Comerica
Annual Report 1998

Plain-text annual report

1 5 0 Y E A R S M A K I N G I T W O R K . C OM E RICA I N CO RPO RATE D 1 9 9 8 A N N U A L R E P O R T Corporate Profile Comerica Incorporated (NYSE: CMA) is a multi-state financial services provider headquartered in Detroit with banking subsidiaries in Michigan, California and Texas, banking operations in Florida, and businesses in seven other states. Comerica also operates banking subsidiaries in Canada and Mexico. Comerica is the 24th largest bank holding company in the U.S., a Fortune 500 company with $37 billion in total assets, and among the top 200 banking companies in the world, based on assets. Comerica is the nation’s 15th largest commercial business lender, 17th largest small business lender and ranks first nationally among the top 15 commercial lenders in commercial loans as a percent of total assets. Comerica’s 11,000 colleagues deliver comprehensive financial services through a network that includes 340 branch and supermarket offices, 814 automated teller machines, banking by personal computer and telephone banking. Comerica is organized into three focused operating units: the Business Bank, the Individual Bank and the Investment Bank. Comerica’s Vision Comerica is in business to help people be successful. We are committed to delivering the highest quality financial services by: . Providing outstanding value and building enduring customer relationships. . Creating a positive environment for our colleagues, built on trust, teamwork and respect. . Demonstrating leadership in our community. . Ensuring a consistent, superior return for our owners. Table of Contents Letter to 2 Shareholders Making It Work 10 18 Directors and Officers— Comerica Incorporated and Subsidiaries Financial Review and Reports 22 Economic Outlook 72 Shareholder and 74 Corporate Information Financial Highlights Year Ended December 31 (dollar amounts in millions, except per share data) 1998 Change 1997 Amount Percent Income Statement Net interest income Net income Basic net income per common share Diluted net income per common share Cash dividends per common share Book value per common share Market value per share Ratios $ 1,461 607 3.79 3.72 1.28 17.94 68.19 $ 1,443 530 3.24 3.19 1.15 16.02 60.17 $ 18 77 .55 .53 .13 1.92 8.02 Return on average common shareholders’ equity 22.54% Return on average assets Average common shareholders’ equity as a percentage 1.74 21.32% 1.52 of average assets Balance Sheet (at December 31) Total assets Total earning assets Loans Deposits Common shareholders’ equity 7.48 6.91 $36,601 33,427 30,605 24,313 2,797 $36,292 33,104 28,895 22,586 2,512 $ 309 323 1,710 1,727 285 1 1% 14 17 17 11 12 13 1% 1 6 8 11 Diluted Net Income per Common Share (in dollars) 3.75 3.00 2.25 1.50 0.75 Excluding restructuring charge Net Income (in millions) 625 500 375 250 125 0.0 94 95 96 97 98 0 94 95 96 97 98 Excluding restructuring charge Comerica Incorporated 2 M ore than 150 years ago, on March 5, 1849, the prede- cessor of Comerica was formed by order of Michigan Governor Epaphroditus Ransom. Called the Detroit Savings Fund Institute, it differed from a bank in that it had neither capital stock nor stockholders, and was formed as a trust. Elon Farnsworth was appointed by Governor Ransom to lead the 11 trustees of Detroit Savings Fund Institute. Mr. Farnsworth and those trustees later became the first direc- tors and shareholders when the Institute was reorganized and renamed Detroit Savings Bank in 1871. This is a letter to all shareholders, past, present and future. We enter our 150th anniversary year with pride in our accomplishments and a clear sense of direction about our future. We have kept our promises: to hold and grow deposits; to deliver a consistent return to you, our shareholders; to help customers and colleagues succeed; and to improve the communities in which we operate. We are fortunate to have a dedicated workforce—colleagues who act as owners because they are owners. They care about their customers, fellow shareholders and the success of Comerica. Thanks to the great efforts of these colleagues, nearly 90 percent of whom are shareholders, we are recognized as a premier business lender and a top 10 bank holding company in financial performance. In 1998, net income for the year rose 14 percent to $607 million. Return on assets was 1.74 percent and return on common equity was 22.54 percent. Above: Elon Farnsworth Right: Eugene A. Miller Dividends per Common Share (in dollars) Return on Average Common Equity (in percentages) 1.50 1.25 1.00 0.75 0.50 0.25 25.0 20.0 15.0 10.0 5.0 0.0 94 95 96 97 98 0.0 94 95 96 97 98 Comerica Incorporated Comerica Excluding restructuring charge Industry average (based on 50 largest U.S. bank holding companies) The bank drew six depositors on opening day (August 17, 1849). By the end of the year, 56 people had deposited $3,287. 4 Our goal is consistent top 10 financial performance. Our first objective is profitability, and our target is to rank in the top 10 of the 50 largest U.S. bank holding companies as measured by return on equity. As a result of significant activities undertaken in 1995 and especially in 1996, we were successful in meeting this objective in 1997 and 1998. We rank among the best. Focus is our key to attaining superior profitability. We operate on a line-of-business basis and carefully define our approach to our various business lines. Some we have identified as “grow” businesses which warrant significant reinvestment. Others we are rationalizing by driving down expenses and driving up targeted marketing. Still others we have divested or would consider divesting. This ongoing process of reinventing the corporation has become a way of life for us. Our second objective is quality, both in credit underwriting and in service. Banks cannot consistently generate exceptional profits without being extraordinary in both areas. Credit quality is absolutely essential, especially when we enter slow- er growth economic environments. Loan growth and profitability at Comerica have never come at the expense of credit quality. For example, even now, when banks’ credit quality measures are excellent, our percentage of non-performing assets is nearly half that of the top 50 banks and below that of our conservative Midwestern peers. Additionally, our loan charge-offs are also typically lower than the industry average and the conservative Midwestern portion of the country. Our third objective is growth. Of course, one of our growth businesses is Comerica’s core competency, commercial lend- ing—both generating and underwriting commercial loans. Our commercial loan growth has outpaced our peers and, as a result, we are again ranked first among the top 15 commer- cial lenders in commercial loans as a percent of assets. Over the last 10 years, commercial loan growth has averaged an impressive 12 percent and has fluctuated very modestly around that average. We rank 15th in commercial lending and 17th in small business lending, another very successful and growing market for us. Our strategy of tapping into high growth metropolitan markets where we can practice our brand of banking fuels our growth, while at the same time helping us even out potential geographic and industry-specific fluctuations. As a result of this strategy, we have seen an increasing proportion of our assets come from non-Michigan markets. This is a trend we expect will continue. Comerica Incorporated Expenses for the first year totaled $355.36 and included: a stove costing $8; wood worth $1.50; advertising for $10; and printing costing $9.25. As Detroit became a center for industry, Detroit Savings Fund Institute ledgers recorded a growth in deposits. Growth, along with profitability and quality, are important objectives of Comerica as it enters 1999, the year of its 150th anniversary. 6 We also have demonstrated our ability to gather consumer assets, particularly in Michigan, where we continue to have a dominant market share. As industry consolidation occurs, we monitor the landscape closely. We believe performance and execution will lead to opportunities down the road. However, we also believe that big is not always best for the customer, nor for the shareholder. If Comerica is going to stand out, it will be because of performance, not size. The results of our focus on consistent top 10 performance have not gone unnoticed by Wall Street. Our stock price has climbed the last several years, rising 13 percent in 1998 after increasing 72 percent in 1997. Including reinvestment of divi- dends, $100 invested in Comerica at the end of 1993 would have returned $452 at the end of 1998, significantly more than a similar investment in the Keefe 50-Bank Index, which would have returned $340, and the S&P 500 Index, which would have returned $294. We return excess capital to our shareholders after supporting balance sheet growth. Our dividend policy has resulted in increased annual dividends for 30 consecutive years, 10 per- cent annual growth and payouts of 34 to 42 percent of our profits. In January 1998, we raised the quarterly cash dividend for common stock by 12 percent to $0.32 per share, reflective of the three-for-two stock split announced that same month. In January 1999, we increased the quarterly cash dividend for common stock by 13 percent, to $0.36 per share. Comparison of five year cumulative total return among Comerica Incorporated, Keefe 50-Bank Index and S&P 500 Index (assumes $100 invested on 12/31/93 and reinvestment of dividends) Comerica Keefe 50-Bank Index S&P 500 $500 $400 $300 $200 $100 0 93 94 95 96 97 98 Comerica Incorporated Within two years, deposits from 320 thrifty souls totaled $25,000, enough to warrant purchase of a new safe for $125. The Institute performed so well it had to move to larger quarters and hire a full-time cashier in 1855. Today, Comerica’s focus on consistent top 10 performance places it among the premier banking companies in the nation. 8 As we celebrate our 150th anniversary in 1999 and contem- plate our future, I am certain of two things: There will continue to be challenges, and we will continue to meet those challenges with the same determination to succeed and dedication to customer service held by the original trustees who laid the foundation of Comerica so long ago. Some of the challenges are familiar ones, like widespread consolidation and competition, that have become defining characteristics of our industry. Other challenges surfaced more recently, like the tumultuous economic conditions in Asia and our own unsettled political and economic arenas. Comerica remains well positioned to weather any changes in the economic climate, as we have consistently in the past. This year, the year 2000 challenge is a top priority. We are devoting substantial human and capital resources to implement our program. We will be ready to conduct business in the year 2000 and beyond. As we face these challenges, we intend to continue to keep our promises—to you, our shareholders, as well as to our cus- tomers, colleagues and communities we serve. While much has changed in 150 years, the nature of Comerica and how we conduct ourselves have not changed. Two months after the Detroit Savings Fund Institute first opened, the Detroit Free Press noted that few knew about the Institute and “it will doubtless require two to three years time for this bank to grow...but the officers are confident that it will continue to increase in importance and usefulness....” Clearly, Comerica has grown to become a top performer in the financial services industry. We welcome the arrival of the year 2000, the new millennium and the next 150 years. Eugene A. Miller Chairman and Chief Executive Officer Only in 1871, when the Institute became Detroit Savings Bank, were the first shares issued. Comerica Incorporated For 150 years, Comerica has made promises— to hold and grow deposits, to deliver a consistent return to shareholders, to help customers and colleagues succeed, to improve the community. Delivery on these promises is the cornerstone upon which Comerica’s reputation was built. Trust is the result, and today Comerica thrives. 10 W hile we continue to develop products and services incon- ceivable 150 years ago, our purpose today remains the same as it was in 1849: We are in business to help people be successful. For example, to provide a wide range of corporate banking and trade finance services to middle market and large corpora- tions doing business in Canada, we opened a new commercial banking subsidiary, Comerica Bank-Canada, in Toronto, Ontario. Together with Comerica Bank-Mexico, which we opened in 1997 in Mexico City and expanded to Monterrey in 1998, we have created an integrated North American distribu- tion system for our corporate customers. We continued to expand our service offerings nationally with the opening of a U.S. Small Business Administration (SBA) lending office in Fort Lauderdale, Florida, and a high technol- ogy banking office in Austin, Texas. Comerica is the 8th largest SBA lender in the nation. Our goal is to be in the top five by the year 2000. We plan to enter at least five additional markets with our SBA lending business in the next two years, as well as increase penetration in our existing markets of California, Michigan, Texas and Florida. The technology sector in Texas has experienced rapid growth in recent years and the presence of experienced bankers able to meet the financial needs of established and start-up technology companies has been limited—until now. Comerica is providing a full range of services through its new office in Austin, as well as from California’s Silicon Valley. Among our new products for business customers are Comerica Export Manager, a Windows®-based software package that automates the export documentation process; and the MasterCard® Fleet Card, designed for companies that maintain fleet and service vehicles. Comerica significantly enhanced its relationship with a Fortune 100 client in 1998 by adding sophisticated spread- sheet functionality to Comerica Gateway, making it the primary information management system for that customer’s bank group. We practice relationship banking to the fullest, and our busi- ness model is about skill, not scale. We train our officers well, give them the tools they need to manage their responsi- bilities, and strive to maintain continuity in their relationships with customers. As we pursue companies of all sizes, we look for those businesses that appreciate the personal attention and capital access that we offer. Comerica Incorporated By the end of April 1933, commercial deposits had more than doubled, from $10 million to $22 million, a sign that the business community had faith in the bank. By the early 1950s, 20-pocket proof machines were used to sort and balance checks. Today, Comerica is among the industry leaders in the use of imaging technology. Comerica’s computerized imaging system processes hundreds of millions of checks each year. 12 T o help our individual and investment banking customers be successful, we strive to offer the products they desire at the prices they are willing to pay, through the distribution channel most convenient for them. Our new Comerica Home ATM personal computer banking program transfers the universal experience of using an automated teller machine (ATM) to the consumer’s personal computer. We expect home banking to parallel the exponential growth of personal computer usage nationwide. A leading internet technology analyst has predicted that in two years, 13 million U.S. households will be banking online—five times as many people as in 1996. We created Comerica Home ATM for this emerging market—a broader segment of customers who want their banking at home to be simple and convenient. We added our 37th ComeriMART supermarket branch in 1998. ComeriMARTs offer customers products and services available at other Comerica Bank branches, plus the conven- ience of banking while shopping. Comerica expanded its strategic alliance with PaineWebber to 41 states with new offices in Cleveland, Ohio, and Memphis, Tennessee. PaineWebber clients in these markets now have access to trust, estate administration, real estate, portfolio management and closely held business services from the Private Banking Division of Comerica Bank. Comerica Securities, our full-service broker-dealer, introduced in July another way for customers to access its products and services. Customers can now locate their discount broker- age accounts, obtain quotes, and perform trades of stocks and bonds through a link in Comerica’s web site. This service joins Comerica Securities’ other computer-based service, PC Trader, and its telephone-based TouchTone service. We have a very strong retail presence in our home state of Michigan. In 1998, we added the convenience of even more ATMs throughout our headquarters state. In the largest agree- ment of its kind between a Michigan bank and a local drug retailer, Comerica announced it will open ATMs in 250 Arbor stores in Michigan, including 22 in the city of Detroit. The Arbor agreement further enhances Comerica’s ATM network, which continues to be the largest in Michigan, with some 720 machines currently, and the 20th largest in the nation. Comerica Incorporated In 1972, Detroit Bank & Trust installed metro Detroit’s first fully automated ATM, which allowed customers to make deposits, pay bills and transfer funds between accounts. Drive-in teller windows helped make banking more convenient for customers. Today, Comerica customers can conduct business with us 24 hours a day, seven days a week, through a choice of distribution channels. 14 H ow the landscape has changed here in our hometown of Detroit these past 150 years! We are very proud of the promise we have kept to Detroit—and to all of the commu- nities in which we operate—to be an outstanding corporate citizen, contributing to the quality of life in each. Comerica has been an active participant in Detroit’s growth, from an office near historic Mariners’ Church 150 years ago, to our headquarters building today—Comerica Tower at Detroit Center. Through our involvement in the neighbor- hoods and status as lead lender in the federally designated Empowerment Zone, Comerica is touching lives and busi- nesses, building success. At the end of 1998 and on the eve of our 150th anniversary, we announced our decision to purchase the naming rights of the new ballpark in downtown Detroit. By calling it Comerica Park, we link Michigan’s oldest and largest bank with the hallowed traditions of baseball and the Detroit Tigers. The national exposure the new park will receive will be a great source of pride for the ball club, the city of Detroit, our colleagues throughout Comerica and fans of the Tigers everywhere. In California, as a legacy to the community in honor of our 150th anniversary, Comerica Bank-California is spearheading The Mayfair Initiative, a major revitalization effort to trans- form the Mayfair neighborhood of East San Jose into a safe, supportive and productive community. Based on the belief that residents must play an active role in shaping the future of the neighborhood in order to sustain pos- itive neighborhood change, the Mayfair Initiative draws on community strengths and involves the residents themselves in the planning, development and implementation of the initiative. Among the many ways Comerica Bank-Texas colleagues support local communities is through the Comerica CoStars program. In 1998, Comerica CoStars volunteered hundreds of hours to worthwhile community projects. Our commitment in Texas to helping people be successful is further evidenced by our partnerships with chambers of commerce. We also provide support and leadership in the community through organizations such as the YMCA, Junior Achievement, Big Brothers and Big Sisters, the Juvenile Diabetes Foundation, the American Heart Association, and the Leukemia Society. Charitable giving is focused on the communities where we do business. Through the Comerica Charitable Foundation, we provided more than 700 grants to non-profit organizations in 1998. Comerica Incorporated Started in 1978 and now reaching 11,000 students in three states, Comerica’s Youth Incen- tive Savings Program teaches school children how to save and how to apply math in every- day life. In 1957, “opening day” at a new branch included cigar giveaways. With the naming of Comerica Park, opening day takes on a different meaning for employees, customers and all followers of America’s favorite pastime. Comerica Park, new home of the Detroit Tigers, is being readied for opening day in the year 2000. 16 learly we owe our continuing success to our dedicated and talented colleagues whose guiding principles are: C . customer service . teamwork . flexibility and adaptability to change . trust and integrity . ownership . learning and personal growth They strive for the highest measure of quality in all that they do. In recognition of their high standards of customer service, 10 colleagues received Comerica’s National Quality Excellence Award in 1998. These individuals were nominated by their peers and their customers because they epitomize the very best in quality customer service. The overall winner was Joseph Davio, president of the Battle Creek Region in Michigan. Other winners were: Barbara Campbell Branch Delivery Systems & Projects Comerica Bank (Michigan) Colleen Green Client Production Services Comerica Incorporated Janet Haskin Deposit Services Comerica Bank (Michigan) Comerica Incorporated Karen Holway Information Services Michael Lawson Branch Delivery Systems & Projects Comerica Bank (Michigan) Clarence Oliver Michigan Real Estate Comerica Bank (Michigan) Rick Pellecchia Consumer Lending Comerica Bank (Michigan) Comerica Bank-Texas Cathy Watson Texas Energy Department Mary Jo Weiss Direct Banking Comerica Bank (Michigan) Approximately 900 colleagues are celebrating 25 or more years of service with Comerica in 1999. Years ago, employees marking important service anniversaries received watches, traditional symbols of lengthy service. Today, colleagues with notable service anniversaries receive shares of Comerica stock. It is a reflection of the new Comerica and its investment in colleagues and the future. We make it work. Comerica Incorporated On June 18, 1992, employees of the new Comerica celebrated the merger of Manufacturers National Corporation and Comerica Incorporated. In 1901, the Michigan banking commissioner commended Detroit Savings Bank on its perform- ance, indicating credit is due “to those who have charge of the daily detailed work...which has been found...to be thoroughly accurate and exceptionally correct.” Today, Comerica remains committed to delivering the highest quality customer service. Howard F. Sims Chairman Sims-Varner & Associates Martin D. Walker Chairman and Chief Executive Officer M.A. Hanna Company Patricia M. Wallington Retired Vice President and Chief Information Officer Xerox Corporation Kenneth L. Way Chairman and Chief Executive Officer Lear Corporation In memoriam Patricia Shontz Longe, who retired from the Comerica Incorporated Board of Directors in March 1998, passed away in August. Her 25 years of service and dedication to this company always will be remembered. Charles L. Gummer President and Chief Executive Officer Comerica Bank-Texas John R. Haggerty Executive Vice President Small Business and Individual Lending Thomas R. Johnson Executive Vice President Corporate Credit Policy George W. Madison Executive Vice President, General Counsel and Corporate Secretary Ronald P. Marcinelli Executive Vice President National Business Finance David B. Stephens Executive Vice President Private Banking Marvin J. Elenbaas Senior Vice President and Controller James R. Tietjen Senior Vice President and General Auditor Executive Officers Eugene A. Miller Chairman and Chief Executive Officer Michael T. Monahan President John D. Lewis Vice Chairman Ralph W. Babb Jr. Executive Vice President and Chief Financial Officer John R. Beran Executive Vice President and Chief Information Officer Joseph J. Buttigieg III Executive Vice President Global Corporate Banking Richard A. Collister Executive Vice President Corporate Staff George C. Eshelman Executive Vice President Investment Bank J. Michael Fulton President and Chief Executive Officer Comerica Bank-California Dale E. Greene Executive Vice President Credit Administration 18 Comerica Incorporated Board of Directors E. Paul Casey Chairman Metapoint Partners James F. Cordes Retired Executive Vice President The Coastal Corporation J. Philip DiNapoli President JP DiNapoli Companies Max M. Fisher Investor John D. Lewis Vice Chairman Comerica Incorporated and Comerica Bank Wayne B. Lyon Chairman, President and Chief Executive Officer Lifestyle Furnishings International, Inc. Eugene A. Miller Chairman and Chief Executive Officer Comerica Incorporated and Comerica Bank Michael T. Monahan President Comerica Incorporated and Comerica Bank Alfred A. Piergallini President and Chief Executive Officer Novartis Consumer Health North America Comerica Incorporated Heinz C. Prechter Chairman and Founder ASC Incorporated Robert S. Taubman President and Chief Executive Officer The Taubman Company, Inc. Alfred H. Taylor Jr. Trustee, Former Chairman and Chief Executive Officer The Kresge Foundation William P. Vititoe Consultant; Former Chairman and Chief Executive Officer Washington Energy Company Gail L. Warden President and Chief Executive Officer Henry Ford Health System Comerica Bank-California Directors Theodore J. Biagini Counsel Hopkins & Carley Jack C. Carsten Principal Technology Investments Leo E. Chavez Chancellor Foothill-DeAnza Community College District J. Philip DiNapoli President JP DiNapoli Companies N. John Douglas President and Chief Executive Officer