007     2006  
    Loans
    Percent of
    Total
    Loans
    Percent of
    Total
 
    Outstanding     Total Loans     Exposure     Outstanding     Total Loans     Exposure  
    (in millions)  
 
Production:
                                               
Domestic
  $ 1,415             $ 2,571     $ 1,737             $ 2,950  
Foreign
    391               1,133       469               1,267  
                                                 
Total production
    1,806       3.6 %     3,704       2,206       4.7 %     4,217  
Dealer:
                                               
Floor plan
    2,817               4,228       3,125               4,312  
Other
    2,567               3,108       2,433               3,089  
                                                 
Total dealer
    5,384       10.6 %     7,336       5,558       11.7 %     7,401  
                                                 
Total automotive
  $ 7,190       14.2 %   $ 11,040     $ 7,764       16.4 %   $ 11,618  
                                                 
 
At December 31, 2007, dealer loans, as shown in the table above, totaled $5.4 billion, of which approximately $3.1 billion, or 59 percent, was to foreign franchises, $1.7 billion, or 31 percent, was to domestic franchises and $561 million, or 10 percent, was to other. Other includes obligations where a primary franchise was indeterminable, such as loans to large public dealership consolidators, and rental car, leasing, heavy truck and recreation vehicle companies.
 
Nonaccrual loans to automotive borrowers comprised approximately four percent of total nonaccrual loans at December 31, 2007. The largest automotive loan on nonaccrual status at December 31, 2007 was $5 million. Total automotive net loan recoveries were $2 million in 2007. The following table presents a summary of automotive net loan and credit-related charge-offs for the years ended December 31, 2007 and 2006.
 
                 
    Years Ended December 31  
    2007     2006  
    (in millions)  
 
Production:
               
Domestic
  $ 3     $ 4  
Foreign
    (5 )      
                 
Total production
  $ (2 )   $ 4  
Dealer
           
                 
Total automotive net loan charge-offs (recoveries)
  $ (2 )   $ 4  
                 
Total automotive charge-offs from the sale of unused commitments*
  $ 3     $ 12  
                 
 
 
Primarily related to domestic-owned production companies.
 
 
All other industry concentrations, as defined by management, individually represented less than 10 percent of total loans at year-end 2007.
 
Commercial Real Estate Lending
 
The Corporation takes measures to limit risk inherent in its commercial real estate lending activities. These measures include limiting exposure to those borrowers directly involved in the commercial real estate markets and adherence to policies requiring conservative loan-to-value ratios for such loans. Commercial real estate loans, consisting of real estate construction and commercial mortgage loans, totaled $14.9 billion at December 31, 2007, of which $5.5 billion, or 37 percent, were to borrowers in the Commercial Real Estate business line. Increased


52

nonaccrual loans, reserves and net charge-offs in the Commercial Real Estate business line reflected challenges in the residential real estate development industry in Michigan and California.
 
The real estate construction loan portfolio contains loans primarily made to long-time customers with satisfactory completion experience. The portfolio totaled $4.8 billion and included approximately 1,650 loans, of which 48 percent had balances less than $1 million at December 31, 2007. The largest real estate construction loan had a balance of approximately $43 million at December 31, 2007. The commercial mortgage loan portfolio totaled $10.1 billion at December 31, 2007 and included approximately 8,900 loans, of which 74 percent had balances of less than $1 million. This total included $8.7 billion of primarily owner-occupied commercial mortgage loans. The largest loan within the commercial mortgage loan portfolio had a balance of approximately $56 million at December 31, 2007.
 
The geographic distribution of commercial real estate loan borrowers is an important factor in diversifying credit risk. The following table indicates, by location of property and by project type, the diversification of the Corporation’s real estate construction and commercial mortgage loans to borrowers in the Commercial Real Estate business line.
 
                                                         
    December 31, 2007  
    Location of Property              
Project Type:
  Western     Michigan     Texas     Florida     Other     Total     % of Total  
    (dollar amounts in millions)  
 
Real estate construction loans:
                                                       
Commercial Real Estate business line:
                                                       
Single Family
  $ 940     $ 107     $ 148     $ 268     $ 150     $ 1,613       40 %
Land Development
    348       116       155       47       53       719       18  
Retail
    168       108       186       43       50       555       14  
Multi-family
    88       24       164       63       74       413       10  
Multi-use
    127       35       38       41       50       291       7  
Office
    103       19       73             16       211       5  
Land Carry
    138                               138       3  
Commercial
    83       16       19       5       9       132       3  
Other
                      7       10       17        
                                                         
Total
  $ 1,995     $ 425     $ 783     $ 474     $ 412     $ 4,089       100 %
                                                         
Commercial mortgage loans:
                                                       
Commercial Real Estate business line:
                                                       
Land Carry
  $ 278     $ 174     $ 108     $ 92     $ 18     $ 670       49 %
Office
    42       57       24       11       3       137       10  
Retail
    9       52       5       3       46       115       8  
Multi-family
    7       91       20       32       35       185       13  
Commercial
    34       34       3             46       117       9  
Multi-use
    11       36       6       15       27       95       7  
Single Family
    12       3       5       11       13       44       3  
Other
    3       3                   8       14       1  
                                                         
Total
  $ 396     $ 450     $ 171     $ 164     $ 196     $ 1,377       100 %
                                                         
 
Of the $4.1 billion of real estate construction loans in the Commercial Real Estate business line, $161 million were on nonaccrual status at December 31, 2007. Substantially all of the nonaccrual loans were Single Family, Land Development and Land Carry project types located in California ($84 million), Michigan ($57 million) and Florida ($18 million).
 