Information Network Radio, L.L.P. J. Michael Fulton President and Chief Executive Officer Comerica Bank-California Walter T. Kaczmarek Executive Vice President Comerica Bank-California Elinor Weiss Mansfield Attorney Linda R. Meier Board Member California Water Service Company Peninsula Community Foundation Haas Public Service Lowell W. Morse Chairman of the Board Cypress Ventures, Inc. Edward P. Roski Jr. President Majestic Realty Company David C. White Executive Vice President Comerica Bank-California Lewis N. Wolff Chairman and Chief Executive Officer Wolff-DiNapoli Comerica Bank-Texas Directors C. Dewitt Brown Jr. President and Chief Executive Officer Dee Brown Masonry 19 James F. Cordes Retired Executive Vice President The Coastal Corporation Thomas M. Dunning Chairman and Chief Executive Officer Lockton Dunning Benefit Company Ruben E. Esquivel Vice President Community and Corporate Relations University of Texas Southwestern Medical Center Charles L. Gummer President and Chief Executive Officer Comerica Bank-Texas Rev. Zan W. Holmes Jr. Senior Pastor St. Luke Community United Methodist Church Jake Kamin Chairman Houston Advisory Board Comerica Bank-Texas W. Thomas McQuaid President Performance Properties Corporation Raymond D. Nasher Chairman Comerica Bank-Texas; Chairman The Nasher Company Calvin E. Person Owner Calvin Person and Associates Boone Powell Jr. President and Chief Executive Officer Baylor University Medical Center Thomas J. Tierney Chairman Corporate Communications Center, Inc. Comerica Incorporated Comerica Bank Directors Lillian Bauder, Ph.D. Vice President Corporate Affairs Masco Corp. Peter D. Cummings President Peter D. Cummings & Associates Anthony F. Earley, Jr. Chairman and Chief Executive Officer DTE Energy Company Roger Fridholm President MSX International Todd W. Herrick President and Chief Executive Officer Tecumseh Products Company David Baker Lewis Chairman Lewis & Munday, P.C. John D. Lewis Vice Chairman Comerica Incorporated and Comerica Bank Eugene A. Miller Chairman and Chief Executive Officer Comerica Incorporated and Comerica Bank Michael T. Monahan President Comerica Incorporated and Comerica Bank John W. Porter Chief Executive Officer Urban Education Alliance, Inc. Commercial Banking Subsidiaries of Comerica Comerica Bank Comerica Tower at Detroit Center, MC 3391 500 Woodward Avenue Detroit, Michigan 48226 (313) 222-4000 (248) 371-5000 20 Eugene A. Miller Chairman and Chief Executive Officer Headquartered in Detroit with offices in metropolitan Detroit, Ann Arbor, Battle Creek, Grand Rapids, Jackson, Kalamazoo, Lansing, Midland and Muskegon. Florida region specializes in private banking services, with offices in Boca Raton, Fort Lauderdale, Palm Beach Gardens, Naples, Sarasota and Tampa. Comerica Bank- California 333 W. Santa Clara Street MC 4805 San Jose, California 95113 (408) 556-5000 J. Michael Fulton President and Chief Executive Officer Headquartered in San Jose with offices in Bay Area (San Jose to San Francisco), Santa Cruz Coastal, Los Angeles (Los Angeles and Orange Counties) and San Diego. Comerica Bank-Texas 1601 Elm Street, MC 6507 Dallas, Texas 75201 (214) 589-1400 Charles L. Gummer President and Chief Executive Officer Headquartered in Dallas with offices in metropolitan Austin, Dallas, Fort Worth and Houston. Comerica Bank-Canada Suite 2210 South Tower Royal Bank Plaza 200 Bay Street P.O. Box 61 Toronto, Ontario M5J2J2 (416) 367-3113 Philip H. Buxton Managing Director Headquartered in Toronto, Comerica Bank-Canada provides a wide range of corporate banking and trade services in Canada. Comerica Bank Mexico, S.A. Edificio Forum Andres Bello No. 10 Piso 17 Col. Chapultepec Polanco Mexico, D.F. 11560 (011) 525-282-2055 Claude H. Miller Managing Director Headquartered in Mexico City, with an additional office in Monterrey, Comerica Bank Mexico, S.A. provides a wide range of corporate banking and trade finance services to middle market and large corporate companies. Other Comerica Components Comerica Investment Services (continued) Wilson, Kemp & Associates, Inc. Offers individualized investment portfolio management services to customers in the Midwest and Florida. W.Y. Campbell & Company Provides investment banking and corporate finance services to Fortune 500 companies and middle market firms. Partnership interest: Munder Capital Management An investment advisory firm. Units of Comerica Incorporated (select business offices located outside of Comerica’s primary markets) Comerica Business Credit Denver Cleveland Dayton Indianapolis International Finance Chicago National Dealer Services Chicago Denver Personal Trust New York City Memphis PaineWebber alliance Dedicated offices in New York City Memphis Cleveland U.S. Banking Chicago Comerica Bank, N.A. Specializes in revolving credit loans; also supports PaineWebber alliance. Comerica West Incorporated U.S. Banking-West Group originates mid-sized loans to business customers with specific emphasis on the Western United States. Comerica Leasing Corporation Provides equipment leasing and financing services for businesses throughout the United States. Comerica Trust Company of Bermuda Ltd. Offers trust services for captive insurance companies and offshore mutual funds. Comerica Investment Services Comerica Securities, Inc. A full service broker- dealer that offers stocks, bonds, mutual funds and annuities to individual investors, along with investment banking services. Comerica Insurance Services, Inc. Offers life, disability, long-term care, group benefits, and property and casualty insurance to businesses and individuals. Professional Life Underwriters Services, Inc. (PLUS) Provides life insurance, annuities and disability insurance products to independent insurance agents. Comerica Incorporated In the beginning, the bank’s footprint was squarely in Detroit. Today, Comerica’s map is like a patchwork quilt—Michigan, California, Texas and Florida are the main sections with other areas stitched in. Comerica prefers to target markets where conditions are favorable to successfully practice its kind of banking. 22 Financial Review and Reports 1998 Financial Highlights 24 Earnings Performance 24 Strategic Lines 30 of Business Balance Sheet 31 and Capital Funds Analysis Risk Management 34 Consolidated 43 Financial Statements Notes to 47 Consolidated Financial Statements Report of Management 68 Report of 68 Independent Auditors Historical Review 69 Comerica Incorporated Table 1: Selected Financial Data Year Ended December 31 (dollar amounts in millions, except per share data) Earnings Summary Total interest income Net interest income Provision for credit losses Securities gains Noninterest income (excluding securities gains) Restructuring charge Noninterest expenses (excluding restructuring charge) Net income Per Share of Common Stock Basic net income Diluted net income Cash dividends declared Common shareholders’ equity Market value Year-end Balances Total assets Total earning assets Total loans Total deposits Total borrowings Medium- and long-term debt Common shareholders’ equity Daily Average Balances Total assets Total earning assets Total loans Total deposits Total borrowings Medium- and long-term debt Common shareholders’ equity Ratios 23 1998 1997 1996 1995 1994 $ 2,617 1,461 113 6 $ 2,648 1,443 146 5 $02,563 1,412 114 14 $02,614 1,300 87 12 $02,092 1,230 56 3 597 (7) 1,027 607 $ 3.79 3.72 1.28 17.94 68.19 $ 36,601 33,427 30,605 24,313 8,862 5,282 2,797 $ 34,987 32,113 28,599 22,253 9,452 6,032 2,617 523 — 1,008 530 $003.24 3.19 1.15 16.02 60.17 $36,292 33,104 28,895 22,586 10,479 7,286 2,512 $34,869 32,025 27,209 21,946 9,798 5,980 2,408 493 90 1,069 417 $002.41 2.38 1.01 14.70 34.92 $34,206 31,110 26,207 22,367 8,731 4,242 2,366 $34,195 31,370 25,352 22,258 8,850 4,745 2,554 487 — 1,086 413 $002.38 2.37 0.91 15.17 26.67 $35,470 32,051 24,442 23,167 9,319 4,644 2,608 $34,129 31,537 23,561 21,655 9,639 4,510 2,511 447 7 1,035 387 $002.20 2.19 0.83 13.64 16.25 $33,430 30,606 22,209 22,432 8,303 4,098 2,392 $31,451 29,038 20,211 21,325 7,527 2,708 2,313 Return on average assets Return on average common shareholders’ equity Efficiency ratio Dividend payout ratio Common shareholders’ equity as a percent of average assets 1.74% 22.54 49.39 34 1.52% 21.32 51.04 36 1.22% 15.98 60.36 42 1.21% 16.46 60.09 38 1.23% 16.74 61.28 38 7.48 6.91 7.47 7.36 7.35 Comerica Incorporated 1998 Financial Highlights Focused on Performance Return on Average Assets (in percentages) Earned 22.54 percent on average common shareholders’ equity, compared to 21.32 percent in 1997. Returned 1.74 percent on average assets, compared to 1.52 percent in 1997. Reported Record Earnings Reported net income of $607 million, or $3.72 per share, compared with $530 million, or $3.19 per share in 1997. 24 Sustained Growth Averaged $35 billion in total assets in both 1998 and 1997 (increased 6 percent excluding the sale of $2.0 billion of consumer assets). Reached $25 billion in average business loans, a 17 percent increase. Averaged $22 billion in total deposits in both 1998 and 1997. Increased average shareholders’ equity to $2.9 billion. Enhanced Shareholders’ Return Raised the quarterly cash dividend 12 percent to $0.32 per share. Declared annual cash dividends of $1.28 per share. Repurchased 2.3 million shares in 1998. Implemented Key Strategies Divested the mortgage servicing business and $2.0 billion of indirect consumer loans and non-relationship credit card receivables and recorded an $11 million pre-tax gain. Invested technology in targeted strategic businesses. Upgraded and/or remediated most major systems as part of a plan to achieve year 2000 readiness. Opened a Canadian commercial banking subsidiary, Comerica Bank-Canada. Comerica Excluding restructuring charge Industry average (based on 50 largest U.S. bank holding companies) 2.50 2.00 1.50 1.00 0.50 0.0 94 95 96 97 98 Earnings Performance Net Interest Income Net interest income, on a fully taxable equivalent (FTE) basis, is the difference between interest earned on assets, including certain yield related fees, and interest paid on lia- bilities. Adjustments are made to the yields on tax-exempt assets in order to present tax-exempt income and fully tax- able income on a comparable basis. Net interest income (FTE) comprised 71 percent of net revenues in 1998, com- pared to 73 percent in 1997 and 74 percent in 1996. The sale of $2.0 billion of indirect consumer loans and non-relation- ship credit card receivables in the second quarter affected net interest income and the net interest margin for 1998. Net interest income (FTE) (in millions) Net interest margin (FTE) (percent of earning assets) Net Interest Income 1600 5.2 1400 5.0 1200 4.8 1000 4.6 800 4.4 600 4.2 400 4.0 200 3.8 0 94 95 96 97 98 3.6 Comerica Incorporated Table 2: Analysis of Net Interest Income–Fully Taxable Equivalent (dollar amounts in millions) Commercial loans International loans Real estate construction loans Commercial mortgage loans Residential mortgage loans Consumer loans Lease financing Total loans (1) Taxable securities Securities exempt from federal income taxes Total investment securities Short-term investments Total earning assets Cash and due from banks Allowance for credit losses Accrued income and other assets Total assets Money market and NOW accounts Savings deposits Certificates of deposit Foreign office deposits (2) Total interest-bearing deposits 16,102 Federal funds purchased and securities sold under agreements to repurchase Other borrowed funds Medium- and long-term debt Other (3) Total interest-bearing sources Noninterest-bearing deposits Accrued expenses and other liabilities Preferred stock Common shareholders’ equity Total liabilities and 2,510 910 6,032 — 25,554 6,151 415 250 2,617 1998 1997 1996 Average Balance Interest Average Rate Average Balance Interest Average Rate Average Balance Interest Average Rate $16,973 $1,365 187 91 334 102 263 44 2,342 989 3,819 1,325 2,575 576 28,599 3,232 2,386 217 139 3,371 143 32,113 1,622 (440) 1,692 $34,987 $ 7,346 1,584 6,521 651 12 229 9 2,624 231 28 345 44 648 137 49 368 (46) 1,156 25 8.04% $14,234 $1,174 138 1,953 7.97 81 866 9.24 322 3,547 8.74 133 1,676 7.69 440 4,486 10.20 33 447 7.65 8.25% $12,686 $1,041 102 1,541 7.07 65 707 9.38 324 3,483 9.08 153 1,960 7.90 457 4,624 9.81 24 351 7.48 8.34 6.72 9.16 6.81 6.25 8.17 3.15 1.79 5.29 6.71 4.02 5.44 5.40 6.10 — 4.52 8.53 6.84 9.32 6.94 6.59 8.29 3.35 2.02 5.39 5.68 4.17 5.49 5.45 6.26 — 4.65 27,209 4,490 2,321 309 18 327 9 2,657 232 34 361 46 673 111 98 374 (51) 1,205 197 4,687 129 32,025 1,686 (402) 1,560 $34,869 $06,926 1,701 6,699 805 16,131 2,017 1,801 5,980 — 25,929 5,815 467 250 2,408 25,352 5,528 2,166 371 28 399 13 2,578 231 44 365 46 686 112 107 295 (49) 1,151 295 5,823 195 31,370 1,576 (361) 1,610 $ 34,195 $ 06,913 2,026 6,887 843 16,669 2,106 1,999 4,745 — 25,519 5,589 400 133 2,554 8.21% 6.64 9.22 9.29 7.83 9.88 6.82 8.54 6.63 9.96 6.79 6.23 8.20 3.33 2.18 5.30 5.46 4.11 5.31 5.36 6.22 — 4.51 shareholders’ equity $34,987 $34,869 $34,195 Net interest income/rate spread (FTE) $1,468 3.65 $1,452 3.64 $1,427 3.69 FTE adjustment (4) $ 7 $0,019 $1,415 Impact of net noninterest-bearing sources of funds Net interest margin (as a percent of average earning assets) (FTE) 0.92 4.57% 0.89 4.53% 0.85 4.54% (1) Nonaccrual loans are included in average balances reported and are used to calculate rates. (2) Includes substantially all deposits by foreign depositors; deposits are pri- marily in excess of $100,000. (3) Net interest rate swap income. If swap income were allocated, average rates on total loans would have been 8.40% in 1998, 8.63% in 1997 and 8.66% in 1996; average rates on medium- and long-term debt would have been 5.77% in 1998, 5.85% in 1997 and 5.80% in 1996. (4) The FTE adjustment is computed using a federal income tax rate of 35%. Comerica Incorporated Net Increase (Decrease) $133 36 16 (2) (20) (17) 9 155 (62) (10) (72) (4) 79 10 (10) (4) — (13) (1) (9) 79 (2) 54 $128 29 15 5 (22) (14) 7 148 (72) (9) (81) (5) 62 — (7) (10) (2) (19) (5) (11) 77 — 42 $020 $025 Table 3: Rate-Volume Analysis–Fully Taxable Equivalent 1998 / 1997 1997 / 1996 (in millions) Increase (Decrease) Increase (Decrease) Due to Rate Due to Volume* Net Increase Increase (Decrease) (Decrease) Due to Rate Due to Volume* Increase (Decrease) 26 Interest income (FTE) Commercial loans International loans Real estate construction loans Commercial mortgage loans Residential mortgage loans Consumer loans Lease financing Total loans Taxable securities Securities exempt from federal income taxes Total investment securities Short-term investments Total interest income (FTE) Interest expense Money market and NOW accounts Savings deposits Certificates of deposit Foreign office deposits Total interest-bearing deposits Federal funds purchased and securities sold under agreements to repurchase Other borrowed funds Medium- and long-term debt Other (1) Total interest expense Net interest income (FTE) $(29) 17 (1) (12) (4) 18 1 (10) (7) (1) (8) — (18) (14) (4) (6) 8 (16) (1) (1) (9) 5 (22) $ 4 *Rate/volume variances are allocated to variances due to volume. (1) Net interest rate swap income. $220 32 11 24 (27) (195) 10 75 (85) (5) (90) — (15) 13 (2) (10) (10) (9) 27 (48) 3 — (27) $191 49 10 12 (31) (177) 11 65 (92) (6 ) (98) — (33) (1) (6) (16) (2) (25) 26 (49) (6) 5 (49) $ 12 $ 16 $ 5 7 1 (7) 2 (3) 2 7 10 (1) 9 1 17 1 (3) 6 2 6 4 2 2 (2) 12 $05 Comerica Incorporated 27 Net interest income (FTE) rose 1 percent to $1,468 million in 1998. This increase was primarily due to a 5 percent increase in average total loans. A significant increase of 19 percent in average commercial loans was offset by the con- sumer loan divestitures cited previously and sales and runoff of investment securities. The net interest margin for 1998 increased slightly to 4.57 percent from 4.53 percent last year. The increase in the net interest margin was primarily due to an increase in the level of noninterest-bearing sources of funds, the consumer loan divestitures and a reduced emphasis on investment securities in the mix of earning assets. Comerica (the “Corporation”) applied various asset and liability management strategies in 1998 to minimize exposure to net interest margin risk. Net interest margin risk represents the potential reduction in net interest income that may result from rate spread compression between, for example, prime and market rates or core deposit and money market rates. Such strategies included permitting investment securities to run off in order to facilitate growth in higher yielding loans. Off-balance sheet interest rate swap contracts entered into in 1998 effectively fixed the yields on certain variable rate loans and altered the interest rate characteristics of debt issued throughout the year. Refer to the Interest Rate Risk discussion on page 36 of this financial review for addi- tional information regarding the Corporation’s asset and lia- bility management policies. In 1997, net interest income (FTE) increased 2 percent over 1996, benefiting from strong growth in average earning assets, primarily commercial loans. The net interest margin for 1997 declined 1 basis point from 1996, principally due to higher funding costs from a greater reliance on purchased funds in the mix of interest-bearing liabilities. This was offset by a favorable shift in earning assets to higher spread loans funded by the sales and runoff of lower yielding investment securities. Provision and Allowance for Credit Losses The provision for credit losses reflects management’s evalu- ation of the adequacy of the allowance for credit losses. The allowance for credit losses represents management’s assess- ment of possible losses inherent in the Corporation’s on- and off-balance sheet credit portfolio. The amount attributable to the off-balance sheet credit portfolio is not material. The Corporation allocates the allowance for credit losses to each loan category based on a defined methodology, which has been in use, without material change, for several years. First, an internal risk rating is assigned to each commercial loan. Included in that risk rating is management’s assessment of the potential failure of a customer to be adequately prepared for the year 2000, but only in those instances where manage- ment has significant information indicating a customer may not be adequately prepared (for more information on year 2000, see the section entitled “Other Matters”). Management then assigns a projected loss ratio to each risk rating based on numerous factors identified below. A detailed credit qual- ity review is performed quarterly on certain commercial loans which have deteriorated below certain levels of credit risk, resulting in an additional allocation of a specific por- tion of the allowance to such loans. The portion of the allowance allocated to consumer loans is determined by applying projected loss ratios to various segments of the loan portfolio. Projected loss ratios incorporate factors such as recent loan loss experience, current economic conditions and trends, geographic dispersion of borrowers, trends with respect to past due and nonaccrual amounts, risk character- istics of various categories and concentrations of loans and transfer risks. However, actual loss ratios experienced in the future could vary from those projected. This uncertainty occurs because a loan’s performance depends not only on economic factors but also other factors unique to each cus- tomer. In addition, the significant diversity in size of corpo- rate loans means that even if the projected number of loans deteriorate, the dollar exposure could significantly vary from estimated amounts. Furthermore, for many economic events which have occurred, the impact on individual cus- tomers may be, as yet, unknown. Such events include, for example, the impact of the Asian economic problems both on assets in that region as well as domestic companies exporting to that region or doing business through sub- sidiaries in that region; depressed oil prices in the energy sector; and high real estate vacancy rates in selected mar- kets. To ensure adequacy to a higher degree of confidence, an unallocated allowance is maintained. Management also considers industry norms and the expectations and input from rating agencies and banking regulators in determining the adequacy of the allowance. The allocation of the allowance for credit losses provided in Table 8 on page 32 is done for analytical purposes. The total allowance, including the unallocated amount, is available to absorb losses from any segment of the portfolio. The provision for credit losses was $113 million in 1998, compared to $146 million in 1997 and $114 million in 1996. The decrease in 1998 was primarily due to the con- sumer loan sale mentioned earlier. Net Loans Charged Off to Average Loans (in percentages) Comerica Industry average (based on 50 largest U.S. bank holding companies) 1.0 0.8 0.6 0.4 0.2 0.0 94 95 96 97 98 Comerica Incorporated Table 4: Analysis of the Allowance for Credit Losses Year Ended December 31 (dollar amounts in millions) Balance at beginning of period Allowance of institutions purchased/sold 28 Loans charged off Domestic Commercial Real estate construction Commercial mortgage Residential mortgage Consumer Lease financing International Total loans charged off Recoveries Domestic Commercial Real estate construction Commercial mortgage Consumer International Total recoveries Net loans charged off Provision for credit losses Balance at end of period Ratio of allowance for credit losses to total loans at end of period Ratio of net loans charged off during the period to average loans outstanding during the period Total net charge-offs decreased to $85 million in 1998, compared to $89 million in 1997 and $85 million in 1996. The ratio of net loans charged off to average total loans was 0.30 percent in 1998 and 0.33 percent in 1997. Commercial loan net charge-offs as a percentage of average commercial loans were 0.18 percent for 1998 and 0.10 percent for 1997. Consumer loan net charge-offs as a percentage of average consumer loans were 2.03 percent for 1998 and 1.79 percent for 1997. Consumer loan net charge-offs declined $28 mil- lion, primarily as a result of the consumer loan divestitures discussed previously. At December 31, 1998, the allowance for credit losses was $452 million, an increase of $28 million since year-end 1997. The allowance as a percentage of total loans increased to 1.48 percent from 1.47 percent at December 31, 1997. The allowance as a percentage of total nonperforming assets decreased to 375 percent at December 31, 1998, from 413 percent at year-end 1997. Comerica Incorporated 1998 $424 — 1997 $367 — 1996 $341 1995 $326 (3) 4 1994 $299 19 49 — 1 — 65 4 7 33 1 4 — 92 — 1 33 1 5 1 86 — — 33 3 8 2 73 — — 126 131 126 119 19 — 9 13 — 41 85 19 1 10 12 — 42 89 18 1 9 13 — 41 85 113 146 114 19 3 8 13 — 43 76 87 25 1 17 — 40 — — 83 15 — 5 14 1 35 48 56 $452 $424 $367 $341 $326 1.48% 1.47% 1.40% 1.40% 1.47% 0.30% 0.33% 0.33% 0.32% 0.24% Noninterest Income Year Ended December 31 (in millions) Fiduciary and investment management income Service charges on deposit accounts Commercial lending fees Securities gains Other Subtotal Consumer businesses sold Bond indenture income Customhouse broker fees Other significant nonrecurring items 1998 1997 1996 $184 158 43 6 198 589 14 — — — $147 141 32 5 176 501 4 23 — — $126 140 23 14 163 466 4 7 11 19 Total noninterest income $603 $528 $507 29 Noninterest income increased $75 million, or 14 percent, to $603 million in 1998, compared to $528 million in 1997 and $507 million in 1996. Noninterest income and noninterest expenses in the second half of 1998 include the consolidated financial results of Munder Capital Management (“Munder”), an investment advisory subsidiary in which a majority interest was obtained by the Corporation in July 1998. The Corporation accounted for its minority interest in periods prior to the third quarter of 1998 under the equity method. After adjusting for acquisitions, divestitures, securities gains and the large nonrecur- ring items discussed below, noninterest income rose $71 million, or 14 percent, in 1998. Fiduciary and investment management income increased $37 million, or 25 percent, in 1998 compared to an increase of $21 million, or 16 percent, in 1997 (after excluding bond indenture income). Excluding the net additional revenues from Munder of $18 million, the increase of 13 percent in 1998 reflects a signifi- cant increase in both personal trust and institutional trust income due to an expanded customer base and market performance of assets under management. Total trust assets under management increased to $137 billion at December 31, 1998, from $117 bil- lion at year-end 1997. Discretionary funds, which represent trust assets over which the Corporation has investment management authority, increased to $50 billion from $30 billion in 1997. The consolidation of Munder contributed $14 billion of trust assets. Service charges on deposit accounts increased $17 million, or 12 percent, in 1998 compared to an increase of $1 million, or 1 per- cent, in 1997. The majority of the 1998 increase related to revi- sions of the commercial account fee structure, growth in demand deposit activity and lower earnings credit allowances. Commercial lending fees increased $11 million, or 38 percent, in 1998 compared to an increase of $9 million, or 35 percent, in 1997. Continued strong commercial loan growth contributed to increases in commercial loan service charges and fees on unfunded commitments in 1998. Commercial loan syndication fees increased $6 million in 1998. Income from securities gains was essentially unchanged from the prior year, totaling $6 million in 1998 and $5 million in 1997. Noninterest Income (in millions) 625 500 375 250 125 0 94 95 96 97 98 Other noninterest income increased $9 million, or 4 percent, in 1998. Higher levels of foreign exchange income, broker- age service fees and automated teller machine surcharges accounted for the majority of this increase. Excluding the impact of acquisitions, divestitures and large nonrecurring items in both periods, other noninterest income increased 13 percent. Significant nonrecurring items in other noninterest income include an $11 million net gain on the sale of the mortgage servicing business and consumer loans discussed previously in 1998, and a $23 million gain on the sale of the Corporation’s bond indenture services business in 1997. Sig- nificant nonrecurring items in 1996 include a $13 million gain on the transfer of merchant services to a joint venture, $9 million of interest on a state tax refund and a $6 million gain on the sale of Comerica Bank-Illinois; offset by a $9 million write-off related to the sale of John V. Carr & Son, Incorporated. Noninterest Expenses Year Ended December 31 (in millions) Salaries Employee benefits Total salaries and employee benefits Net occupancy expense Equipment expense Outside processing fee expense Other Subtotal Restructuring charge Other significant nonrecurring items 1998 $ 500 65 1997 1996 $ 464 75 $ 475 86 565 90 60 43 269 1,027 (7) — 539 89 62 42 271 1,003 — 5 561 99 69 42 280 1,051 90 18 Total noninterest expenses $1,020 $1,008 $1,159 Noninterest expenses increased 1 percent to $1,020 million in 1998, compared to $1,008 million in 1997 and $1,159 million ($1,069 million, excluding the restructuring charge) in 1996. Excluding the effect of acquisitions, divestitures and the large nonrecurring items discussed below, noninter- est expenses increased $25 million, or 3 percent, in 1998. Total salaries expense increased $36 million, or 8 percent, in 1998 versus a decrease of $11 million, or 2 percent, in 1997. The increase in 1998 was primarily from the consoli- dation of Munder, annual merit increases and increased incentives tied to performance. The number of full-time equivalent employees increased 174, or 2 percent, from year-end 1997, primarily due to Munder. Employee benefits expense decreased $10 million, or 13 per- cent, in 1998 versus a decrease of $11 million, or 12 percent, in 1997. The reduction in 1998 was primarily due to reduced pension expense as a result of benefits from reduced staff lev- els related to the Direction 2000 program and the consumer loan and mortgage servicing divestitures mentioned earlier, as well as higher levels of benefits from company-owned life insurance policies. Excluding the effect of acquisitions and divestitures, salaries and benefits increased 4 percent in 1998. Comerica Incorporated 30 Net occupancy and equipment expenses, on a combined basis, decreased $1 million, or 1 percent, in 1998 versus a decrease of $17 million, or 10 percent, in 1997. After adjusting for acquisi- tions and divestitures, net occupancy and equipment expenses declined 2 percent in 1998. Outside processing fees were essentially unchanged from the prior year, totaling $43 million in 1998 and $42 million in 1997. Other noninterest expenses decreased $7 million in 1998, com- pared to a $22 million decrease in 1997. Other noninterest expenses included $5 million of litigation accruals in 1997 and a loss of $18 million in 1996 on the sale of a portion of the bankcard portfolio. Loss-sharing provisions in that bankcard sales agreement expose the Corporation to maximum addition- al losses of $14 million over the last six months of the agree- ment. Management does not expect to incur significant additional losses as a result of these provisions. Excluding acquisitions, divestitures and the large nonrecurring items described above, other noninterest expenses increased $4 mil- lion, or less than 2 percent. The minimal increase reflects man- agement’s continued efforts to control expenses. The Corporation recorded a pre-tax restructuring charge of $90 million in 1996 in connection with a major program (Direction 2000) to improve efficiency, revenue and customer service. The charge included $48 million for termination benefits, $21 mil- lion for occupancy and equipment write-offs and $21 million for other costs. Estimated annual benefits of $110 million (cost savings of $85 million and revenue enhancements of $25 mil- lion) were anticipated from the program. The Corporation com- pleted implementation during the first quarter of 1998. Full annual realization of the estimated benefits of the plan will not occur until 1999. As a result of the program, the Corporation eliminated 1,890 employee positions, about 15 percent of total positions at year-end 1996. Reinvestment opportunities during the implementation phase created 300 new positions. During 1998, the Corporation incurred $22 million of termination ben- efits, occupancy and equipment write-offs and other costs which it charged against the restructuring reserve, compared to $61 million in 1997. A reduction of $7 million, netted against other noninterest expenses, was made to eliminate the restruc- turing liability in 1998. Additional information regarding the Noninterest Expenses (in millions) Restructuring charge 1200 1000 800 600 400 200 0 94 95 96 97 98 Comerica Incorporated Corporation’s restructuring reserve can be found in Note 15 on page 56. The Corporation’s efficiency ratio is defined as total noninterest expenses divided by the sum of net interest revenue (FTE) and noninterest income, excluding securities gains. The ratio was 49.39 percent in 1998, compared to 51.04 percent in 1997 and 60.36 percent in 1996 (55.67 percent excluding the restructur- ing charge). Income Taxes The provision for income taxes was $324 million in 1998, com- pared to $287 million in 1997 and $229 million in 1996. The effective tax rate, computed by dividing the provision for income taxes by income before taxes, was 34.8 percent in 1998, 35.0 percent 1997 and 35.4 percent in 1996. Strategic Lines of Business The Corporation has strategically aligned its operations into three major lines of business: the Business Bank, the Individ- ual Bank and the Investment Bank. In addition to the three major lines of business the Finance Division is also reported as a segment. The Corporation’s investment securities portfolio is included in the total assets of the Finance Division. Note 22 on page 63 describes how these segments were identified and pre- sents the financial results of these business lines for the years ended December 31, 1998, 1997 and 1996. Business Bank net income increased $11 million, or 3 percent, in 1998, principally due to additional net interest income result- ing from 18 percent average loan growth and a $26 million increase in noninterest income. This was partially offset by a higher provision for credit losses resulting from loan growth. Individual Bank net income increased $42 million, or 19 per- cent, in 1998. Financial results for the Individual Bank for 1998 were affected by the sale of the mortgage servicing business and the sale of $2.0 billion of consumer assets. Net interest income declined $75 million, or 10 percent, from 1997, while the provision for credit losses decreased $96 million, reflecting the results of the sale. Noninterest income in 1998 includes an $11 million net gain related to the sale. Noninterest income in 1996 includes a $13 million gain on the sale of the merchant services business. Net income for the Investment Bank increased $1 million in 1998, principally due to higher levels of institutional trust fees, discount brokerage fees and the consolidation of Munder. Net income for Finance increased $7 million in 1998, primarily due to a $6 million increase in net interest income. This increase was due to the favorable impact of managing the Cor- poration’s exposure to interest rate risk. This increase in swap income was partially offset by a reduction in interest income due to investment security runoff. Net loss for Other decreased $16 million in 1998, primarily due to a decline in the allowance for credit losses not assigned to specific business lines. An adjustment of $7 million, netted against noninterest expenses, was made to eliminate the restruc- turing liability in 1998. Included in noninterest income for 1997 is a $23 million gain on the sale of the Corporation’s bond indenture services business. Noninterest expenses in 1996 include a $90 million restructuring charge in connection with Direction 2000. Table 5: Analysis of Investment Securities and Loans December 31 (in millions) Investment securities available for sale U.S. government and agency securities State and municipal securities Other securities 1998 1997 1996 1995 1994 $12,206 115 391 $13,239 170 597 $13,968 228 604 $16,038 371 450 $12,674 — 232 Total investment securities available for sale 2,712 4,006 4,800 6,859 2,906 Investment securities held to maturity U.S. government and agency securities State and municipal securities Other securities Total investment securities held to maturity — — — — — — — — — — — — — — — — 4,462 422 86 4,970 31 Total investment securities $12,712 $14,006 $14,800 $16,859 $17,876 Commercial loans International loans Government and official institutions Banks and other financial institutions Other Total international loans Real estate construction loans Commercial mortgage loans Residential mortgage loans Consumer loans Lease financing Total loans $19,086 $15,805 $13,520 $12,041 $10,634 12 433 2,268 2,713 1,080 4,179 1,038 1,862 647 6 339 1,740 2,085 941 3,634 1,565 4,348 517 11 323 1,372 1,706 751 3,446 1,744 4,634 406 6 583 796 1,385 641 3,254 2,221 4,570 330 18 660 517 1,195 414 3,056 2,436 4,215 259 $30,605 $28,895 $26,207 $24,442 $22,209 Balance Sheet and Capital Funds Analysis Total assets were $36.6 billion at year-end 1998, represent- ing a $0.3 billion increase from $36.3 billion on December 31, 1997. On an average basis, total assets remained rela- tively flat, with $35.0 billion in 1998, compared to $34.9 billion in 1997. Earning Assets Total earning assets were $33.4 billion at year-end 1998, rep- resenting a $0.3 billion increase from $33.1 billion at December 31, 1997. On an average basis, total earning assets were $32.1 billion in 1998, compared to $32.0 billion in 1997. The average balance of commercial and commercial mortgage loans increased $3.0 billion, or 17 percent, from 1997. Real estate construction loans rose an average $123 million, or 14 percent in 1998. The commercial portfolio, especially small business and middle market loans, continues to grow in all the Corporation’s markets. This growth, along with an increase of approximately 5 percent in commercial loan commitments to extend credit, is attributable to effective marketing efforts, strong customer relationships and contin- ued economic strength in the commercial loan markets. Average international loans increased $389 million, consisting largely of loans originated to facilitate trade with limited cross-border risk. This growth reflects the increasing global activity of the Corporation’s traditional customer base and an increased international presence. The Corporation undertakes risk management practices to minimize risk inherent in international lending arrangements. These prac- tices include structuring bilateral arrangements or participat- ing in bank facilities which secure repayment from sources external to the borrower’s country. Accordingly, such inter- national outstandings are excluded from cross-border risk of that country. Mexican cross-border risk of $576 million, or 1.57 percent of assets and Canadian cross-border risk of $380 million, or 1.04 percent of assets, were the only coun- tries with exposure exceeding 1.00 percent of assets at December 31, 1998. There were no countries with exposure between 0.75 percent and 1.00 percent of total assets at year-end 1998. Canadian cross-border risk at year-end 1998 includes a $14 million loan on nonaccrual status. Table 6 on page 32 provides additional information on the Corpora- tion’s Mexican and Canadian cross-border risk. Comerica Incorporated Table 6: Mexican and Canadian Cross-Border Risk December 31 (in millions) Mexico 1998 1997 1996 Canada 1998 1997 1996 32 Governments and Official Institutions Banks and Other Financial Institutions Commercial and Industrial $ 15 41 192 — — — $214 78 26 — — — $347 295 50 380 256 128 Total $576 414 268 380 256 128 Table 7: Loan Maturities and Interest Rate Sensitivity December 31, 1998 (in millions) Commercial loans Commercial mortgage loans International loans Real estate construction loans Total Loans maturing after one year Predetermined interest rates Floating interest rates Total Within One Year* After One But Within Five Years $14,647 1,286 2,516 730 $19,179 $3,518 1,961 172 267 $5,918 $2,735 3,183 $5,918 After Five Years $ 921 932 25 83 Total $19,086 4,179 2,713 1,080 $1,961 $27,058 $1,521 440 $1,961 *Includes demand loans, loans having no stated repayment schedule or maturity and overdrafts. Table 8: Allocation of the Allowance for Credit Losses 1998 1997 1996 1995 1994 Percent Percent Allocated of Total Allocated of Total Allocated of Total Allocated of Total Allocated of Total Loans Allowance Loans Allowance Loans Allowance Loans Allowance Loans Allowance Percent Percent Percent December 31 (in millions) Domestic Commercial Real estate construction Commercial mortgage Residential mortgage Consumer Lease financing International Unallocated $131 62% $094 55% $ 98 52% $118 49% $119 48% 4 21 — 48 6 17 225 4 14 3 6 2 9 — 7 18 1 116 1 5 182 3 13 5 15 2 7 — 6 27 2 120 1 3 110 3 13 7 18 1 6 — 5 33 2 84 1 2 96 3 13 9 19 1 6 — 6 35 2 60 1 3 100 2 14 11 19 1 5 — Total $452 100% $424 100% $367 100% $341 100% $326 100% Comerica Incorporated Average residential mortgage loans decreased $351 million, primarily due to management’s decision to sell the majority of mortgage originations. Average consumer loans, com- prised of installment, revolving credit and bankcard loans, declined $1.9 billion, primarily as a result of the sale of $2.0 billion of indirect consumer loans and non-relationship bankcard receivables. Average installment, revolving credit and bankcard loans decreased $1,611 million, $75 million and $225 million, respectively, during the period. Average investment securities declined to $3.4 billion in 1998, compared to $4.7 billion in 1997. This decline reflects sales and runoff of securities primarily to fund growth in higher-yielding loans and to divest lower earning variable rate assets. Average U.S. government and agency securities decreased $955 million and average state and municipal securities decreased $58 million, while average other securi- ties decreased $303 million. The Corporation shifted away from purchasing on-balance sheet securities to balance inter- est rate sensitivity and preserve net interest margin, to pur- chasing off-balance sheet interest rate swaps that accomplish the same interest risk reduction objective. The decline in U.S. government and agency securities principally resulted from sales and paydowns, while the tax exempt portfolio of state and municipal securities continued to decrease as reduced tax advantages for these types of securities deterred additional investment. Other securities consist primarily of collateralized mortgage obligations (CMOs), Brady bonds and Eurobonds. Other Earning Assets Short-term investments in interest-bearing deposits with banks, federal funds sold and securities purchased under agreements to resell provide a range of maturities under one year to supplement corporate liquidity. Interest-bearing deposits with banks are investments with banks in developed countries or foreign banks’ international banking facilities located in the United States. Federal funds sold provide a vehicle to control the reserve position and serve correspon- dent banks, as well as offer supplemental earnings opportu- nities. Average short-term investments increased slightly to $143 million during 1998, from $129 million during 1997. Table 9: Maturity Distribution of Domestic Certificates of Deposit of $100,000 and Over December 31 (in millions) Three months or less Over three months to six months Over six months to twelve months Over twelve months Total 1998 $1,619 323 324 179 $2,445 Deposits and Borrowed Funds Average deposits increased $307 million, or 1 percent, from 1997. Average noninterest-bearing deposits grew $336 mil- lion, or 6 percent, from 1997, largely due to the growth in related commercial loan business. Average interest-bearing transaction, savings and money market deposits increased 4 percent during 1998, to $8.9 billion. Average certificates of deposit decreased $332 million, or 4 percent, from 1997. Average federal funds purchased and securities sold under agreements to repurchase increased $493 million, or 24 per- cent, from 1997. 33 The Corporation uses medium-term debt (both domestic and European) and long-term debt to provide the necessary fund- ing to support expanding loan volumes. Medium-term debt provides a funding source with maturities ranging from one month to 15 years and durations that are similar to deposit liabilities. Long-term subordinated notes help maintain the bank’s total capital ratio at the level that qualifies for the lowest FDIC risk-based insurance premium. Medium-term debt decreased $2.2 billion, representing the net result of the issuance of $3.0 billion and the maturity of $5.2 billion of notes, during 1998. Long-term debt increased $231 million during 1998, primarily from the issuance of $250 million of subordinated notes offset by the maturity of $75 million of subordinated debentures. Further information on medium- and long-term debt is included in Note 9 of the consolidated financial statements on page 52. The increases in average deposits, federal funds purchased and securities sold under agreements to repurchase, and medium- and long-term debt balances were offset by a decline of $891 million, or 49 percent, in other borrowed funds. The decline in other borrowed funds was attributable to more attractive short-term funding alternatives, such as federal funds purchased, and the reduced availability of trea- sury tax and loan deposits. Capital Shareholders’ equity was $3.0 billion at December 31, 1998. Comerica repurchased 2.3 million shares equaling $149 mil- lion of capital during 1998. At December 31, 1998, the Cor- poration had remaining authorization to purchase 20 million shares of common stock. Excluding share repurchases, the remaining change in capi- tal is the net effect of increases in capital from retained earn- ings of $391 million and $47 million of common stock issued for employee stock plans and a decrease of $5 million in nonowner equity, principally a change in value of avail- able-for-sale securities. Comerica Incorporated 34 The Corporation declared common dividends totaling $199 million on net income applicable to common stock of $590 million, representing a dividend payout ratio of 34 percent. The payout ratio in 1997 was 36 percent. The Corporation targeted a payout ratio between 30 to 40 percent, although the board of directors constantly reassesses this target in light of changing market and industry conditions. On January 15, 1998, the Corporation’s board of directors declared a three-for-two stock split, effected in the form of a 50 percent stock dividend paid April 1, 1998, as well as increased the quarterly cash dividend 12 percent to $0.32 per common share. At December 31, 1998, the Corporation and all of its bank- ing subsidiaries exceeded the capital ratios required for an institution to be considered “well capitalized” by the stan- dards developed under the Federal Deposit Insurance Corpo- ration Improvement Act of 1991. See Note 17 of the consolidated financial statements on page 57 for the capital ratios. RISK MANAGEMENT The Corporation assumes various types of risk in the normal course of business. The most significant risk exposures are credit, interest rate and liquidity risk. In addition, like other large corporations, the Corporation is exposed to operating risk. The Corporation employs risk management processes to identify, measure, monitor and control these risks. Credit Risk Credit risk represents the risk that a customer or counterpar- ty may not perform in accordance with contractual terms. Credit risk is inherent in the financial services business and results from extending credit to customers, purchasing secu- rities and entering into off-balance sheet financial derivative instruments. Policies and procedures for measuring and managing this risk are formulated, approved and communi- cated throughout the Corporation. Credit executives are involved in the origination and underwriting process to ensure adherence to risk policies and underwriting stan- dards. The Corporation also manages credit risk through diversification, limiting exposure to any single industry or customer, selling participations to third parties and requiring collateral. Nonperforming Assets The Corporation’s policies regarding nonaccrual loans reflect the importance of identifying troubled loans early. Consumer loans are directly charged off no later than 180 days past due, or earlier if deemed uncollectible. Loans other than consumer are generally placed on nonaccrual sta- tus when management determines that principal or interest may not be fully collectible, but no later than when the loan is 90 days past due on principal or interest, unless it is fully collateralized and in the process of collection. Loan amounts in excess of probable future cash collections are charged off at the time the loan is placed on nonaccrual status, to an Comerica Incorporated amount that represents management’s assessment of the ulti- mate collectibility of the loan. Interest previously accrued but not collected on nonaccrual loans is charged against current income. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable. Nonperforming Assets to Loans and Other Real Estate (in percentages) Comerica Industry average (based on 50 largest U.S. bank holding companies) 3.0 2.5 2.0 1.5 1.0 0.5 0.0 94 95 96 97 98 Nonperforming assets as a percent of total loans and other real estate were 0.39 percent and 0.36 percent at year-end 1998 and 1997, respectively. Nonaccrual loans at December 31, 1998, increased 38 percent to $108 million from an unusually low amount of $78 million at year-end 1997. The nonaccrual loan table below indicates the percentage of nonaccrual loan value to original contractual value and demonstrates the conservative and prompt nature of the cor- porate charge-off and payment application policy. Other real estate owned (ORE) declined significantly to $5 million, primarily due to the sale of one large property. Nonaccrual Loans December 31 (dollar amounts in millions) Carrying value Contractual value Carrying value as a percentage of contractual value Concentration of Credit 1998 $108 159 1997 $078 119 68% 66% Loans to companies and individuals involved with the auto- motive industry, including suppliers, manufacturers and deal- ers, represented the largest significant industry concentration at December 31, 1998. These loans totaled $4.6 billion, or 15 percent of total loans at December 31, 1998, versus $4.3 billion, or 15 percent, at December 31, 1997. Table 10: Analysis of Investment Securities Portfolio–Fully Taxable Equivalent † Maturity Within 1 Year Weighted Average Maturity Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Yrs./Mos. After 10 Years 5 - 10 Years 1 - 5 Years Total $ 41 5.66 % $ 21 5.40 % $ — — % $ — — % $ 62 5.57% 1/0 31 6.58 74 7.63 809 6.21 1,230 6.53 2,144 6.45 10/2 35 32 6.39 56 6.45 21 6.11 6 6.38 115 6.37 15 12.84 168 8.22 74 8.05 48 8.18 305 8.41 — — — — — — — — 86 — 3/1 6/2 — December 31, 1998 (dollar amounts in millions) Available for sale U.S. Treasury U.S. government and agency State and municipal securities Other bonds, notes and debentures Federal Reserve Bank stock and other investments* Total investment securities available for sale $119 6.88 % $319 7.59 % $904 6.36 % $1,284 6.59 % $2,712 6.65% 9/2 *Balances are excluded in the calculation of total yield. †Based on final contractual maturity. Table 11: Summary of Nonperforming Assets and Past Due Loans December 31 (dollar amounts in millions) Nonperforming assets Nonaccrual loans Commercial loans International loans Real estate construction loans Real estate mortgage loans (principally commercial) Total nonaccrual loans Reduced-rate loans Total nonperforming loans Other real estate Total nonperforming assets Nonperforming loans as a percentage of total loans Nonperforming assets as a percentage of total loans and other real estate Allowance for credit losses as a percentage of total nonperforming assets Loans past due 90 days or more and still accruing 1998 1997 1996 1995 1994 $ 77 20 1 10 108 8 116 5 $059 1 3 15 78 8 86 17 $072 — 3 28 103 8 111 29 $087 — 7 37 131 3 134 29 $089 — 17 56 162 2 164 40 $121 $103 $140 $163 $204 0.38% 0.30% 0.42% 0.55% 0.74% 0.39% 0.36% 0.53% 0.67% 0.92% 375% 413% 263% 209% 160% $ 40 $053 $052 $057 $039 Comerica Incorporated 36 These totals include floor plan loans to automobile dealers of $1,454 million and $1,408 million at December 31, 1998 and 1997, respectively. All other industry concentrations individ- ually represented less than 5 percent of total loans at year- end 1998. The Corporation has successfully operated in the Michigan economy in spite of a loan concentration and several down- turns in the auto industry. The largest automotive industry loan on nonaccrual status at December 31, 1998, was $13 million. There were no other automotive industry-related loans larger than $3 million on nonaccrual status as of year- end 1998. The Corporation incurred $6 million of automotive industry-related charge-offs during 1998. Commercial Real Estate Lending The real estate construction loan portfolio contains loans pri- marily made to customers with satisfactory project comple- tion experience. The portfolio has approximately 1,069 loans, of which 74 percent have balances of less than $1 million. The largest real estate construction loan has a balance of approximately $20 million. The commercial mortgage loan portfolio, 56 percent of which relates to owner-occupied properties, also consists pri- marily of loans to long-time customers. Of the approximately 7,071 loans in the portfolio, 87 percent have balances under $1 million and the largest loan has a balance of approximate- ly $30 million. Additionally, the Corporation’s policy requires a 75 percent or less loan-to-value ratio for all com- mercial mortgage and real estate construction loans. This pol- icy is within bank regulatory limits. The geographic distribution of the real estate construction and commercial mortgage loan portfolios is also an important factor in evaluating credit risk. The following table indicates the diversification of the portfolios throughout the markets served by the Corporation. Geographic Distribution December 31, 1998 (in millions) Real Estate Construction Commercial Mortgage Michigan California Texas Florida Other Total $ 460 170 328 66 56 $1,080 $2,540 706 440 150 343 $4,179 Interest Rate Risk Interest rate risk arises primarily through the Corporation’s core business activities of extending loans and taking deposits. The Corporation actively manages its material exposure to interest rate risk. The principal objective of asset and liability management is to maximize net interest income while operating within acceptable limits established for inter- est rate risk and maintaining adequate levels of funding and liquidity. The Corporation utilizes various on- and off-bal- ance sheet financial instruments to manage the extent to Comerica Incorporated which net interest income may be affected by fluctuations in interest rates. The Asset Liability Policy Committee (ALPC) establishes and the board of directors approve corporate policies and risk limits pertaining to asset and liability man- agement activities. The ALPC monitors compliance with these policies, and is comprised of executive and senior management from various areas of the Corporation, includ- ing finance, lending, investments and deposit gathering. The ALPC meets regularly to discuss asset and liability manage- ment strategies. Interest Rate Sensitivity Interest rate risk arises in the normal course of business due to differences in the repricing and maturity characteristics of assets and liabilities. Since no single measurement system satisfies all management objectives, a combination of tech- niques are used to manage interest rate risk, including simu- lation analysis, asset and liability repricing schedules and duration of equity. The ALPC regularly reviews the results of these interest rate risk measurements. The Corporation frequently evaluates net interest income under various balance sheet and interest rate scenarios. The results of these analyses provide the information needed to assess the proper balance sheet structure. An unexpected change in the pace of economic activity, whether domesti- cally or internationally, could translate into a materially dif- ferent interest rate environment than currently expected. A process is maintained where management evaluates “base” net interest income under what is believed to be the most likely balance sheet structure and interest rate environment. This “base” net interest income is then evaluated against interest rate scenarios that are taken up and down 200 basis points from the most likely rate environment. 