Commercial mortgage loans in the Commercial Real Estate business line totaled $1.4 billion and included $66 million of nonaccrual loans at December 31, 2007, primarily Land Development projects located in Michigan ($55 million).


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Net charge-offs in the Commercial Real Estate business line were $52 million in 2007, and included $34 million in the Midwest market, $16 million in the Western market and $2 million in the Texas market.
 
The following table illustrates, by location of lending office, the diversification of the Corporation’s real estate construction and commercial mortgage loan portfolios.
 
                                 
    December 31, 2007  
    Real Estate Construction     Commercial Mortgage  
    Amount     %     Amount     %  
    (dollar amounts in millions)  
 
Michigan
  $ 2,141       44 %   $ 5,160       52 %
California
    1,541       32       2,660       26  
Texas
    777       16       924       9  
Florida
    188       4       325       3  
Other
    169       4       979       10  
                                 
Total
  $ 4,816       100 %   $ 10,048       100 %
                                 
 
Market Risk
 
Market risk represents the risk of loss due to adverse movements in market rates or prices, which include interest rates, foreign exchange rates and equity prices; the failure to meet financial obligations coming due because of an inability to liquidate assets or obtain adequate funding and the inability to easily unwind or offset specific exposures without significantly lowering prices because of inadequate market depth or market disruptions.
 
The Asset and Liability Policy Committee (ALPC) establishes and monitors compliance with the policies and risk limits pertaining to market risk management activities. The ALPC meets regularly to discuss and review market risk management strategies and is comprised of executive and senior management from various areas of the Corporation, including finance, lending, deposit gathering and risk management.
 
Interest Rate Risk
 
Interest rate risk arises primarily through the Corporation’s core business activities of extending loans and accepting deposits. The Corporation’s balance sheet is predominantly characterized by floating rate commercial loans funded by a combination of core deposits and wholesale borrowings. This creates a natural imbalance between the floating rate loan portfolio and the more slowly repricing deposit products. The result is that growth in our core businesses will lead to a greater sensitivity to interest rate movements, without mitigating actions. An example of such an action is purchasing investment securities, primarily fixed rate, which provide liquidity to the balance sheet and act to mitigate the inherent interest sensitivity. The Corporation actively manages its exposure to interest rate risk, with the principal objective of optimizing net interest income while operating within acceptable limits established for interest rate risk and maintaining adequate levels of funding and liquidity.
 
Interest Rate Sensitivity
 
Interest rate risk arises in the normal course of business due to differences in the repricing and cash flow characteristics of assets and liabilities. Since no single measurement system satisfies all management objectives, a combination of techniques is used to manage interest rate risk. These techniques examine earnings at risk and economic value of equity utilizing multiple simulation analyses.
 
The Corporation frequently evaluates net interest income under various balance sheet and interest rate scenarios, using simulation modeling analysis as its principal risk management evaluation technique. The results of these analyses provide the information needed to assess the balance sheet structure. Changes in economic activity, different from those management included in its simulation analyses, whether domestically or internationally, could translate into a materially different interest rate environment than currently expected. Management evaluates “base” net interest income under an unchanged interest rate environment and what is believed to be the most likely balance sheet structure. This “base” net interest income is then evaluated against non-parallel interest rate scenarios that increase and decrease approximately 200 basis points (but no lower than zero percent)


54

from the unchanged interest rate environment. For this analysis, the rise or decline in interest rates occurs in a linear fashion over twelve months. In addition, adjustments to asset prepayment levels, yield curves, and overall balance sheet mix and growth assumptions are made to be consistent with each interest rate environment. These assumptions are inherently uncertain and, as a result, the model cannot precisely predict the impact of higher or lower interest rates on net interest income. Actual results may differ from simulated results due to timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies, among other factors. However, the model can indicate the likely direction of change. Derivative instruments entered into for risk management purposes are included in these analyses. The table below as of December 31, 2007 and 2006 displays the estimated impact on net interest income during the next 12 months as it relates the unchanged interest rate scenario results to those from the 200 basis point non-parallel shock described above.
 
Sensitivity of Net Interest Income to Changes in Interest Rates
 
                                 
    December 31  
    2007     2006  
    Amount     %     Amount     %  
    (in millions)  
 
Change in Interest Rates:
                               
+200 basis points
  $ 38       2 %   $ 34       2 %
−200 basis points
    (36 )     (2 )     (51 )     (2 )
 
Corporate policy limits adverse change to no more than four percent of management’s most likely net interest income forecast and the Corporation operated within this policy guideline. The change in interest rate sensitivity from December 31, 2006 to December 31, 2007 was primarily a result of loan and deposit growth, activities in the Financial Services Division, competitive deposit pricing, maturity of swaps and additions to the investment securities portfolio. In addition, a variety of alternative scenarios are performed to assist in the portrayal of the Corporation’s interest rate risk position, including, but not limited to, flat balance sheet and most likely rates, 200 basis point parallel rate shocks and yield curve twists. Interest rate risk will be actively managed principally through the use of on-balance sheet financial instruments or interest rate swaps so that the desired risk profile is achieved.
 