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 dif- fer from simulated results due to timing, magnitude and fre- quency of interest rate changes and changes in market conditions and management strategies, among other factors. Derivative financial instruments and other financial instru- ments used for purposes other than trading are included in this analysis. The measurement of risk exposure at year-end 1998 for a 200-basis-point decline in short-term interest rates identified approximately $72 million of net interest income at risk during 1999. If short-term interest rates rise 200 basis points, the Corporation would have approximately $49 million of net interest income benefit. Year-end 1997 net interest income at risk was measured at $35 million for a 200-basis-point decline in interest rates and $22 million for a 200-basis-point rise in interest rates. The change in expo- sure is the result of differences in the economic scenarios in the shocked environments and therefore differences in the timing and magnitude of rate changes. Further, anticipated 37 interest rate levels and yield curve differences create faster amortization on certain loans, securities and interest rate swaps in the 1998 rate shock. Corporate policy limits adverse change to no more than 5 percent of management’s most likely net interest income forecast. In either case, the Corporation is within the policy guideline. Most assets and liabilities reprice either at maturity or in accordance with their contractual terms. However, several balance sheet components demonstrate characteristics that require adjustments to more accurately reflect repricing and cash flow behavior. Assumptions based on historical pricing relationships and anticipated market reactions are made to certain core deposit categories to reflect the elasticity of the changes in the related interest rates relative to changes in market interest rates. In addition, estimates are made con- cerning early loan and security repayments. Prepayment assumptions are based on the expertise of portfolio managers along with input from financial markets. Consideration is given to current and future interest rate levels. While man- agement recognizes the limited ability of a traditional gap schedule to accurately portray interest rate risk, adjustments are made to provide a more accurate picture of the Corpora- tion’s interest rate risk profile. This additional interest rate risk measurement tool provides a directional outlook on the impact of changes in interest rates. As market rates approach expected turning points, management adjusts the interest rate sensitivity. This sensitivity is measured as a percentage of earning assets. The operating range for inter- est rate sensitivity, on an elasticity-adjusted basis, is between an asset sensitive position of 10 percent of earning assets and a lia- bility sensitive position of 10 percent of earning assets. The table on page 38 shows the interest sensitivity gap as of year-end 1998 and 1997. The report reflects the contractual repricing and payment schedules of assets and liabilities, including an estimate of all early loan and security repay- ments which adds $540 million of rate sensitivity to the 1998 year-end gap. In addition, the schedule identifies the adjustment for the price elasticity on certain core deposits. The Corporation remained asset sensitive throughout 1998, as asset sensitivity generated by the consumer divestitures cited previously and continued investment security amortization was primarily hedged through the use of interest rate swaps. The Corporation had a one-year asset sensitive gap of $2,111 million, or 6 percent of earning assets, as of December 31, 1998. This compares to a $1,156 million asset sensitive gap, or 3 percent of earning assets, on December 31, 1997. Man- agement anticipates continued material growth in asset sensi- tivity throughout 1999, and will analyze both on- and off-balance sheet alternatives to hedge this increased asset sensitivity and achieve the desired interest rate risk profile for the Corporation. The Corporation utilizes interest rate swaps predominantly as asset and liability management tools with the overall objective of managing the sensitivity of net interest income to changes in interest rates. To accomplish this objective, the Corporation uses interest rate swaps primarily to modify the interest rate characteristics of certain assets and liabilities (e.g., from a floating rate to a fixed rate, a fixed rate to a floating rate, or from one floating rate index to another). This strategy assists management in achieving interest rate risk objectives. Risk Management Derivative Financial Instruments and Foreign Exchange Contracts Risk Management Notional Activity (in millions) Balances at December 31, 1996 Additions Maturities/amortizations Balances at December 31, 1997 Additions Maturities/amortizations Terminations Interest Rate Contracts Foreign Exchange Contracts $8,220 3,857 (3,510) $8,567 3,402 (4,330) (755) $ 482 5,715 (5,598) $ 599 7,218 (6,904) — Totals $ 8,702 9,572 (9,108) $ 9,166 10,620 (11,234) (755) Balances at December 31, 1998 $6,884 $ 913 $ 7,797 The notional amount of risk management interest rate swaps totaled $6,869 million at December 31, 1998, and $8,515 million at December 31, 1997. The fair value of risk man- agement interest rate swaps at December 31, 1998, was a positive $146 million, compared to a positive $123 million at December 31, 1997. For the year ended December 31, 1998, risk management interest rate swaps generated $46 million in net interest income, compared to $51 million in net interest income for the year ended December 31, 1997. These off-balance sheet instruments represented 75 percent of total derivative financial instruments and foreign exchange contracts, including commitments, at year-end 1998 and 74 percent at year-end 1997. The table on page 39 summarizes the expected maturity dis- tribution 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 Decem- ber 31, 1998. The swaps have been grouped by the assets and liabilities to which they have been designated. In addition to interest rate swaps, the Corporation employs various other types of off-balance sheet derivative and for- eign exchange contracts 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 and mortgages held for sale). Such instruments include interest rate caps and floors, purchased put options, foreign exchange forward contracts, foreign exchange gener- ic swap agreements and cross-currency swaps. The aggre- gate notional amounts of these risk management derivative and foreign exchange contracts at December 31, 1998 and 1997, were $928 million and $651 million, respectively. Further information regarding risk management financial instruments and foreign currency exchange contracts is pro- vided in Notes 1, 9, 18 and 25. Comerica Incorporated Table 12: Schedule of Rate Sensitive Assets and Liabilities 38 (dollar amounts in millions) Assets Cash and due from banks Short-term investments Investment securities Commercial loans (including lease financing) International loans Real estate related loans Consumer loans Total loans Other assets Total assets Liabilities Deposits Noninterest-bearing Savings Money market and NOW Certificates of deposit Foreign office Total deposits Short-term borrowings Medium- and long-term debt Other liabilities Total liabilities Shareholders’ equity December 31, 1998 Interest Sensitivity Period December 31, 1997 Interest Sensitivity Period Within One Year Over One Year Within One Year Over One Year Total Total $ — $ 1,773 7 1,831 103 881 $ 1,773 110 2,712 $0000— 196 1,223 $01,927 7 2,783 $01,927 203 4,006 17,555 2,713 3,856 1,044 25,168 618 2,178 — 2,441 818 5,437 19,733 2,713 6,297 1,862 30,605 783 1,401 14,742 2,085 3,907 2,100 22,834 742 1,580 — 2,233 2,248 6,061 16,322 2,085 6,140 4,348 28,895 519 1,261 $26,770 $ 9,831 $36,601 $24,995 $11,297 $36,292 $ 1,451 — 5,991 5,275 1,382 $ 5,548 1,533 1,901 1,232 — $ 6,999 1,533 7,892 6,507 1,382 $00,459 — 5,570 5,562 309 $06,302 1,601 1,724 1,059 — $06,761 1,601 7,294 6,621 309 14,099 10,214 24,313 11,900 10,686 22,586 3,580 3,771 64 — 1,511 315 3,580 5,282 379 3,193 5,961 149 — 1,325 316 3,193 7,286 465 21,514 12,040 33,554 21,203 12,327 33,530 (8) 3,055 3,047 (1) 2,763 2,762 Total liabilities and shareholders’ equity $21,506 $15,095 $36,601 $21,202 $15,090 $36,292 Sensitivity impact of interest rate swaps (5,549) 5,549 Interest sensitivity gap Gap as a percentage of earning assets Sensitivity impact from elasticity adjustments (1) (285) (1)% 2,396 285 1% (2,396) Interest sensitivity gap with elasticity adjustments Gap as a percentage of earning assets $ 2,111 $ (2,111) 6% (6)% — — — — — — (4,377) 4,377 (584) (2)% 584 2% 1,740 (1,740) $01,156 $ (1,156) 3% (3)% — — — — — — (1) Elasticity adjustments for NOW, savings and money market deposit accounts are based on historical pricing relationships dating back to 1985 as well as expected future pricing relationships. Comerica Incorporated Table 13: Remaining Expected Maturity of Risk Management Interest Rate Swaps (dollar amounts in millions) 1999 2000 2001 2002 2003 2004- 2026 Total Dec. 31 1997 Variable Rate Asset Designation: Receive fixed swaps Generic Amortizing Index amortizing Weighted average: (1) Receive rate Pay rate $0,0— $ 0700 — 573 — 1,221 $3,250 — 133 $0,— — 182 $ — $0— $3,950 — — 2,169 — — 60 $0 700 100 3,504 6.35% 5.34% 6.35% 5.33% 5.72% 6.49% 6.14% 5.26% 5.52% 5.58% —% —% 6.01% 5.30% 6.33% 5.90% 39 Floating/floating swaps $0,0— $ — $ — $0,— $ ,— $ 0— $ — $0 55 Fixed Rate Asset Designation: Pay fixed swaps Generic Index amortizing Weighted average: (1) Receive rate Pay rate Medium- and Long-term Debt Designation: $0, 02 4 $ — $0,0— — 7 $,0— — $0— $ 0— $ — — 2 11 $ 2 17 5.44% 6.55% 5.62% 5.34% —% —% —% —% —% —% —% —% 5.54% 5.88% 5.97% 5.85% Generic receive fixed swaps $ 0,— $0200 $0 — $150 $, — $350 $ 700 $2,200 Weighted average: (1) Receive rate Pay rate —% —% 6.91% 5.26% —% 7.37% —% 5.16% —% 7.56% —% 5.34% 7.33% 5.28% 6.84% 5.83% Floating/floating swaps $ — $ 0, 37 $0,0— $,—±— $, — $ ”— $ 37 $1,937 Weighted average: (2) Receive rate Pay rate —% —% 4.98% 5.19% —% —% —% —% —% —% —% —% 4.98% 5.19% 5.73% 5.77% Total notional amount $1,227 $1,517 $ 3,383 $332 $ 60 $350 $6,869 $8,515 (1) Variable rates paid or received are based primarily on one-month and three-month LIBOR rates paid or received at December 31, 1998. (2) Variable rates paid are based on LIBOR at December 31, 1998, while variable rates received are based on prime. Comerica Incorporated Operational Risk Operational risk is the risk of unexpected losses attributable to human error, system failures, fraud, unauthorized trans- actions and inadequate internal controls and procedures. The Corporation mitigates this risk through a system of internal controls that are designed to keep operating risks at appropriate levels. The Corporation’s internal audit staff monitors and assesses the overall effectiveness of the sys- tem of internal controls on an ongoing basis and provides an opinion on the environment to management and the Audit Committee. Companies experience operational losses which are routinely incurred in business operations. Comerica has established an Operational Risk Committee comprised of executives from several disciplines. This group is charged with surfacing significant operational risks which may impact customer service, reputation or result in financial loss if not adequately addressed. The internal audit staff independently supports an active Audit Committee oversight process. The Audit Committee serves as an independent extension of the Board of Direc- tors. Routine and special meetings are scheduled periodical- ly to provide detail on relevant operational risks. Other Matters The Corporation initiated a company-wide project to pre- pare its computer systems, applications and infrastructure for year 2000 readiness. The following discussion of the implications of the year 2000 issue for the Corporation con- tains numerous forward-looking statements based on inher- ently uncertain information. The cost of the project and the planned date to complete the internal year 2000 modifica- tions are based on management’s best estimates, derived uti- lizing a number of assumptions of future events such as the continued availability of internal and external resources, including employees, third party modifications and other fac- tors. However, there can be no guarantee that these estimates will be achieved and actual results could differ. In addition, the Corporation places a high degree of reliance on the computer systems of third parties, such as customers, suppliers, and other financial and governmental institutions. Although the Corporation is assessing the readiness of these third parties and has prepared contingency plans, there can be no guarantee that business-critical third party vendors or other significant third parties, such as public utilities, will adequately address their year 2000 issues. Customer-Initiated and Other Derivative Financial Instruments and Foreign Exchange Contracts Customer-Initiated and Other Notional Activity (in millions) Balances at December 31, 1996 Additions Maturities/amortizations Balances at December 31, 1997 Additions Maturities/amortizations 40 Interest Rate Contracts Foreign Exchange Contracts Totals) $390 464 (358) $496 417 (232) $ 644 43,462 (42,269) $ 1,034 43,926) (42,627) $ 1,837 36,171 (37,335) $ 2,333) 36,588) (37,567) Balances at December 31, 1998 $681 $ 673 $ 1,354) On a limited basis, the Corporation writes interest rate caps and enters into foreign exchange contracts and interest rate swaps to accommodate the needs of customers requesting such services. At December 31, 1998 and 1997, customer- initiated activity represented 15 percent and 20 percent, respectively, of total derivative and foreign exchange con- tracts, including commitments. Refer to Note 18 on page 57 for further information regarding customer-initiated and other derivative financial instruments and foreign exchange contracts. Liquidity Risk Liquidity is the ability to meet financial obligations through the maturity or sale of existing assets or acquisition of addi- tional funds. Liquidity requirements are satisfied with vari- ous funding sources, including a $7.5 billion medium-term note program which allows the Michigan, California and Texas banks to issue debt with maturities between one month and 15 years. The Michigan bank has an additional $2 billion European note program. At year-end 1998, unis- sued debt related to the two programs totaled $5.7 billion. In addition, liquid assets totaled $4.6 billion, at December 31, 1998. The Corporation also had available $1.9 billion from a collateralized borrowing account with the Federal Reserve Bank at year-end 1998. Purchased funds at December 31, 1998, excluding certificates of deposit with maturities beyond one year and medium- and long-term debt, approxi- mated $7.2 billion. The parent company had available a $250 million commer- cial paper facility at December 31, 1998, all of which was unused. Another source of liquidity for the parent company is dividends from its subsidiaries. As discussed in Note 17 on page 57, subsidiary banks are subject to regulation and may be limited in their ability to pay dividends or transfer funds to the holding company. During 1999, the subsidiary banks can pay dividends up to $543 million plus current net profits without prior regulatory approval. One measure of current parent company liquidity is investment in sub- sidiaries as a percent of shareholders’ equity. An amount over 100 percent represents the reliance on subsidiary divi- dends to repay liabilities. As of December 31, 1998, the ratio was 108 percent. Comerica Incorporated 41 Customers and vendors who have significant relationships with the Corporation continue to be evaluated to determine their preparation and readiness for the year 2000. The poten- tial failure of those customers to be adequately prepared for year 2000 is included in management’s credit and review process used to establish loss reserves. A high level risk reduction strategy is being implemented to manage and miti- gate risks to our asset/liability position. There can be no guarantee that the remediation of the systems of the Corpo- ration’s vendors or customers will be completed on a timely basis. The Corporation relies on suppliers and customers for cer- tain information processing services, and is addressing year 2000 issues with both groups. Management has identified critical vendors and inquired as to their year 2000 readiness plans and status. The Corporation has completed written risk assessments on each and has asked those found to pose a significant risk to demonstrate how risks will be addressed. Measures to minimize risk are being undertaken with those that appear to pose a significant risk. There may be certain business-critical third parties, such as utilities or telecommu- nication companies, where alternative arrangements or sources are limited or unavailable. The Corporation is also reliant on its customers to make the necessary preparations for year 2000 so that their business operations will not be interrupted, as an interruption could threaten their ability to honor financial commitments. The Corporation identified borrowers, capital market counterpar- ties, funding sources and large depositors having financial volumes sufficiently large to warrant inquiry as to year 2000 preparation. Written risk assessments have been completed on each. Customers found to have a significant risk of not being ready for year 2000 are encouraged to make the neces- sary effort. The Corporation is undertaking measures to min- imize risk with those that appear to pose a significant risk. Comerica’s senior executives, the board of directors and a project steering committee regularly review the year 2000 program and its progress. In addition, the federal and state agencies that regulate the banking industry regularly monitor our year 2000 program. Readiness Preparation Comerica will be ready to conduct business in the year 2000. The Corporation established an extensive enterprise- wide and centrally managed year 2000 program in early 1996. The year 2000 team includes the active involvement of senior executives as well as seasoned project managers and business unit liaisons from throughout the company. The Corporation is evaluating and monitoring the year 2000 readiness of vendors, customers and third party processors. At Comerica, completing a successful year 2000 program is our top priority so that the arrival of the 21st century will be a celebration of quality customer service. Many factors can affect a company’s ability to deliver quality services at any given time. While we will be “ready” to do business in the year 2000, we of course cannot guarantee that our services will be uninterrupted due to the century date change or otherwise. To minimize customer service disruptions, the Corporation has implemented a no-vacation policy for the entire organization from December 27, 1999, through January 31, 2000. Additional guidelines are being implemented within business units prior- and post-event as required. The Corporation’s year 2000 program is comprised of numerous individual projects which address the following broad areas: data processing systems, telecommunications and data networks, building facilities and security systems, vendor risk, customer risk, contingency planning and com- munications. All mission critical applications and services were significantly year 2000 ready as of December 31, 1998, with the remaining systems planned for completion prior to the end of 1999. As of December 31, 1998, the Cor- poration has completed 75 percent of remediation effort and 45 percent of testing. The Corporation has a major focus on completing testing for all components, having in place what is believed to be an extensive testing methodology, validation and verifica- tion process. To alleviate disruptions due to errors, state of the art data aging and testing tools are being utilized to vali- date year 2000 readiness for applications. The year 2000 program utilizes Comerica’s Year 2000 Testing and Clean Management Guidelines for all components. The Corpora- tion plans to conduct a complete systems test in the second quarter of 1999 to validate its findings. Furthermore, the Corporation is documenting contingency plans for all busi- ness critical applications to minimize any disruptions to customer service caused by year 2000 issues. The Corporation does not significantly rely on embedded technology in its critical processes. Embedded technology does control some building security and operations such as power management, ventilation and elevator control. Build- ing facilities are presently being evaluated, and it is man- agement’s plan to confirm year 2000 readiness or replace the embedded technology by approximately June 30, 1999. Comerica Incorporated Operational failures among the Corporation’s sources of major funding, larger borrowers and capital market counter- parties could affect their ability to continue to provide fund- ing or meet obligations when due. Similar to the situation outlined above with suppliers, public information has not generally been available. At this time, it is not possible to accurately estimate the likelihood, or potential impact, of significant disruptions among the Corporation’s funding sources and obligors. Contingency Plans The Corporation is developing remediation contingency plans and business resumption contingency plans specific to the year 2000. Remediation contingency plans address the actions to be taken if the current approach to remediating a system is falling behind schedule or otherwise appears in jeopardy of failing to deliver a year 2000 ready system when needed. Business resumption contingency plans address the actions that would be taken if critical business functions can not be carried out in the normal manner due to system or supplier failure. The Corporation developed remediation contingency plans with trigger dates for review and implementation for critical data systems. The Corporation is also enhancing its existing business resumption plans to reflect year 2000 issues and is developing plans designed to coordinate the efforts of its personnel and resources in addressing any year 2000 prob- lems that become known after December 31, 1999. This annual report to shareholders includes forward-looking statements based on management’s current expectations and/or the assumptions made in the earnings simulation analysis. Numerous factors could cause variances in these projections, and their underlying assumptions, such as changes in interest rates, the industries where the Corpora- tion has a concentration of loans, changes in the level of fee income, year 2000 expenses, economic conditions and con- tinuing consolidation in the banking industry. 42 Cost Included in the Corporation’s estimate of year 2000 project cost are internal and external development costs, asset impairment write-offs and the cost of software and hardware for systems that are not ready, or would not have been ready by the new century as a result of normal replacement. The Corporation’s current estimate is that year 2000 project cost, both internal and external, will total approximately $50 mil- lion, of which the Corporation incurred approximately $21 million in 1996, 1997 and 1998. The increase in the total estimate from previously reported numbers relates primarily to costs, not yet incurred, associated with expansion of the scope for personal computers and recently approved enhancements to the year 2000 retention incentive plan. Of the $21 million incurred to date, $5 million was for capital assets which the Corporation is expensing over their useful lives. The Corporation will fund the remaining year 2000 costs yet to be incurred by normal operating cash flow. The project is staffed with external resources as well as internal staff redeployed from less time-sensitive assignments. The Corporation does not believe the redeployment of existing staff will have a material adverse effect on its business, results of operations or financial position. Approximately $8 million of the remaining cost is for capital assets which will be expensed over their useful lives. Estimated total project cost could change further as efforts continue. Risks The Corporation has grouped the principal risks associated with the year 2000 problem into three categories. The first is the risk that the Corporation does not successfully ready operations for the year 2000. The Corporation, like other financial institutions, is heavily dependent on computer sys- tems. The complexity of these systems and dependence on one another makes it impossible to switch to other systems immediately as would be required if necessary corrections were not made in advance. Management believes it will be able to make the necessary corrections in advance. Computer failure of third parties may jeopardize the Corpo- ration’s operations, but how seriously depends on the nature and duration of such failures. The most serious impact on the Corporation’s operations from suppliers would result if basic services such as telecommunications, electric power suppliers, and services provided by other financial institu- tions and governmental agencies were disrupted. Significant public disclosure of the state of readiness among basic infra- structure and other suppliers has not generally been avail- able. Although inquiries are underway, the Corporation does not yet have sufficient information to estimate the likelihood of significant disruptions among its suppliers. Comerica Incorporated Consolidated Balance Sheets Comerica Incorporated and Subsidiaries December 31 (in thousands, except share data) Assets Cash and due from banks Short-term investments Investment securities available for sale Commercial loans International loans Real estate construction loans Commercial mortgage loans Residential mortgage loans Consumer loans Lease financing Total loans Less allowance for credit losses Net loans Premises and equipment Customers’ liability on acceptances outstanding Accrued income and other assets Total assets Liabilities and Shareholders’ Equity Noninterest-bearing deposits Interest-bearing deposits Total deposits Federal funds purchased and securities sold under agreements to repurchase Other borrowed funds Acceptances outstanding Accrued expenses and other liabilities Medium- and long-term debt Total liabilities Nonredeemable preferred stock—$50 stated value Authorized—5,000,000 shares Issued—5,000,000 shares in 1998 and 1997 Common stock—$5 par value Authorized—325,000,000 shares Issued—157,233,088 shares in 1998 and 156,815,367 shares in 1997 Capital surplus Unrealized net losses on investment securities available for sale Retained earnings Deferred compensation Less cost of common stock in treasury—1,351,997 shares in 1998 Total shareholders’ equity 1998 1997 $01,773,100 $ 01,927,087 109,640 2,712,165 19,086,541 2,713,259 1,079,614 4,179,271 1,037,941 1,861,630 646,607 30,604,863 43 202,957 4,005,962 15,805,549 2,085,090 940,910 3,633,785 1,565,445 4,347,665 516,600 28,895,044 (452,409) (424,147) 30,152,454 28,470,897 352,650 12,335 1,488,487 380,157 18,392 1,286,946 $36,600,831 $36,292,398 $ 6,999,337 17,313,796 24,313,133 $06,761,202 15,825,115 22,586,317 3,108,985 471,168 12,335 366,338 5,282,259 592,860 2,600,041 18,392 446,625 7,286,387 33,554,218 33,530,622 250,000 250,000 786,165 24,649 (6,455) 2,086,589 (5,202) (89,133) 3,046,613 784,077 —1 (1,937) 1,731,419 (1,783) —0 2,761,776 Total liabilities and shareholders’ equity $36,600,831 $36,292,398 See notes to consolidated financial statements. Comerica Incorporated Consolidated Statements of Income Comerica Incorporated and Subsidiaries Year Ended December 31 (in thousands, except per share data) Interest Income Interest and fees on loans Interest on investment securities Taxable Exempt from federal income tax 44 Total interest on investment securities Interest on short-term investments Total interest income Interest Expense Interest on deposits Interest on short-term borrowings Federal funds purchased and securities sold under agreements to repurchase Other borrowed funds Interest on medium- and long-term debt Net interest rate swap income Total interest expense Net interest income Provision for credit losses 1998 1997 1996 $2,382,329 $2,317,844 $2,160,981 218,378 7,252 225,630 8,815 310,399 10,797 321,196 8,363 372,331 17,443 389,774 12,025 2,616,774 2,647,403 2,562,780 647,825 673,265 685,539 136,616 49,095 367,777 (45,810) 110,752 98,258 374,022 (51,670) 111,729 107,155 294,990 (48,911) 1,155,503 1,204,627 1,150,502 1,461,271 113,000 1,442,776 146,000 1,412,278 114,000 Net interest income after provision for credit losses 1,348,271 1,296,776 1,298,278 Noninterest Income Fiduciary and investment management income Service charges on deposit accounts Commercial lending fees Securities gains Other noninterest income Total noninterest income Noninterest Expenses Salaries and employee benefits Net occupancy expense Equipment expense Outside processing fee expense Restructuring charge Other noninterest expenses Total noninterest expenses Income before income taxes Provision for income taxes Net Income Net income applicable to common stock Basic net income per common share Diluted net income per common share Cash dividends declared on common stock Dividends per common share See notes to consolidated financial statements. Comerica Incorporated 184,354 157,416 43,326 6,116 211,936 603,148 565,303 89,911 60,147 42,785 (6,840) 268,738 147,336 141,078 31,342 5,195 203,001 527,952 538,926 89,380 61,759 41,683 — 276,238 133,482 140,436 23,249 13,588 196,199 506,954 560,784 99,211 68,827 42,481 90,000 297,723 1,020,044 1,007,986 1,159,026 931,375 324,299 816,742 286,266 646,206 229,045 $0,607,076 $0,530,476 $0,417,161 $0,589,976 $0,513,376 $0,408,136 $3.79 3.72 $3.24 3.19 $0 199,403 $1.28 $0,181,272 $1.15 0,0$2.41 0,002.38 $0,170,067 $1.01 Consolidated Statements of Changes in Shareholders’ Equity Comerica Incorporated and Subsidiaries (in thousands, except share data) Non- redeemable Preferred Common Stock Stock Capital Surplus Unrealized Gains and (Losses) on Investment Securities Available for Sale Retained Earnings Compensation Total Deferred Treasury Shareholders’ Equity Stock Balances at January 1, 1996 $5000,— $575,473 $410,618 $ (4,141) $1,640,980 $(1,974) $(13,229) $2,607,727 Net income for 1996 Nonowner changes in equity: Unrealized holding gains/(losses) arising during the period Less: Reclassification adjustment for gains/(losses) included in net income Nonowner changes in equity before income taxes Provision for income taxes related to nonowner changes in equity Nonowner changes in equity, net of tax Net income and nonowner changes in equity Issuance of preferred stock Cash dividends declared: Preferred stock Common stock Purchase and retirement of 12,176,496 shares of common stock Issuance of common stock for: Employee stock plans Acquisitions Amortization of deferred compensation — — — — — — — 250,000 — — — — — — — — — — — — — — — — — — — (3,256) — — — (60,883) (519,924) — 897 — 21,000 — — 14,090 ) 98,472 — 45 —. 417,161 (15,101) 13,588. (28,689) (10,041) (18,648) — — — — — — — — — — (9,025) — (170,067) — — — — (5,065) (20,076) 208 — —. —. —. —. —. —. —. —. —. —. —. —. —. —. —. —. —. —. —. —. 417,161 (15,101) 13,588 (28,689) (10,041) (18,648) 398,513 246,744 (9,025) (170,067) —. (36,324) (622,196) (1,197) — 926 40,295. 9,258 — 34,009 128,938 926 Balances at December 31, 1996 250,000 536,487 526,8— (22,789) 1,854,116 (2,245) .5, 1—) 2,615,569 Net income for 1997 Nonowner changes in equity: Unrealized holding gains/(losses) arising during the period Less: Reclassification adjustment for gains/(losses) included in net income Nonowner changes in equity before income taxes Provision for income taxes related to nonowner changes in equity Nonowner changes in equity, net of tax Net income and nonowner changes in equity Cash dividends declared: Preferred stock Common stock Purchase and retirement of 3,618,479 shares of common stock Issuance of common stock under employee stock plans Amortization of deferred compensation Stock split (three-for-two) — — — — — — — — — — — — — — — — — — — — — — — — — — — — (18,092) (30,750) 4,323 — — — — 261,359 30,750 — — — 530,476 37,275 05,195 32,080 11,228 20,852 — — — — — — — — (17,100) — (181,272) — (193,451) 9 — — — — (261,359) —. —. —. —. —. —. —. —. —. —. (531) 993 —. —. 530,476 —. —. —. —. —. —. —. —. —. —. —. —. 37,275 5,195 32,080 11,228 20,852 551,328 (17,100) (181,272) (242,293) 34,551 993 — Balances at December 31, 1997 250,000 784,077 0001— (1,937) 1,731,419 (1,783) .000,—. 2,761,776 Net income for 1998 Nonowner changes in equity: Unrealized holding gains/(losses) arising during the period Less: Reclassification adjustment for gains/(losses) included in net income Nonowner changes in equity before income taxes Provision for income taxes related to nonowner changes in equity Nonowner changes in equity, net of tax Net income and nonowner changes in equity Cash dividends declared: Preferred stock Common stock Purchase and retirement of 60,000 shares of common stock Purchase of 2,199,650 shares of common stock Issuance of common stock under employee stock plans Amortization of deferred compensation — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — 5607,076 (835) 6,116) (6,951) (2,433) (4,518) — — — — — — — — (17,100) — (199,403) (300) (3,182) — — 2,388 — 27,831 — — — — — — — —. —. —. —. —. —. —. —. —. —. — 607,076 —. —. (835) 6,116 —.2,080 (6,951) —. —. —. —. —. —. (2,433) (4,518) 602,558 (17,100) (199,403) (3,482) —. (145,202). (145,202) Balances at December 31, 1998 $250,000 $786,165 $ 24,649 $ (6,455) $2,086,589 $ (5,202).$ (89,133) $3,046,613 ( ) Indicates deduction. See notes to consolidated financial statements. Comerica Incorporated (35,403) — (4,604) 1,185 56,069. —. 46,281 1,185 Consolidated Statements of Cash Flows Comerica Incorporated and Subsidiaries Year Ended December 31 (in thousands) Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities 46 Provision for credit losses Depreciation Restructuring charge Net (increase) decrease in trading account securities Net (increase) decrease in loans held for sale Net (increase) decrease in accrued income receivable Net increase (decrease) in accrued expenses Net amortization of intangibles Funding for employee benefit plans Other, net Total adjustments Net cash provided by operating activities Investing Activities Net (increase) decrease in interest-bearing deposits with banks Net (increase) decrease in federal funds sold and securities purchased under agreements to resell Proceeds from sale of investment securities available for sale Proceeds from maturity of investment securities available for sale Purchases of investment securities available for sale Net increase in loans (other than loans purchased) Purchase of loans Fixed assets, net Net (increase) decrease in customers’ liability on acceptances outstanding Net cash provided by acquisitions/sales Net cash provided by (used in) investing activities Financing Activities Net increase (decrease) in deposits Net increase (decrease) in short-term borrowings Net increase (decrease) in acceptances outstanding Proceeds from issuance of medium- and long-term debt Repayments and purchases of medium- and long-term debt Proceeds from issuance of preferred stock Proceeds from issuance of common stock Purchase of common stock for treasury and retirement Dividends paid Net cash provided by (used in) financing activities Net increase (decrease) in cash and due from banks Cash and due from banks at beginning of year Cash and due from banks at end of year Interest paid Income taxes paid Noncash investing and financing activities Loan transfers to other real estate Stock issued for acquisitions See notes to consolidated financial statements. Comerica Incorporated 1998 1997 1996 $ 607,076 $0 530,476 $0 417,161 113,000 57,633 (21,923) 2,796 (5,236) 19,487 2,973 30,414 — (116,295) 146,000 58,529 (61,237) (3,093) (2,666) (23,730) 54,330 28,375 — (134,982) 114,000 66,776 90,000 4,659 473,493 924 (39,720) 30,803 (25,000) 187,438 82,849 61,526 903,373 689,925 592,002 1,320,534 (1,184) 24,010 (3,705) 96,941 111,511 1,209,291 (126,239) (3,768,220) (1,115) (35,609) 6,057 1,878,907 (117,601) 238,506 1,456,447 (924,509) (2,615,226) (162,128) (31,023) 14,710 — 4,898 1,211,250 1,531,012 (643,796) (1,852,199) (77,805) (46,038) (12,341) 200,459 (629,660) (2,116,814) 311,735 1,726,816 387,252 (6,057) 3,200,000 (5,212,498) — 50,885 (148,684) (211,966) 219,144 (1,296,290) (14,710) 5,600,000 (2,555,382) — 35,082 (242,293) (195,412) (825,859) (129,056) 12,341 2,251,000 (2,553,650) 246,744 35,206 (622,196) (173,414) (214,252) 1,550,139 (1,758,884) (153,987) 1,927,087 25,327 1,901,760 (126,615) 2,028,375 $1,773,100 $1,927,087 $1,901,760 $1,188,599 $1,161,812 $1,201,146 $ 256,880 $0,266,428 $0,212,530 $ $ 5,084 $0,017,076 $0,010,534 — $0,128,9— $0,128,938 Notes to Consolidated Financial Statements Comerica Incorporated and Subsidiaries 1 Accounting Policies Organization Comerica Incorporated is a registered bank holding company headquartered in Detroit, Michigan. The Corporation’s principal lines of business are the Business Bank, the Individual Bank and the Investment Bank. The core businesses are tailored to each of the Corporation’s four primary geographic markets: Michigan, Texas, California and Florida. The accounting and reporting policies of Comerica Incorporated and its subsidiaries conform to generally accepted accounting principles and prevailing practices within the banking industry. Management makes estimates and assumptions that affect the amounts reported in the financial statements and accompanying footnotes. Actual results could differ from these estimates. The following is a summary of the more significant accounting and reporting policies. Consolidation The consolidated financial statements include the accounts of the Corporation and its subsidiaries after elimination of all significant intercompany accounts and transactions. Prior years’ financial statements are reclassified to conform with current financial statement presentation. For acquisitions accounted for as pooling-of-interests combina- tions, the historical consolidated financial statements are restat- ed to include the accounts and results of operations. For acquisitions using the purchase method of accounting, the assets acquired and liabilities assumed are adjusted to fair market val- ues at the date of acquisition, and the resulting net discount or premium is accreted or amortized into income over the remain- ing lives of the relevant assets and liabilities. Goodwill repre- senting the excess of cost over the net book value of identifiable assets acquired is amortized on a straight-line basis over periods ranging from 10 to 30 years (weighted average of 18 years). Core deposit intangible assets are amortized on an accelerated method over 10 years. Loans Held for Sale Loans held for sale, normally mortgages, are carried at the lower of cost or market. Market value is determined in the aggregate. Securities Investment securities held to maturity are those securities which management has the ability and positive intent to hold to matu- rity. Investment securities held to maturity are stated at cost, adjusted for amortization of premium and accretion of discount. Investment securities that fail to meet the ability and positive intent criteria are accounted for as securities available for sale, and stated at fair value with unrealized gains and losses, net of income taxes, reported as a component of shareholders’ equity. Trading account securities are carried at market value. Realized and unrealized gains or losses on trading securities are included in noninterest income. Gains or losses on the sale of securities are computed based on the adjusted cost of the specific security. 47 Premises and Equipment Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation, computed on the straight-line method, is charged to operations over the estimated useful lives of the properties. Leasehold improvements are amortized over the terms of their respective leases or the esti- mated useful lives of the improvements, whichever is shorter. Allowance for Credit Losses The allowance for credit losses reflects management’s assess- ment of possible losses inherent in the Corporation’s on- and off-balance sheet credit portfolio. The allowance for credit loss- es attributable to the off-balance sheet credit portfolio is not material. The allowance for credit losses is allocated to each loan category based on a defined methodology, which has been in use, without material change, for several years. First, an inter- nal risk rating is assigned to each commercial loan. Included in that risk rating is management’s assessment of the potential fail- ure of a customer to be adequately prepared for the year 2000, but only in those instances where management has significant information that a customer may not be adequately prepared. Management then assigns a projected loss ratio to each risk rat- ing based on numerous factors identified below. A detailed cred- it quality review is performed quarterly on certain commercial loans which have deteriorated below certain levels of credit risk, resulting in an additional allocation of a specific portion of the allowance to such loans. The portion of the allowance allocated to consumer loans is determined by applying projected loss ratios to various segments of the loan portfolio. Projected loss ratios incorporate factors such as recent loan loss experience, current economic conditions and trends, geographic dispersion of borrowers, trends with respect to past due and nonaccrual amounts, risk characteristics of various categories and concen- trations of loans and transfer risks. However, actual loss ratios experienced in the future could vary from those projected. This uncertainty occurs because a loan’s performance depends, not only on economic factors, but also other factors unique to each customer. In addition, the significant diversity in size of corpo- rate loans means that even if the projected number of loans deteriorate, the dollar exposure could significantly vary from estimated amounts. Management also considers industry norms, and the expectations and input from rating agencies and bank- ing regulators in determining the adequacy of the allowance. Loans which are deemed uncollectible are charged off and deducted from the allowance. The provision for credit losses and recoveries on loans previously charged off are added to the allowance. Comerica Incorporated 48 1 Accounting Policies (continued) Nonperforming Assets Nonperforming assets are comprised of loans for which the accrual of interest has been discontinued, loans for which the terms have been renegotiated to less than market rates due to a serious weakening of the borrower’s financial condition and other real estate which has been acquired primarily through foreclosure and is awaiting disposition. Consumer loans are generally not placed on nonaccrual status and are directly charged off no later than 180 days past due, or earlier if deemed uncollectible. Loans other than consumer are generally placed on nonaccrual status when principal or interest is past due 90 days or more and/or when, in the opinion of management, full collection of principal or interest is unlikely. At the time a loan is placed on nonaccrual status, interest previ- ously accrued but not collected is charged against current income. Income on such loans is then recognized only to the extent that cash is received and where future collection of prin- cipal is probable. Other real estate acquired is carried at the lower of cost or fair value, minus estimated costs to sell. When the property is acquired through foreclosure, any excess of the related loan balance over fair value is charged to the allowance for credit losses. Subsequent write-downs, operating expenses and losses upon sale, if any, are charged to noninterest expenses. Stock-Based Compensation The Corporation elected to continue to apply Accounting Prin- ciples Board opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in measuring and rec- ognizing compensation expense for its stock-based compensa- tion plans, and to disclose the pro forma effect of applying the fair value method contained in Statement on Financial Account- ing Standards (SFAS) No. 123, “Accounting for Stock-based Compensation.” Information on the Corporation’s stock-based compensation plans is included in Note 12. Pension Costs Pension costs are charged to salaries and employee benefits expense and funded consistent with the requirements of federal law and regulations. Postretirement Benefits Postretirement benefits are recognized in the financial state- ments during the employee’s active service period. Derivative Financial Instruments and Foreign Exchange Contracts Interest rate and foreign exchange swaps, interest rate caps and floors, and futures and forward contracts may be used to man- age the Corporation’s exposure to interest rate and foreign cur- rency risks. These instruments, with the exception of futures and forwards, are accounted for on an accrual basis since there is a high correlation with the on-balance sheet instrument being Comerica Incorporated hedged. If this correlation ceases to exist, the existing unreal- ized gain or loss is amortized over the remaining term of the instrument, and future changes in fair value are accounted for in noninterest income or expense. Net interest income or expense, including premiums paid or received, is recognized over the life of the contract and reported as an adjustment to interest expense. Realized gains and losses on futures and forwards are generally deferred and amortized over the life of the contract as an adjustment to net interest income. Gains or losses on early termination of risk management derivative financial instruments are deferred and amortized as an adjustment to the yields of the related assets or liabilities over their remaining contractual life. If the designated asset or liability matures, or is disposed of or extinguished, any unrealized gains or losses on the related derivative instrument are recognized currently and reported as an adjustment to interest expense. Foreign exchange futures and forward contracts, foreign currency options, interest rate caps and interest rate swap agree- ments executed as a service to customers are accounted for on a fair value basis. As a result, the fair values of these instruments are recorded in the consolidated balance sheet with both real- ized and unrealized gains and losses recognized currently in noninterest income. Income Taxes Provisions for income taxes are based on amounts reported in the statements of income (after exclusion of nontaxable income such as interest on state and municipal securities) and include deferred income taxes on temporary differences between the tax basis and financial reporting basis of assets and liabilities. Statements of Cash Flows For the purpose of presentation in the statements of cash flows, cash and cash equivalents are defined as those amounts includ- ed in the balance sheet caption, “Cash and due from banks.” Loan Origination Fees and Costs Loan origination and commitment fees are deferred and recog- nized over the life of the related loan or over the commitment period as a yield adjustment. Loan fees on unused commit- ments and fees related to loans sold are recognized currently as noninterest income. Nonowner Changes in Equity In 1997, the Corporation adopted SFAS No. 130, “Reporting Comprehensive Income.” This statement establishes standards for the reporting and display of net income and nonowner changes in equity and its components in a full set of general- purpose financial statements. The Corporation has elected to present information regarding this statement in the Consolidated Statements of Changes in Shareholders’ Equity on page 45. The caption “Net income and nonowner changes in equity,” represents total comprehensive income as defined in the state- ment. 2 Acquisitions During 1998, Comerica obtained a majority interest in Munder Capital Management, an investment advisory firm. Net income for the third and fourth quarter of 1998 includes the consolidated financial results of Munder. The Corporation’s minority interest in periods prior to the third quarter of 1998 was accounted for under the equity method. Intangible assets increased $133 million as a result of the consolidation. The fair market value of total assets acquired and total liabilities assumed was not material. 