In addition to the simulation analysis, an economic value of equity analysis is performed for a longer term view of the interest rate risk position. The economic value of equity analysis begins with an estimate of the mark-to-market valuation of the Corporation’s balance sheet and then applies the estimated impact of rate movements upon the market value of assets, liabilities and off-balance sheet instruments. The economic value of equity is then calculated as the difference between the market value of assets and liabilities net of the impact of off-balance sheet instruments. The market value change in the economic value of equity is then compared to the corporate policy guideline limiting such adverse change to 10 percent of the base economic value of equity as a result of a parallel 200 basis point increase or decrease in interest rates. The Corporation operated within this policy parameter. As with net interest income shocks, a variety of alternative scenarios are performed to measure the impact on economic value of equity, including changes in the level, slope and shape of the yield curve.
 
Sensitivity of Economic Value of Equity to Changes in Interest Rates
 
                                 
    December 31  
    2007     2006  
    Amount     %     Amount     %  
    (in millions)  
 
Change in Interest Rates:
                               
+200 basis points
  $ 241       3 %   $ 155       2 %
−200 basis points
    (789 )     (9 )     (351 )     (4 )
 
The change in economic value of equity sensitivity from December 31, 2006 to December 31, 2007 was primarily due to the issuance of $515 million of 6.576% fixed rate subordinate notes due 2037, which accounted for the majority of the decline under the 200 basis point parallel decrease in the interest rates scenario in the table above. Other contributing factors were changes in loan and funding mix, and a runoff in interest rate swaps partly offset by additions to the investment securities portfolio.


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The Corporation uses investment securities and derivative instruments, predominantly interest rate swaps, as asset and liability management tools with the overall objective of managing the volatility of net interest income from changes in interest rates. Swaps modify the interest rate characteristics of certain assets and of liabilities (e.g., from a floating rate to a fixed rate, from a fixed rate to a floating rate or from one floating rate index to another). These tools assist management in achieving the desired interest rate risk management objectives.
 
Risk Management Derivative Instruments
 
Risk Management Notional Activity
 
                         
    Interest
    Foreign
       
    Rate
    Exchange
       
    Contracts     Contracts     Totals  
    (in millions)  
 
Balance at January 1, 2006
  $ 11,455     $ 411     $ 11,866  
Additions
    100       5,521       5,621  
Maturities/amortizations
    (3,102 )     (5,377 )     (8,479 )
Terminations
          (4 )     (4 )
                         
Balance at December 31, 2006
  $ 8,453     $ 551     $ 9,004  
Additions
    400       4,035       4,435  
Maturities/amortizations
    (3,452 )     (4,037 )     (7,489 )
Foreign currency translation adjustment
    1             1  
                         
Balance at December 31, 2007
  $ 5,402     $ 549     $ 5,951  
                         
 
The notional amount of risk management interest rate swaps totaled $5.4 billion at December 31, 2007, and $8.5 billion at December 31, 2006. The decrease in notional amount of $3.1 billion from December 31, 2006 to December 31, 2007 reflects maturities and a current preference for on-balance sheet risk management utilizing the investment securities portfolio. The fair value of risk management interest rate swaps was a net unrealized gain of $143 million at December 31, 2007, compared to a net unrealized loss of $19 million at December 31, 2006.
 
For the year ended December 31, 2007, risk management interest rate swaps generated $55 million of net interest expense, compared to $108 million of net expense for the year ended December 31, 2006. The decrease in swap expense for 2007, compared to 2006, was primarily due to the maturities of interest rate swaps that carried a negative spread.
 
Table 11 on page 57 summarizes the expected maturity distribution of the notional amount of risk management interest rate swaps and provides the weighted average interest rates associated with amounts to be received or paid as of December 31, 2007. Swaps have been grouped by asset and liability designation.
 
In addition to interest rate swaps, the Corporation employs various other types of derivative instruments to mitigate exposures to interest rate and foreign currency risks associated with specific assets and liabilities (e.g., loans or deposits denominated in foreign currencies). Such instruments may include interest rate caps and floors, purchased put options, foreign exchange forward contracts and foreign exchange swap agreements. The aggregate notional amounts of these risk management derivative instruments at December 31, 2007 and 2006 were $549 million and $551 million, respectively.
 
Further information regarding risk management derivative instruments is provided in Notes 1, 11, and 20 to the consolidated financial statements on pages 72, 89 and 107, respectively.


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TABLE 11: REMAINING EXPECTED MATURITY OF RISK MANAGEMENT INTEREST RATE SWAPS
 
                                                                 
                                        Dec. 31,
    Dec. 31,
 
                                  2013-
    2007
    2006
 
    2008