3 Investment Securities Information concerning investment securities as shown in the consolidated balance sheets of the Corporation was as follows: Gross Gross (in thousands) Cost Unrealized Unrealized Estimated Fair Value Losses Gains December 31, 1998 U.S. government and agency securities State and municipal securities Other securities Total securities available for sale December 31, 1997 U.S. government and agency securities State and municipal securities Other securities Total securities available for sale $2,196,736 $13,463 $ 3,993 $2,206,206 110,711 415,901 4,587 2,129 48 27,321 115,250 390,709 $2,723,348 $20,179 $31,362 $2,712,165 $3,239,423 $24,223 $24,994 $3,238,652 1164,394 603,176 5,902 7,584 244 13,502 170,052 597,258 $4,006,993 $37,709 $38,740 $4,005,962 The cost and estimated fair values of debt securities by con- tractual maturity were as follows (securities with multiple maturity dates are classified in the period of final maturity). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. During 1996, Comerica acquired Metrobank, which was accounted for as a purchase. The fair market value of both total assets acquired and total liabilities assumed was $1 bil- lion. The purchase price of the transaction totaled $125 mil- lion. Intangible assets recorded were $62 million. 49 December 31, 1998 (in thousands) Contractual maturity Within one year Over one year to five years Over five years to ten years Over ten years Subtotal securities Mortgage-backed securities Equity and other nondebt securities Total securities available for sale Estimated Fair Value Cost $ 86,471 $ 86,698 229,832 232,735 104,535 58,508 94,834 44,343 479,346 458,610 2,158,400 2,167,837 85,602 85,718 $2,723,348 $2,712,165 Sales and calls of investment securities available for sale resulted in realized gains and losses as follows: Year Ended December 31 (in thousands) Securities gains Securities losses Total Available for Sale 1998 1997 $ 7,629 (1,513) $ 6,890 (1,695) $ 6,116 $ 5,195 Assets, principally securities, carried at approximately $1.9 billion at December 31, 1998, were pledged to secure public deposits (including State of Michigan deposits of $39 million at December 31, 1998) and for other purposes as required by law. Comerica Incorporated A loan is impaired when it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement. Consis- tent with this definition, all nonaccrual and reduced-rate loans (with the exception of residential mortgage and consumer loans) are impaired. December 31 (in thousands) Average impaired loans for the year Total period-end impaired loans Period-end impaired loans requiring an allowance Impairment allowance 1998 1997 1996 $ 85,500 101,417 $73,502 70,470 $114,253 98,050 87,494 21,951 60,376 20,358 59,960 19,528 Those impaired loans not requiring an allowance repre- sent loans for which the fair value exceeded the recorded investment in the loan. Eighty-one percent of the total impaired loans at December 31, 1998, are evaluated based on fair value of related collateral. Remaining loan impairment is based on the present value of expect- ed future cash flows discounted at the loan’s effective interest rate. 4 Nonperforming Assets The following table summarizes nonperforming assets and loans which are contractually past due 90 days or more as to interest or principal payments. Nonperforming assets consist of nonaccrual loans, reduced-rate loans and other real estate. Nonaccrual loans are those on which interest is not being recognized. Reduced-rate loans are those on which interest has been renegotiated to lower than market rates because of the weakened financial condition of the borrower. 50 Nonaccrual and reduced-rate loans are included in loans on the consolidated balance sheet. December 31 (in thousands) Nonaccrual loans Commercial loans International loans Real estate construction loans Commercial mortgage loans Residential mortgage loans Total Reduced-rate loans 1998 1997 $077,175 20,350 452 6,788 3,468 $058,914 1,000 3,438 11,088 3,719 108,233 78,159 7,464 7,583 Total nonperforming loans 115,697 85,742 Other real estate 4,956 17,046 Total nonperforming assets $120,653 $102,788 Loans past due 90 days and still accruing $040,209 $052,805 Gross interest income that would have been recorded had the nonaccrual and reduced-rate loans performed in accordance with original terms $ 13,674 $010,088 Interest income recognized $ 3,899 $002,399 5 Allowance for Credit Losses An analysis of changes in the allowance for credit losses follows: (in thousands) 1998 1997 1996 Balance at January 1 Allowance of institutions purchased/sold Loans charged off Recoveries on loans previously $424,147 $367,165 $341,344 — (125,627) — (131,140) (3,630) (125,912) charged off 40,889 42,122 41,363 Net loans charged off Provision for credit losses (84,738) 113,000 (89,018) 146,000 (84,549) 114,000 Balance at December 31 $452,409 $424,147 $367,165 As a percent of total loans 1.48% 1.47% 1.40% Comerica Incorporated 6 Significant Group Concentrations of Credit Risk Concentrations of both on-balance sheet and off-balance sheet credit risk are controlled and monitored as part of credit policies. The Corporation is a regional bank holding company with a geographic concentration of its on-balance sheet and off-balance sheet activities centered in Michigan. In addition, the Corporation has an industry concentration with the automotive industry, which includes manufacturers and their finance subsidiaries, suppliers, dealers and company executives. At December 31, 1998 and 1997, exposure from loan commitments and guarantees to companies related to the automotive industry totaled $9.0 billion and $8.3 billion, respectively. Additionally, commercial real estate loans, including commercial mortgages and construction loans, totaled $5.3 billion in 1998 and $4.6 billion in 1997. Approximately $2.4 billion of commercial real estate loans at December 31, 1998, involved mortgages on owner-occupied properties. Those borrowers are involved in business activities other than real estate, and the sources of repayment are not dependent on the performance of the real estate market. 51 7 Premises and Equipment and Other Noncancelable Obligations Rental expense for leased properties and equipment amount- ed to $41 million in 1998 and 1997, and $44 million in 1996. Future minimum payments under noncancelable obligations are as follows: (in thousands) 1999 2000 2001 2002 2003 2004 and later $044,466 044,113 040,723 036,497 032,764 283,234 At December 31, 1998, the parent company had available a $250 million commercial paper facility. This facility is supported by a $250 million line of credit agreement, all of which was unused. Under the current agreement the line will expire in May of 1999. A summary of premises and equipment at December 31 by major category follows: (in thousands) Land Buildings and improvements Furniture and equipment Total cost 1998 1997 $049,356 341,260 327,498 $ 52,934 353,308 344,681 718,114 750,923 Less accumulated depreciation and amortization (365,464) (370,766) Net book value $352,650 $380,157 8 Short-term Borrowings Federal funds purchased and securities sold under agree- ments to repurchase generally mature within one to four days from the transaction date. Other borrowed funds, con- sisting of commercial paper, borrowed securities, term feder- al funds purchased, short-term notes and treasury tax and loan deposits, generally mature within one to 120 days from the transaction date. The following is a summary of short- term borrowings at December 31, 1998 and 1997: Federal Funds Purchased and Securities Sold Under Agreements to Repurchase Other Borrowed Funds $3,108,985 $ 471,168 4.83% 3.91% $1,592,860 $2,600,041 (in thousands) December 31, 1998 Amount outstanding at year-end Weighted average interest rate at year-end December 31, 1997 Amount outstanding at year-end Weighted average interest rate at year-end 5.26% 5.30% Comerica Incorporated 9 Medium- and Long-term Debt Medium- and long-term debt consisted of the following at December 31: All subordinated notes and debentures with maturities greater than one year qualify as Tier 2 capital. (in thousands) 1998 1997 Parent Company 7.25% subordinated notes due 2007 9.75% subordinated notes due 1999 10.125% subordinated debentures due 1998 $ 159,669 74,970 — $ 148,509 74,877 74,965 52 Total parent company 234,639 298,351 Subsidiaries Subordinated notes: 7.25% subordinated notes due 2007 8.375% subordinated notes due 2024 7.25% subordinated notes due 2002 6.875% subordinated notes due 2008 7.125% subordinated notes due 2013 7.875% subordinated notes due 2026 6.00% subordinated notes due 2008 198,301 155,502 149,404 104,186 155,181 174,086 247,798 198,100 147,938 149,246 99,220 148,224 146,914 — Total subordinated notes 1,184,458 889,642 Medium-term notes: Floating rate based on LIBOR indices Floating rate based on Treasury indices Floating rate based on Prime indices Floating rate based on Federal Funds indices Fixed rate notes with interest rate 3,612,076 37,000 2,811,793 487,000 — 1,100,007 — 349,998 of 6.65% 199,810 1,349,596 During 1998, the Corporation terminated certain swaps that hedged the fixed interest rate exposure of several debt instruments. In accordance with policy, the gain resulting from early termination was deferred and is being amortized over the remaining life of the debt. The unamortized balance is included in the carrying value of debt outstanding. The Corporation currently has two medium-term note pro- grams: a senior note program and a European note program. Under these programs, certain bank subsidiaries may offer an aggregate principal amount of up to $9.5 billion. The notes can be issued as fixed or floating rate notes and with terms from one month to 15 years. The interest rates on the floating rate medium-term notes based on LIBOR ranged from three-month LIBOR minus 0.14% to three-month LIBOR plus 0.10%. The notes are due from 1999 to 2002. The interest rate on the floating rate medium-term notes based on U.S. Treasury indices is equal to the two-year Constant Treasury Maturity Rate plus 0.01%. The notes are due in 2000. The fixed rate notes mature in 2000. The medi- um-term notes do not qualify as Tier 2 capital and are not insured by the FDIC. The principal maturities of medium- and long-term debt are as follows: $2,826,907 469,043 316,517 485,422 2,587 1,181,783 Total medium-term notes 3,848,886 6,098,394 (in thousands) Notes payable 14,276 — Total subsidiaries 5,047,620 6,988,036 Total medium- and long-term debt $5,282,259 $7,286,387 Concurrent with the issuance of certain of the medium- and long-term debt presented above, the Corporation entered into interest rate swap agreements to convert the stated rate of the debt to a rate based on the indices identified in the following table: 1999 2000 2001 2002 2003 2004 and later (in thousands) Subsidiaries Subordinated notes: 7.25% subordinated notes 7.25% subordinated notes Medium-term notes: Floating rate based on LIBOR indices Floating rate based on Treasury indices Fixed rate notes with interest rate of 6.65% Principal Amount of Debt Converted Base Rate at 12/31/98 Base Rate $200,000 6-month LIBOR 5.16% 150,000 6-month LIBOR 5.16 108,000 3-month LIBOR 37,000 3-month LIBOR 5.28 5.28 200,000 3-month LIBOR 5.28 Comerica Incorporated 10 Shareholders’ Equity The board of directors authorized the repurchase of up to 40.5 million shares of Comerica Incorporated common stock for general corporate purposes, acquisitions and employee benefit plans. At December 31, 1998, 20.5 million shares had been repurchased under this program. At December 31, 1998, the Corporation had reserved 8.4 million shares of common stock for issuance to employees and directors under the long-term incentive plans. In January 1998, the Corporation declared a three-for-two stock split, effected in the form of a 50 percent stock divi- dend paid April 1, 1998. All per share data included in the consolidated financial statements and in the related notes have been retroactively adjusted to reflect the split. 11 Net Income per Common Share Basic net income per common share is computed by divid- ing net income applicable to common stock by the weighted average number of shares of common stock outstanding dur- ing the period. Diluted net income per common share is computed by dividing net income applicable to common stock by the weighted average number of shares, nonvested stock and dilutive common stock equivalents outstanding during the period. Common stock equivalents consist of common stock issuable under the assumed exercise of stock options granted under the Corporation’s stock plans, using the treasury stock method. A computation of earnings per share follows: The Corporation issued 5 million shares of Fixed/Adjustable Rate Noncumulative Preferred Stock, Series E, with a stated value of $50 per share. Dividends are payable quarterly, at a rate of 6.84% per annum through July 1, 2001. Thereafter, the rate will be equal to 0.625% plus an effective rate, but not less than 7.34% nor greater than 13.34%. The effective rate will be equal to the highest of the Treasury Bill Rate, the Ten Year Constant Treasury Maturity Rate and the Thirty Year Constant Treasury Maturity Rate (as defined in the prospectus). The Corporation, at its option, may redeem all or part of the outstanding shares on or after July 1, 2001. 53 Year Ended December 31 (in thousands, except per share data) 1998 1997 1996 Basic Average shares outstanding 155,859 158,333 169,076 Net income Less preferred stock dividends $607,076 17,100 $530,476 17,100 $417,161 9,025 Net income applicable to common stock Basic net income per common share $589,976 $513,376 $408,136 $3.79 $3.24 $2.41 Diluted Average shares outstanding Nonvested stock Common stock equivalents Net effect of the assumed 155,859 191 158,333 204 169,076 195 exercise of stock options 2,707 2,503 1,956 Diluted average shares 158,757 161,040 171,227 Net income Less preferred stock dividends $607,076 17,100 $530,476 17,100 $417,161 9,025 Net income applicable to common stock Diluted net income per common share $589,976 $513,376 $408,136 $3.72 $3.19 $2.38 Comerica Incorporated 54 12 Long-term Incentive Plans The Corporation has long-term incentive plans under which it has awarded both shares of restricted stock to key execu- tive officers and stock options to executive officers, directors and key personnel of the Corporation and its subsidiaries. The Corporation has elected to follow Accounting Principles Board opinion No. 25, “Accounting For Stock Issued to Employees” (APB 25) and related Interpretations in account- ing for its employee and director stock options. Under APB 25, no compensation expense is recognized because the exer- cise price of the Corporation’s employee and director stock options equals the market price of the underlying stock on the date of grant. The maturity of each option is determined at the date of grant; however, no options may be exercised later than ten years from the date of grant. The options may have restrictions regarding exercisability. Pro forma information regarding net income and earnings per share is required under SFAS No. 123, “Accounting for Stock-Based Compensation,” and has been determined as if the Corporation had accounted for its employee and director stock options under the fair value method of that Statement. The fair value of options was estimated at the date of grant using a Black-Scholes option pricing model. The Black- Scholes model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation mod- els require the input of highly subjective assumptions includ- ing the expected stock price volatility. The Black-Scholes model may not necessarily provide a reliable single measure of the fair value of employee and director stock options. The Corporation’s employee and director stock options have characteristics significantly different from those of traded options and changes in the subjective input assumptions can materially affect the fair value estimate. The fair value of the options was estimated using a Black- Scholes option valuation model with the following weighted- average assumptions for 1998, 1997 and 1996, respectively: risk-free interest rates of 5.54%, 6.49% and 6.07%; expected dividend yields of 3.45%, 3.77% and 4.00%; expected volatility factors of the market price of Comerica Common Stock of 21%, 20% and 21%; and an expected life of the options of 4.3, 4.4 and 5.0 years. For purposes of pro forma disclosures, the estimated fair value of the options granted in 1995 and thereafter is amortized to expense over the options’ vesting period. Since the Corporation’s options generally vest over a four-year period, the pro forma disclosures are not indicative of future amounts until SFAS No. 123 is applied to all outstanding nonvested options. Had compensation cost for the Corporation’s stock-based compensation plans been determined in accordance with the fair value provisions of SFAS No. 123, net income and earn- ings per share would have been as follows: (in thousands, except per share data) 1998 1997 1996 Pro forma net income $578,335 $506,875 $404,121 Pro forma earnings per share: Basic Diluted $3.71 3.64 $3.20 3.15 $2.39 2.36 Average per Share Exercise Market Price Price $16.39 25.61 18.95 12.78 $26.67 25.61 28.95 29.34 8.49 26.42 $18.95 40.28 26.00 15.93 $24.77 71.37 42.92 21.33 $34.92 40.28 43.07 44.81 $60.17 71.37 64.33 64.07 Number 6,768,497 1,894,143 (321,119) (1,775,613) — 595,718 7,161,626 1,994,182 (266,295) (1,252,170) — 7,637,343 2,058,542 (232,617) (1,213,818) — Outstanding—December 31, 1995 Granted Cancelled Exercised Expired Acquisition of Metrobank Outstanding—December 31, 1996 Granted Cancelled Exercised Expired Outstanding—December 31, 1997 Granted Cancelled Exercised Expired Outstanding—December 31, 1998 7,68,249,450 $36.39 $68.19 Exercisable—December 31, 1998 Available for grant— December 31, 1998 4,173,748 104,458 The following table summarizes information about stock options outstanding at December 31, 1998: Outstanding Exercisable Exercise Price Range Average Shares Life (a) $ 8.59 - $18.00 18.59 - 21.00 21.59 - 25.42 28.33 - 52.67 65.13 - 71.58 Total 1,264,438 1,453,242 1,817,533 1,719,856 1,994,381 8,249,450 3.3 5.4 6.3 8.1 9.2 6.8 Average Exercise Price $13.70 19.01 24.43 39.86 71.37 Average Exercise Price $13.70 19.11 23.75 39.30 — Shares 1,263,912 1,147,004 1,073,750 689,082 — $36.39 4,173,748 $22.00 (a) Average contractual life remaining in years. Comerica Incorporated 13 Employee Benefit Plans The Corporation has a defined benefit pension plan in effect for substantially all full-time employees. Staff expense includes income of $3.0 million in 1998, $0.3 million in 1997 and $1.4 million in 1996 for the plan. Benefits under the plan are based pri- marily on years of service and the levels of compensation during the five highest paid consecutive calendar years occurring during the last ten years before retirement. The plan's assets primarily consist of units of certain collective investment funds administered by Munder Capital Management, equity securities, U.S. govern- ment and agency securities and corporate bonds and notes. The Corporation’s postretirement benefits plan continues postre- tirement health care and life insurance benefits for retirees as of December 31, 1992, provides a phase-out for employees over 50 as of that date and substantially reduces all benefits for remaining employees. The Corporation has funded the plan with a company- owned life insurance contract. The following tables set forth reconciliations of the Corporation's pension and postretirement plan obligations and plan assets: Defined Benefit Pension Plan Postretirement Benefit Plan Components of net periodic benefit cost/(income): Defined Benefit Pension Plan (in thousands) Service cost Interest cost Expected return on plan assets Amortization of unrecognized 1998 1997 1996 $13,924 36,039 (48,887) $12,400 33,823 (42,313) $11,675 31,572 (39,654) transition asset (4,834) (4,834) (4,834) Amortization of unrecognized prior service cost Amortization of unrecognized net loss (331) 1,071 (353) 978 (338) 188 55 Net periodic benefit income $ (3,018) $ (299) $ (1,391) Postretirement Benefit Plan (in thousands) Service cost Interest cost Expected return on plan assets Amortization of unrecognized transition obligation Amortization of unrecognized net gain 1998 1997 1996 $ 262 5,509 (5,829) $ 273 5,710 (5,413) $ 402 5,597 (5,205) 4,628 — 4,628 (56) 4,628 (377) (in thousands) 1998 1997 1998 1997 Net periodic benefit cost $4,570 $5,142 $5,045 Change in benefit obligation: Benefit obligation at January 1 $525,329 $462,776 $81,584 $76,420 273 Service cost 5,710 Interest cost — Curtailment 5,979 Actuarial (gain)/loss (6,798) Benefits paid 13,924 36,039 (5,518) (3,631) (23,202) 12,400 33,823 — 39,720 (23,390) 262 5,509 — (423) (6,222) Actuarial assumptions were as follows: Defined Benefit Pension Plan 1998 1997 1996 Discount rate used in determining benefit obligation Long-term rate of return on assets Rate of compensation increase 7.0% 7.0% 7.5% 9.0% 9.0% 9.0% 5.0% 5.0% 5.0% Benefit obligation at December 31 $542,941 $525,329 $80,710 $81,584 Postretirement Benefit Plan 1998 1997 1996 Change in plan assets: Fair value of plan assets at January 1 Actual return on plan assets Employer contributions Benefits paid Fair value of plan assets at $585,215 $515,164 $86,727 $80,547 7,941 5,037 (6,798) 66,181 — (23,202) 89,527 3,914 (23,390) 4,226 3,581 (6,222) December 31 $628,194 $585,215 $88,312 $86,727 The following table sets forth the funded status of the defined benefit pension and postretirement plan and amounts recognized on the Corporation’s balance sheet: Defined Benefit Pension Plan Postretirement Benefit Plan (in thousands) 1998 1997 1998 1997 Funded status at December 31 Unrecognized net gain Unrecognized net transition (asset)/obligation Unrecognized prior service cost $85,253 $59,886 $ 7,602 $ 5,143 (8,294) (44,829) (22,834) (7,115) (10,524) (2,394) (15,358) 64,477 — (2,956) 69,105 — Prepaid benefit cost $27,506 $18,738 $64,964 $65,954 Discount rate used in determining benefit obligation Long-term rate of return on assets 7.0% 7.0% 7.5% 6.7% 6.7% 6.7% A 6 percent health care cost trend rate was projected for 1998 and is assumed to decrease gradually to 5 percent during 1999, remaining constant thereafter. Increasing each health care rate by one percentage point would increase the accumu- lated postretirement benefit obligation by $6 million at December 31, 1998, and the aggregate of the service and interest cost components by $392 thousand for the year ended December 31, 1998. Decreasing each health care rate by one percentage point would decrease the accumulated postretire- ment benefit obligation by $5 million at December 31, 1998, and the aggregate of the service and interest cost components by $341 thousand for the year ended December 31, 1998. The Corporation also maintains defined contribution plans (including 401(k) plans) for various groups of its employees. All of the Corporation’s salaried and regular part-time employees are eligible to participate in one or more of the plans. The Corporation makes matching contributions, most of which are based on a declining percentage of employee contributions (currently, maximum per employee is $1,000) as well as a performance-based matching contribution based on the Corporation’s financial performance. Staff expense includes expense of $10.3 million in 1998, $9.7 million in 1997 and $10.4 million in 1996 for the plans. Comerica Incorporated 14 Income Taxes The current and deferred components of income taxes were as follows: The principal components of deferred tax (assets) liabilities at December 31 were as follows: (in thousands) Currently payable Federal Foreign State and local 56 Deferred federal, state and local 1998 1997 1996 (in thousands) $245,486 27,263 13,847 $239,680 30,723 15,584 $225,863 5,912 11,039 286,596 37,703 285,987 279 242,814 (13,769) Allowance for credit losses Lease financing transactions Allowance for depreciation Deferred loan origination fees and costs Investment securities available for sale Employee benefits Restructuring charge Other temporary differences, net 1998 1997 $(142,889) 165,974 10,899 (25,554) (3,507) (6,824) — (35,563) $(132,990) 122,127 15,567 (20,088) (149) (7,625) (10,150) (34,440) Total $324,299 $286,266 $229,045 There were $2.1 million, $1.8 million and $4.8 million of income taxes provided on securities transactions in 1998, 1997 and 1996, respectively. Total $ (37,464) $ (67,748) The provision for income taxes differs from that computed by applying the federal statutory rate of 35 percent for the reasons in the following analysis: (in thousands) 1998 1997 1996 Tax based on federal statutory rate Effect of tax-exempt interest income Other $325,981 (4,039) 2,357 $285,860 (5,687) 6,093 $226,172 (8,842) 11,715 Provision for income taxes $324,299 $286,266 $229,045 15 Restructuring The Corporation recorded a restructuring charge of $90 mil- lion in 1996 in connection with a program to improve efficiency, revenue and customer service. The charge only includes direct and incremental costs associated with the program. The table at right provides details on the restruc- turing-related reserve which was eliminated in 1998. Termination benefits primarily include severance payments. The occupancy and equipment portion consists of lease termination costs, space consolidation and estimated losses on the disposal of vacated properties. Other charges consist primarily of the project costs incurred during the assessment phase of the program. An adjustment of $7 million, netted against noninterest expenses, was made to eliminate the restructuring liability in 1998. (in thousands) Balances at 12/31/96 Activity Balances at 12/31/97 Activity Adjustment Employee Termination Occupancy and Equipment Other Total $48,000 (38,000) $10,000 (10,000) —) $21,000 (10,000) $ 21,000 (13,000) $90,000 (61,000) $11,000 (6,000) (5,000) $ 8,000 (6,000) (2,000) $29,000 (22,000) (7,000) Balances at 12/31/98 $0 00—) $00 0—) $00 0—) $000 —) 16 Transactions with Related Parties The bank subsidiaries have had, and expect to have in the future, transactions with the Corporation’s directors and their affiliates. Such transactions were made in the ordinary course of business and included extensions of credit, all of which were made on substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers and did not, in management’s opinion, involve more than normal risk of collectibility or present other unfavorable features. The aggregate amount of loans attributable to persons who were related parties at December 31, 1998, approximated $177 million at the beginning and $309 million at the end of 1998. During 1998, new loans to related parties aggregated $304 million and repayments totaled $172 million. Comerica Incorporated 17 Regulatory Capital and Banking Subsidiaries Banking regulations limit the transfer of assets in the form of dividends, loans or advances from the bank subsidiaries to the Corporation. Under the most restrictive of these regulations, the aggregate amount of dividends which can be paid to the Corporation without obtaining prior approval from bank regu- latory agencies approximated $543 million at January 1, 1999, plus current year’s earnings. Substantially all the assets of the Corporation’s subsidiaries are restricted from transfer to the Corporation in the form of loans or advances. Dividends paid to the Corporation by its banking subsidiaries amounted to $442 million in 1998, $354 million in 1997 and $322 million in 1996. The Corporation and its banking subsidiaries are subject to various regulatory capital requirements administered by the federal banking agencies. Quantitative measures established by regulation to ensure capital adequacy require the maintenance of minimum amounts and ratios of Tier 1 and total capital (as defined in the regulations) to average and risk-weighted assets. At December 31, 1998, the Corporation and all of its banking subsidiaries exceeded the ratios required for an institution to be considered “well capitalized” (total capital ratio greater than 10 percent). At December 31, 1997, the Corporation and its Comerica Bank subsidiary exceeded the ratios required to be considered “adequately capitalized” (total capital ratio greater than 8 percent). Comerica Bank-Texas and Comerica Bank-California exceeded the ratios required to be “well capi- talized” at year-end 1997. The following is a summary of the capital position of the Corporation and its significant banking subsidiaries: 57 (in thousands) December 31, 1998 Tier 1 capital Total capital Tier 1 capital to average assets (minimum–3.0%) Tier 1 capital to risk–weighted assets (minimum–4.0%) Total capital to risk–weighted assets (minimum–8.0%) December 31, 1997 Tier 1 capital Total capital Tier 1 capital to average assets (minimum–3.0%) Tier 1 capital to risk–weighted assets (minimum–4.0%) Total capital to risk–weighted assets (minimum–8.0%) 18 Financial Instruments with Off-Balance Sheet Risk In the normal course of business, the Corporation enters into various off-balance sheet transactions involving derivative financial instruments, foreign exchange contracts and credit- related financial instruments to manage exposure to fluctua- tions in interest rate, foreign currency and other market risks and to meet the financing needs of customers. These finan- cial instruments involve, to varying degrees, elements of credit and market risk in excess of the amount reflected in the consolidated balance sheets. Credit risk is the possible loss that may occur in the event of nonperformance by the counterparty to a financial instru- ment. The Corporation attempts to minimize credit risk aris- ing from off-balance sheet financial instruments by evaluating the creditworthiness of each counterparty adher- ing to the same credit approval process used for traditional lending activities. Counterparty risk limits and monitoring procedures have also been established to facilitate the man- agement of credit risk. Collateral is obtained, if deemed nec- Comerica Inc. (Consolidated) Comerica Bank Comerica Bank- Texas Comerica Bank- California $2,699,143 4,435,977 $2,263,522 3,740,843 $310,743 407,268 $330,998 453,387 7.68% 8.02% 8.12% 8.04% 6.26 10.28 6.42 10.60 8.07 10.58 7.35 10.07 $2,513,820 3,961,243 $2,037,217 3,243,206 $325,394 359,674 $329,963 370,531 7.09% 7.15% 8.92% 9.07% 6.28 9.90 6.20 9.87 9.43 10.42 9.03 10.14 essary, based on the results of management’s credit evalua- tion. Collateral varies, but may include cash, investment securities, accounts receivable, inventory, property, plant and equipment or real estate. Derivative financial instruments and foreign exchange con- tracts are traded over an organized exchange or negotiated over-the-counter. Credit risk associated with exchange-trad- ed contracts is typically assumed by the organized exchange. Over-the-counter contracts are tailored to meet the needs of the counterparties involved and, therefore, contain a greater degree of credit risk and liquidity risk than exchange-traded contracts which have standardized terms and readily avail- able price information. The Corporation reduces exposure to credit and liquidity risks from over-the-counter derivative and foreign exchange contracts by conducting such transac- tions with investment-grade domestic and foreign investment banks or commercial banks. Comerica Incorporated 18 Financial Instruments with Off-Balance Sheet Risk (continued) 58 Market risk is the potential loss that may result from move- ments in interest or foreign currency rates which cause an unfavorable change in the value of a financial instrument. The Corporation manages this risk by establishing counter- party and monetary exposure limits and monitoring compli- ance with those limits. Market risk arising from derivative and foreign exchange positions entered into on behalf of customers is reflected in the consolidated financial state- ments and may be mitigated by entering into offsetting transactions. Market risk inherent in off-balance sheet deriv- ative and foreign exchange contracts held or issued for risk management purposes is generally offset by changes in the value of rate sensitive on-balance sheet assets or liabilities. Termination of derivative contracts, other than by a counter- party, is unlikely as a particular instrument can be offset by entering into an opposite-effect derivative product to facili- tate risk management strategies. Derivative Financial Instruments and Foreign Exchange Contracts The Corporation, as an end-user, employs a variety of off- balance sheet financial instruments for risk management pur- poses. Activity related to these instruments is centered predominantly in the interest rate markets and mainly involves interest rate swaps. Various other types of instru- ments are also used to manage exposures to market risks, including interest rate caps and floors, total return swaps, for- eign exchange forward contracts and foreign exchange swap agreements. Refer to the section entitled “Risk Management Derivative Financial Instruments and Foreign Exchange Con- tracts” in the financial review on page 37 for further informa- tion about the Corporation’s objectives for using such instruments. The following table presents the composition of off-balance sheet derivative financial instruments and foreign exchange contracts, excluding commitments, held or issued for risk management purposes at December 31, 1998 and 1997. Notional amounts, which represent the extent of involvement in the derivatives market, are generally used to determine the contractual cash flows required in accordance with the terms of the agreement. These amounts are typically not exchanged, significantly exceed amounts subject to credit or market risk and are not reflected in the consolidated balance sheets. During 1998, the Corporation terminated its portfolio of zero- coupon interest rate swaps. The notional amount of these swaps totaled $700 million. A portion of these swaps were replaced with paying swaps. The Corporation also terminated its portfolio of principal only total return swaps in conjunction with divesting the mortgage servicing business. The notional amount of these swaps was $55 million. Credit risk, which excludes the effects of any collateral or netting arrangements, is measured as the cost to replace, at current market rates, contracts in a profitable position. The amount of this exposure is represented by the gross unrealized gains on derivative and foreign exchange contracts. Comerica Incorporated Notional/ Contract Unrealized Unrealized Amount Gains Fair Losses Value $6,869 $152 $ (6) $146 15 — — — — — — — (in millions) December 31, 1998 Risk management Interest rate contracts: Swaps Options, caps and floors purchased Caps written Total interest rate contracts 6,884 152 (6) 146 Foreign exchange contracts: Spot and forwards Swaps 782 131 Total foreign exchange contracts 913 Total risk 32 12 44 (29) — 3 12 (29) 15 management $7,797 $196 $(35) $161 December 31, 1997 Risk management Interest rate contracts: Swaps Options, caps and floors purchased Caps written Total interest $8,515 $137 $(14) $123 52 — — — — — — — rate contracts 8,567 137 (14) 123 Foreign exchange contracts: Spot and forwards Swaps 445 154 Total foreign exchange contracts 599 Total risk 12 5 17 (9) — (9) 3 5 8 management $9,166 $154 $(23) $131 Bilateral collateral agreements with counterparties covered 94 percent and 93 percent of the notional amount of interest rate derivative contracts at December 31, 1998 and 1997, respectively. These agreements reduce credit risk by providing for the exchange of marketable investment securities to secure amounts due on contracts in an unreal- ized gain position. In addition, at December 31, 1998, master netting arrangements had been established with all interest rate swap counterparties and certain foreign exchange counterparties. These arrangements effectively reduce credit risk by permitting settlement, on a net basis, of contracts entered into with the same counterparty. The Corporation has not experienced any material credit losses associated with derivative or foreign exchange contracts. 18 Financial Instruments with Off-Balance Sheet Risk (continued) On a limited scale, fee income is earned from entering into various transactions, principally foreign exchange contracts and interest rate caps, at the request of customers. The Corporation does not speculate in derivative financial instruments for the purpose of profiting in the short-term from favorable movements in market rates. Fair values for customer-initiated and other derivative and foreign exchange contracts represent the net unrealized gains or losses on such contracts and are recorded in the con- solidated balance sheets. Changes in fair value are recognized in the consolidated income statements. For the year ended December 31, 1998, unrealized gains and unrealized losses on customer-initiated and other foreign exchange contracts averaged $14 million and $9 million, respectively. For the year ended December 31, 1997, unrealized gains and unrealized losses averaged $23 million and $18 million, respectively. These contracts also generated noninterest income of $9 million in 1998 and $7 million in 1997. Average positive and negative fair values and income related to customer-initiated and other interest rate contracts were not material for 1998 and 1997. The following table presents the composition of off-balance sheet derivative financial instruments and foreign exchange contracts held or issued in connection with customer-initiat- ed and other activities at December 31, 1998 and 1997. Notional/ Contract Unrealized Unrealized Amount Fair Losses Value Gains (in millions) December 31, 1998 Customer-initiated and other Interest rate contracts: Caps and floors written Caps and floors purchased Swaps $ 241 176 264 $ — 1 7 $ (1) $ (1) 1 1 — (6) Total interest rate contracts Foreign exchange contracts: Spot, forwards, futures and options 681 8 (7) 1 673 20 (13) 7 Total customer-initiated and other $1,354 $ 28 $(20) $ 8 December 31, 1997 Customer-initiated and other Interest rate contracts: Caps written Floors purchased Swaps $ 314 32 150 $ — — 6 $ — $ — — — (6) — Total interest rate contracts Foreign exchange contracts: Spot, forwards, futures 496 6 (6) — and options 1,837 37 (33) 4 Total customer-initiated and other $2,333 $ 43 $(39) $0 4 59 Detailed discussions of each class of derivative financial instrument and foreign exchange contract held or issued by the Corporation for both risk management and customer- initiated and other activities are provided below. Interest Rate Swaps Interest rate swaps are agreements in which two parties periodically exchange fixed cash payments for variable pay- ments based on a designated market rate or index (or vari- able payments based on two different rates or indices for basis swaps), applied to a specified notional amount until a stated maturity. In some cases, the payments may be based on the change in the value of an underlying security. The Corporation’s swap agreements are structured such that vari- able payments are primarily based on one-month and three- month LIBOR. These instruments are principally negotiated over-the-counter and are subject to credit risk, market risk and liquidity risk. Interest Rate Options, Including Caps and Floors Option contracts grant the option holder the right to buy or sell an underlying financial instrument for a predetermined price before the contract expires. Interest rate caps and floors are option-based contracts which entitle the buyer to receive cash payments based on the difference between a designated reference rate and the strike price, applied to a notional amount. Written options, primarily caps, expose the Corporation to market risk but not credit risk. A fee is received at inception for assuming the risk of unfavorable changes in interest rates. Purchased options contain both credit and market risk; however, market risk is limited to the fee paid. Options are either exchange-traded or negotiated over-the-counter. All interest rate caps and floors are over- the-counter agreements. Foreign Exchange Contracts The Corporation uses foreign exchange rate swaps, includ- ing generic receive variable swaps and cross-currency swaps, for risk management purposes. Generic receive vari- able swaps involve payment, in a foreign currency, of the difference between a contractually fixed exchange rate and an average exchange rate determined at settlement, applied to a notional amount. Cross-currency swaps involve the ex- change of both interest and principal amounts in two differ- ent currencies. Other foreign exchange contracts such as futures, forwards and options are primarily entered into as a service to customers and to offset market risk arising from such positions. Futures and forward contracts require the delivery or receipt of foreign currency at a specified date and exchange rate. Foreign currency options allow the hold- er to purchase or sell a foreign currency at a specified date and price. Foreign exchange futures are exchange-traded, while forwards, swaps and most options are negotiated over- the-counter. Foreign exchange contracts expose the Corpora- tion to both market risk and credit risk. Comerica Incorporated 18 Financial Instruments with Off-Balance Sheet Risk (continued) Commitments Unused Commitments to Extend Credit 60 The Corporation also enters into commitments to purchase or sell earning assets for risk management purposes. These transactions, which are similar in nature to forward con- tracts, did not have a material impact on the consolidated financial statements for the years ended December 31, 1998 and 1997. Commitments to purchase and sell U.S. Treasury and municipal bond securities related to the Corporation’s trading account totaled $17 million and $2 million at December 31, 1998 and 1997, respectively. At December 31, 1997, $30 million of commitments with settlement terms of up to 120 days had been initiated to reduce interest rate risk on fixed rate residential mortgage loans originated or held for sale. No such commitments were outstanding at year-end 1998. Outstanding commitments expose the Corporation to both credit and market risk. Available credit lines on fixed rate credit card and check product accounts, which have characteristics similar to option contracts, totaled $1.6 billion and $1.8 billion at December 31, 1998 and 1997, respectively. These commit- ments expose the Corporation to the risk of a reduction in net interest income as interest rates increase. Market risk exposure arising from fixed rate revolving credit commit- ments is very limited, however, since it is unlikely that a significant number of customers with these accounts will simultaneously borrow up to their maximum available credit lines. Additional information concerning unused commit- ments to extend credit is provided in the “Credit-Related Financial Instruments” section below. Credit-Related Financial Instruments The Corporation issues off-balance sheet financial instru- ments in connection with commercial and consumer lending activities. Credit risk associated with these instruments is represented by the contractual amounts indicated in the following table: (in millions) 1998 1997 Unused commitments to extend credit Standby letters of credit and financial guarantees Commercial letters of credit Credit default swaps $28,393 3,632 328 44 $27,528 3,088 449 26 19 Contingent Liabilities Commitments to extend credit are legally binding agree- ments to lend to a customer, provided there is no violation of any condition established in the contract. These commit- ments generally have fixed expiration dates or other termina- tion clauses and may require payment of a fee. Since many commitments expire without being drawn upon, the total contractual amount of commitments does not necessarily represent future cash requirements of the Corporation. Total unused commitments to extend credit at December 31, 1998 and 1997, included $3 billion and $4 billion, respectively, of variable and fixed rate revolving credit commitments. Other unused loan commitments, primarily variable rate, totaled $25 billion at December 31, 1998, and $24 billion at December 31, 1997. Standby and Commercial Letters of Credit and Financial Guarantees Standby and commercial letters of credit and financial guar- antees represent conditional obligations of the Corporation which guarantee the performance of a customer to a third party. Standby letters of credit and financial guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. Long-term standby letters of credit and financial guarantees, defined as those maturing beyond one year, expire in decreasing amounts through the year 2012, and were $1,432 million and $1,309 million at December 31, 1998 and 1997, respectively. The remaining standby letters of credit and financial guarantees, which mature within one year, totaled $2,200 million and $1,779 million at December 31, 1998 and 1997, respectively. Com- mercial letters of credit are issued to finance foreign or domestic trade transactions. Credit Default Swaps Credit default swaps allow the Corporation to diversify its loan portfolio by assuming credit exposure from different borrowers or industries without actually extending credit in the form of a loan. Credit risk associated with credit default swaps was $44 million at December 31, 1998 and $26 mil- lion at December 31, 1997. The Corporation and its subsidiaries are parties to litigation and claims arising in the normal course of their activities. Although the amount of ultimate liability, if any, with respect to such matters cannot be determined with reason- able certainty, management, after consultation with legal counsel, believes that the litigation and claims, some of which are substantial, will not have a material adverse effect on the Corporation’s consolidated financial position. In addition, management cannot predict with reasonable cer- tainty the likelihood, or the impact, of any future claims that may be brought against the Corporation. For example, although the Corporation is not currently a named defendant in any lawsuits involving year 2000 readiness, it is impossi- ble to know whether any claims in connection with the year 2000 will be asserted in the future, and the potential liability, if any, that may arise from such claims. Comerica Incorporated 20 Usage Restrictions Cash and due from banks may include amounts required to be deposited with the Federal Reserve Bank. These reserve balances vary, depending on the level of customer deposits in the Corporation’s subsidiary banks. At December 31, 1998 and 1997, the Federal Reserve balances were $269 million and $587 million, respectively. 21 Estimated Fair Values of Financial Instruments Disclosure of the estimated fair values of financial instru- ments, which differ from carrying values, often requires the use of estimates. In cases where quoted market values are not available, the Corporation uses present value techniques and other valuation methods to estimate the fair values of its financial instruments. These valuation methods require con- siderable judgment, and the resulting estimates of fair value can be significantly affected by the assumptions made and methods used. Accordingly, the estimates provided herein do not necessarily indicate amounts which could be realized in a current exchange. Furthermore, as the Corporation normal- ly intends to hold the majority of its financial instruments until maturity, it does not expect to realize many of the esti- mated amounts disclosed. The disclosures also do not include estimated fair value amounts for items which are not defined as financial instruments, but which have significant value. These include such items as core deposit intangibles, the future earnings potential of significant customer relation- ships and the value of trust operations and other fee generat- ing businesses. The Corporation does not believe that it would be practicable to estimate a representational fair value for these types of items. The Corporation used the following methods and assumptions: Cash and short-term investments: The carrying amount approximates the estimated fair value of these instruments, which consist of cash and due from banks, interest-bearing deposits with banks and federal funds sold. Trading account securities: These securities are carried at quoted market value or the market value for comparable securities, which represents estimated fair value. Loans held for sale: The market value of these loans repre- sents estimated fair value. The market value is determined on the basis of existing forward commitments or the market values of similar loans. Investment securities: The market value of investment secu- rities, which is based on quoted market values or the market values for comparable securities, represents estimated fair value. 61 Domestic commercial loans: These consist of commercial, real estate construction, commercial mortgage and equip- ment lease financing loans. The estimated fair value of the Corporation’s variable rate commercial loans is represented by their carrying value, adjusted by an amount which esti- mates the change in fair value caused by changes in the credit quality of borrowers since the loans were originated. The estimated fair value of fixed rate commercial loans is calculated by discounting the contractual cash flows of the loans using year-end origination rates derived from the Treasury yield curve or other representative bases. The resulting amounts are adjusted to estimate the effect of changes in the credit quality of borrowers since the loans were originated. International loans: The estimated fair value of the Corpora- tion’s short-term international loans which consist of trade- related loans, or loans which have no cross-border risk due to the existence of domestic guarantors or liquid collateral, is represented by their carrying value, adjusted by an amount which estimates the effect on fair value of changes in the credit quality of borrowers or guarantors. The esti- mated fair value of long-term international loans is based on the quoted market values of these loans or on the market values of international loans with similar characteristics. Retail loans: This category consists of residential mortgage, consumer and auto lease financing loans. The estimated fair value of residential mortgage loans is based on discounted contractual cash flows or market values of similar loans sold in conjunction with securitized transactions. For con- sumer loans, the estimated fair values are calculated by dis- counting the contractual cash flows of the loans using rates representative of year-end origination rates. The resulting amounts are adjusted to estimate the effect of changes in the credit quality of borrowers since the loans were originated. Customers’ liability on acceptances outstanding: The carry- ing amount approximates the estimated fair value. Loan servicing rights: The estimated fair value represents those servicing rights recorded under SFAS No. 125, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” Fair value is computed using discounted cash flow analyses, using interest rates and prepayment speed assumptions currently quoted for comparable instruments. Comerica Incorporated 62 21 Estimated Fair Values of Financial Instruments (continued) Deposit liabilities: The estimated fair value of demand deposits, consisting of checking, savings and certain money market deposit accounts, is represented by the amounts payable on demand. The carrying amount of deposits in for- eign offices approximates their estimated fair value, while the estimated fair value of term deposits is calculated by dis- counting the scheduled cash flows using the year-end rates offered on these instruments. Short-term borrowings: The carrying amount of federal funds purchased, securities sold under agreements to repur- chase and other borrowings approximates estimated fair value. Acceptances outstanding: The carrying amount approxi- mates the estimated fair value. Medium- and long-term debt: The estimated fair value of the Corporation’s variable rate medium- and long-term debt is represented by its carrying value. The estimated fair value of the fixed rate medium- and long-term debt is based on quot- ed market values. If quoted market values are not available, the estimated fair value is based on the market values of debt with similar characteristics. Derivative financial instruments and foreign exchange con- tracts: The estimated fair value of interest rate swaps repre- sents the amount the Corporation would receive or pay to terminate or otherwise settle the contracts at the balance sheet date, taking into consideration current unrealized gains and losses on open contracts. The estimated fair value of foreign exchange futures and forward contracts and commit- ments to purchase or sell financial instruments are based on quoted market prices. The estimated fair value of interest rate and foreign currency options (including interest rate caps and floors) are determined using option pricing models. Credit-related financial instruments: The estimated fair value of unused commitments to extend credit and standby and commercial letters of credit is represented by the estimated cost to terminate or otherwise settle the obligations with the counterparties. This amount is approximated by the fees cur- rently charged to enter into similar arrangements, consider- ing the remaining terms of the agreements and any changes in the credit quality of counterparties since the agreements were entered into. This estimate of fair value does not take into account the significant value of the customer relation- ships and the future earnings potential involved in such arrangements as the Corporation does not believe that it would be practicable to estimate a representational fair value for these items. Comerica Incorporated The estimated fair values of the Corporation’s financial instru- ments at December 31, 1998 and 1997 are as follows: (in millions) Assets Cash and short-term investments Trading account securities Loans held for sale Investment securities available for sale Commercial loans International loans Real estate construction loans Commercial mortgage loans Residential mortgage loans Consumer loans Lease financing Total loans Less allowance for credit losses 1998 1997 Carrying Amount Estimated Fair Value Carrying Amount Estimated Fair Value $ 1,830 $ 1,830 $12,080 $12,080 6 46 2,712 19,086 2,713 1,080 4,179 1,038 1,862 647 6 46 2,712 19,016 2,696 9 41 4,006 15,805 2,085 1,075 941 4,216 3,634 1,071 1,807 648 1,565 4,348 517 9 41 4,006 15,743 2,080 933 3,617 1,608 4,231 518 30,605 30,529 28,895 28,730 (452) — (424) — 15,840 22,601 3,193 Net loans 30,153 30,529 28,471 28,730 Customers’ liability on acceptances outstanding Loan servicing rights Liabilities Demand deposits 12 4 12 4 18 28 18 31 (noninterest-bearing) 6,999 6,999 6,761 6,761 Interest-bearing deposits 17,314 17,340 15,825 Total deposits 24,313 24,339 22,586 Short-term borrowings Acceptances outstanding Medium- and 3,580 3,580 3,193 12 12 18 18 long-term debt 5,282 5,355 7,286 7,395 Off-balance Sheet Financial Instruments Derivative financial instruments and foreign exchange contracts Risk management: Unrealized gains Unrealized losses Customer-initiated and other: Unrealized gains Unrealized losses — — 28 (20) 196 (35) 28 (20) — — 43 (39) Credit-related financial instruments — (13) — 154 (23) 43 (39) (13) 22 Business Segment Information The Corporation has strategically aligned its operations into three major lines of business: the Business Bank, the Individual Bank and the Investment Bank. These lines of business are differentiated based on the products and ser- vices provided. Lines of business results are produced by the Corporation’s internal management accounting system. This system measures financial results based on the internal organizational structure of the Corporation; information presented is not necessarily comparable with similar infor- mation for any other financial institution. The management accounting system assigns balance sheet and income state- ment items to each line of business using certain methodolo- gies which are constantly being refined. For comparability purposes, amounts in all periods are based on methodologies in effect at December 31, 1998. These methodologies, which are briefly summarized in the following paragraph, may be modified as management accounting systems are enhanced and changes occur in the organizational structure or product lines. In addition to the three major lines of business, the Finance Division is also reported as a segment. The Corporation’s internal funds transfer pricing system records cost of funds or credit for funds using a combination of matched maturity funding for certain assets and liabilities and a blended rate based on various maturities for the remaining assets and liabilities. The credit loss provision is assigned based on the amount necessary to maintain an allowance for credit losses adequate for that line of business. Noninterest income and expenses directly attributable to a line of business are assigned to that business. Direct expens- es incurred by areas whose services support the overall Corporation are allocated to the business lines as follows: Product processing expenditures are allocated based on standard unit costs applied to actual volume measurements; administrative expenses are allocated based on estimated time expended; and corporate overhead is assigned based on the ratio of a line of business’ noninterest expenses to total noninterest expenses incurred by all business lines. Common equity is allocated based on credit, operational and business risks. The following discussion provides information about the activities of each line of business. A discussion of the finan- cial results and the factors impacting 1998 performance can be found in the section entitled “Strategic Lines of Busi- ness” in the financial review on page 30. The Business Bank is comprised of middle market lending, asset-based lending, large corporate banking and internation- al financial services. This line of business meets the needs of medium-size businesses, multinational corporations and gov- ernmental entities by offering various products and services, including commercial loans and lines of credit, deposits, cash management, capital market products, international trade finance, letters of credit, foreign exchange manage- ment services and loan syndication services. 63 The Individual Bank includes consumer lending, consumer deposit gathering, mortgage loan origination and servicing, small business banking (annual sales under $5 million) and private banking. This line of business offers a variety of consumer products, including deposit accounts, direct and indirect installment loans, credit cards, home equity lines of credit and residential mortgage loans. In addition, a full range of financial services is provided to small businesses and municipalities. Private lending and personal trust ser- vices are also provided to meet the personal financial needs of affluent individuals (as defined by individual net income or wealth). The Investment Bank is responsible for the sale of mutual fund and annuity products, as well as life, disability and long-term care insurance products. This line of business also offers institutional trust products, retirement services and provides investment management and advisory ser- vices, investment banking and discount securities brokerage services. The Finance segment includes the Corporation’s securities portfolio and asset and liability management activities. This segment is responsible for managing the Corporation’s funding, liquidity and capital needs, performing interest sensitivity gap and earnings simulation analysis and execut- ing various strategies to manage the Corporation’s exposure to interest rate risk. The Other category includes divested business lines, the income and expense impact of cash and credit loss reserves not assigned to specific business lines, miscellaneous other items of a corporate nature and certain direct expenses not allocated to business lines. Information in this note complies with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” as of December 31, 1998, which established standards for the way public business enterprises report information about operating segments in annual financial statements and interim financial reports issued to share- holders. Comerica Incorporated 22 Business Segment Information (continued) Lines of business/segment financial results were as follows: (dollar amounts in millions) 1998 1997 1996 1998 1997 1996 1998 1997 1996 Business Bank Individual Bank Investment Bank* 64 Earnings Summary Net interest income (FTE) Provision for credit losses Noninterest income Noninterest expenses Restructuring charge Provision for income taxes Net income (loss) Selected Average Balances Assets Loans Deposits Common equity Statistical Data $ 746 79 154 308 — 185 328 $ 658 (11) 128 299 — 181 317 $ 621 2 122 294 — 163 284 $ 679 (14) 300 586 — 142 265 $ 754 82 269 598 — 120 223 $ 776 109 277 659 — 101 184 $22,908 21,555 4,332 1,340 $19,884 18,276 3,929 1,062 $17,397 16,156 3,914 941 $ 7,651 7,076 17,213 736 $ 9,534 8,936 17,055 769 $ 9,881 9,201 17,262 707 $ (3) — 122 113 — 2 4 $ 33 1 34 27 $ (2) — 107 101 — 1 3 $ 28 — 41 23 $ (1) — 94 90 — 1 2 $22 — 48 17 Return on average assets Return on average common equity Efficiency ratio 1.43% 1.60% 1.63% 1.47% 1.24% 1.02% 5.62% 4.15% 2.67% 24.49 34.51 29.93 38.35 30.18 39.74 35.98 59.82 28.95 58.39 26.09 62.73 14.29 n/m 12.84 n/m 11.01 n/m Finance Other Total 1998 1997 1996 1998 1997 1996 1998 1997 1996 $ 46 — 8 3 — 18 33 $4,320 280 704 333 $ 40 — 4 3 — 15 26 $5,152 70 902 294 $ 27 — 6 3 — 10 20 $7,375 224 931 364 $ — 48 19 17 (7) (16) (23) $ 75 (313) (30) 181 $ 2 75 20 7 — (21) (39) $271 (73) 19 260 $ 4 3 8 23 90 (31) (73) $ 1,468 113 603 1,027 (7) 331 607 $ 1,452 146 528 1,008 — 296 530 $01,427 114 507 1,069 90 244 417 $(480) (229) 103 525 $34,987 28,599 22,253 2,617 $34,869 27,209 21,946 2,408 $34,195 25,352 22,258 2,554 Earnings Summary Net interest income (FTE) Provision for credit losses Noninterest income Noninterest expenses Restructuring charge Provision for income taxes Net income (loss) Selected Average Balances Assets Loans Deposits Common equity Statistical Data Return on average assets Return on average common equity Efficiency ratio 0.28% 10.01 n/m 0.22% 8.99 n/m 0.17% 5.39 n/m n/m% n/m n/m n/m% n/m n/m n/m% n/m n/m 1.74% 22.54 49.39 1.52% 1.22% 21.32 51.04 15.98 60.36 *Included in noninterest expenses are fees internally transferred to other lines of business for referrals to the Investment Bank. If excluded, Investment Bank net income would have been $8 million in 1998, $6 million in 1997 and $2 million in 1996. Return on average common equity would have been 31.49% in 1998, 27.89% in 1997 and 11.01% in 1996. n/m - not meaningful Comerica Incorporated 23 Parent Company Financial Statements BALANCE SHEETS—Comerica Incorporated December 31 (in thousands, except share data) Assets Cash and due from banks Time deposits with banks Investment securities available for sale Investment in subsidiaries, principally banks Premises and equipment Other assets Total assets Liabilities and Shareholders’ Equity Long-term debt Other liabilities Total liabilities Nonredeemable preferred stock—$50 stated value Authorized—5,000,000 shares Issued—5,000,000 shares in 1998 and 1997 Common stock—$5 par value Authorized—325,000,000 shares Issued—157,233,088 shares in 1998 and 156,815,367 shares in 1997 Capital surplus Unrealized net losses on investment securities available for sale Retained earnings Deferred compensation Less cost of common stock in treasury—1,351,997 shares in 1998 Total shareholders’ equity Total liabilities and shareholders’ equity STATEMENTS OF INCOME—Comerica Incorporated Year Ended December 31 (in thousands) Income Income from subsidiaries Dividends from subsidiaries Other interest income Intercompany management fees Other interest income Other noninterest income Total income Expenses Interest on long-term debt and other borrowed funds Net interest rate swap income Salaries and employee benefits Occupancy expense Equipment expense Restructuring charge Other noninterest expenses Total expenses Income before income taxes and equity in undistributed net income of subsidiaries Income tax expense (credit) Equity in undistributed net income of subsidiaries, principally banks Net Income 65 1998 1997 $ 2,728 22,600 22,392 3,280,384 5,855 57,235 $ 372 80,400 20,822 3,017,058 6,566 40,009 $3,391,194 $3,165,227 $ 234,639 109,942 $ 298,351 105,100 344,581 403,451 250,000 250,000 786,165 24,649 (6,455) 2,086,589 (5,202) (89,133) 784,077 — (1,937) 1,731,419 (1,783) — 3,046,613 2,761,776 $3,391,194 $3,165,227 1998 1997 1996 $442,495 3,899 157,393 545 2,628 $353,500 3,626 166,952 559 2,070 $322,000 3,372 264,368 1,773 5,278 606,960 526,707 596,791 22,214 (1,648) 61,583 6,630 1,873 100 36,002 26,129 (2,818) 65,766 9,373 2,053 — 54,262 26,328 (2,794) 123,271 22,483 24,806 27,000 63,310 126,754 154,765 284,404 480,206 13,279 466,927 371,942 6,111 365,831 312,387 (1,931) 314,318 140,149 164,645 102,843 $607,076 $530,476 $417,161 Comerica Incorporated 23 Parent Company Financial Statements (continued) STATEMENTS OF CASH FLOWS—Comerica Incorporated Year Ended December 31 (in thousands) Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities Undistributed earnings of subsidiaries, principally banks 66 Depreciation Restructuring charge Other, net Total adjustments Net cash provided by operating activities Investing Activities Purchase of investment securities available for sale Proceeds from sale of investment securities available for sale Proceeds from sales of fixed assets and other real estate Purchases of fixed assets Net decrease in bank time deposits Net increase in receivables from subsidiaries Capital transactions with subsidiaries 1998 1997 1996 $607,076 $530,476 $417,161 (140,149) 1,755 (6,008) 4,908 (164,645) 1,800 (20,992) 7,465 (102,843) 20,595 27,000 23,091 (139,494) (176,372) (32,157) 467,582 354,104 385,004 (11,640) 1,983 136 (1,222) 57,800 — (134,752) (4,092) 427 28,958 (1,424) 25,300 (375) (3,283) (4,820) — 603 (20,345) 25,100 — 131,871 Net cash provided by (used in) investing activities (87,695) 45,511 132,409 Financing Activities Net increase (decrease) in advances from subsidiaries Repayments and purchases of long-term debt Net decrease in short-term borrowings Proceeds from issuance of preferred stock Proceeds from issuance of common stock Purchase of common stock for treasury and retirement Dividends paid Net cash used in financing activities Net increase (decrease) in cash on deposit at bank subsidiary Cash on deposit at bank subsidiary at beginning of year Cash on deposit at bank subsidiary at end of year Interest paid Income taxes recovered (paid) Noncash investing and financing activities Stock issued for acquisitions (4,054) (63,712) — — 50,885 (148,684) (211,966) 3,818 141 (842) — 35,082 (242,293) (195,412) (3,523) (259) — 246,744 35,206 (622,196) (173,414) (377,531) (399,506) (517,442) 2,356 372 109 263 (29) 292 $ 2,728 $0 00372 $111,263 $ 15,290 $ 25,799 $125,942 $ 975 $ (1,145) $ 11,150 $ — $ — $128,938 The preceding parent company financial statements reflect the sale of the Corporation’s information services, transaction processing and operations services departments to a subsidiary, Comerica Bank, on January 1, 1997. Comerica Incorporated 24 Summary of Quarterly Financial Information The following quarterly information is unaudited. However, in the opinion of management, the information reflects all adjustments which are necessary for the fair presentation of the results of operations for the periods presented. (in thousands, except per share data) Interest income Interest expense Net interest income Provision for credit losses Securities gains/(losses) Noninterest income (excluding securities gains) Noninterest expenses Net income Basic net income per common share Diluted net income per common share (in thousands, except per share data) Interest income Interest expense Net interest income Provision for credit losses Securities gains/(losses) Noninterest income (excluding securities gains) Noninterest expenses Net income Basic net income per common share Diluted net income per common share 67 Fourth Quarter $652,121 281,371 370,750 36,000 6,081 161,306 263,051 157,820 $0.99 0.97 Fourth Quarter $682,163 316,281 365,882 37,000 3,836 136,928 257,368 139,927 $0.86 0.85 1998 1997 Third Quarter $639,562 279,127 360,435 21,000 174) 151,940 253,821 154,490 $0.97 0.95 Third Quarter $674,671 313,090 361,581 34,000 1,096 135,251 252,622 137,067 $0.84 0.83 Second Quarter $651,230 286,752 364,478 28,000 11 148,784 253,299 150,383 $0.94 0.92 Second Quarter $663,326 299,798 363,528 34,000 (234) 121,681 249,259 129,710 $0.79 0.78 First Quarter $673,861 308,253 365,608 28,000 (150) 135,002 249,873 144,383 $0.89 0.88 First Quarter $627,243 275,458 351,785 41,000 497 128,897 248,737 123,772 $0.75 0.74 25 Pending Accounting Pronouncements In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, “Accounting for Derivative Instru- ments and Hedging Activities,” which is required to be adopted in years beginning after June 15, 1999. The State- ment permits early adoption as of the beginning of any fiscal quarter. The Corporation expects to adopt the new Statement effective January 1, 2000. The Statement will require the Corporation to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjust- ed to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in fair value of derivatives will either be offset against the change in fair value of the hedged assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative’s change in fair value will be immediately recognized in earnings. The Corporation has not yet determined what the effect of SFAS No. 133 will be on the earnings and financial position of the Corporation. Comerica Incorporated Report of Management Report of Independent Auditors Board of Directors, Comerica Incorporated We have audited the accompanying consolidated balance sheets of Comerica Incorporated and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Comerica Incorporated and subsidiaries at December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Detroit, Michigan January 19, 1999 68 Management is responsible for the accompanying financial statements and all other financial information in this Annual Report. The financial statements have been prepared in con- formity with generally accepted accounting principles and include amounts which of necessity are based on manage- ment’s best estimates and judgments and give due considera- tion to materiality. The other financial information herein is consistent with that in the financial statements. In meeting its responsibility for the reliability of the finan- cial statements, management develops and maintains sys- tems of internal accounting controls. These controls are designed to provide reasonable assurance that assets are safeguarded and transactions are executed and recorded in accordance with management’s authorization. The concept of reasonable assurance is based on the recognition that the cost of internal accounting control systems should not exceed the related benefits. The systems of control are con- tinually monitored by the internal auditors whose work is closely coordinated with and supplements in many instances the work of independent auditors. The financial statements have been audited by independent auditors Ernst & Young LLP. Their role is to render an inde- pendent professional opinion on management’s financial statements based upon performance of procedures they deem appropriate under generally accepted auditing standards. The Corporation’s Board of Directors oversees manage- ment’s internal control and financial reporting responsibili- ties through its Audit Committee as well as various other committees. The Audit Committee, which consists of direc- tors who are not officers or employees of the Corporation, meets periodically with management and internal and inde- pendent auditors to assure that they and the Committee are carrying out their responsibilities, and to review auditing, internal control and financial reporting matters. Eugene A. Miller Chairman and Chief Executive Officer Ralph W. Babb Jr. Executive Vice President and Chief Financial Officer Marvin J. Elenbaas Senior Vice President and Controller Comerica Incorporated Historical Review–Average Balance Sheets Comerica Incorporated and Subsidiaries Consolidated Financial Information (in millions) Assets Cash and due from banks Short-term investments Investment securities Commercial loans International loans Real estate construction loans Commercial mortgage loans Residential mortgage loans Consumer loans Lease financing Total loans 1998 1997 1996 1995 1994 $01,622 $01,686 $01,576 $01,500 $01,532 143 129 195 351 3,371 4,687 5,823 7,625 16,973 2,342 989 3,819 1,325 2,575 576 14,234 1,953 866 3,547 1,676 4,486 447 12,686 1,541 707 3,483 1,960 4,624 351 11,302 1,257 541 3,157 2,450 4,569 285 823 8,004 9,598 1,107 403 2,916 2,175 3,795 217 28,599 27,209 25,352 23,561 20,211 69 Less allowance for credit losses (440) (402) (361) (340) (322) Net loans 28,159 26,807 24,991 23,221 19,889 Accrued income and other assets 1,692 1,560 1,610 1,432 1,203 Total assets $34,987 $34,869 $34,195 $34,129 $31,451 Liabilities and Shareholders’ Equity Noninterest-bearing deposits Interest-bearing deposits Total deposits Federal funds purchased and securities sold under agreements to repurchase Other borrowed funds Accrued expenses and other liabilities Medium- and long-term debt Total liabilities Shareholders’ equity $06,151 16,102 $05,815 16,131 $05,589 16,669 $04,767 16,888 $04,700 16,625 22,253 21,946 22,258 21,655 21,325 2,510 910 415 6,032 2,017 1,801 467 5,980 2,106 1,999 400 4,745 2,816 2,313 324 4,510 2,817 2,002 286 2,708 32,120 32,211 31,508 31,618 29,138 2,867 2,658 2,687 2,511 2,313 Total liabilities and shareholders’ equity $34,987 $34,869 $34,195 $34,129 $31,451 Comerica Incorporated Historical Review–Statements of Income Comerica Incorporated and Subsidiaries Consolidated Financial Information (in millions, except per share data) Interest Income Interest and fees on loans Interest on investment securities Taxable Exempt from federal income tax 70 Total interest on investment securities Interest on short-term investments Total interest income Interest Expense Interest on deposits Interest on short-term borrowings Federal funds purchased and securities sold under agreements to repurchase Other borrowed funds Interest on medium- and long-term debt Net interest rate swap (income)/expense Total interest expense Net interest income Provision for credit losses Net interest income after provision for credit losses Noninterest Income Fiduciary and investment management income Service charges on deposit accounts Commercial lending fees Securities gains Other noninterest income Total noninterest income Noninterest Expenses Salaries and employee benefits Net occupancy expense Equipment expense Outside processing fee expense Restructuring charge Other noninterest expenses Total noninterest expenses Income before income taxes Provision for income taxes Net Income 1998 1997 1996 1995 1994 $2,382 $2,318 $2,161 $2,091 $1,577 219 7 226 9 310 11 321 9 372 18 390 12 474 26 500 23 446 31 477 38 2,617 2,648 2,563 2,614 2,092 648 673 686 721 543 137 49 368 (46) 1,156 1,461 113 1,348 111 98 374 (51) 1,205 1,443 146 1,297 112 107 295 (49) 1,151 1,412 114 1,298 166 136 289 2 1,314 1,300 87 1,213 121 79 148 (29) 862 1,230 56 1,174 184 158 43 6 212 603 565 90 60 43 (7) 269 147 141 32 5 203 528 539 89 62 42 — 276 133 140 23 14 197 507 561 99 69 42 90 298 125 130 21 12 211 499 562 99 68 49 — 308 122 124 20 3 181 450 549 99 68 46 7 273 1,020 1,008 1,159 1,086 1,042 931 324 817 287 646 229 626 213 582 195 $0,607 $0,530 $0,417 $0,413 $0,387 Net income applicable to common stock $0,590 $0,513 $0,408 $0,413 $0,387 Basic net income per common share Diluted net income per common share Cash dividends declared on common stock Dividends per common share $3.79 3.72 $199 $1.28 $3.24 3.19 $181 $1.15 $2.41 2.38 $170 $1.01 $2.38 2.37 $158 $0.91 $2.20 2.19 $145 $0.83 Comerica Incorporated Historical Review-Statistical Data Comerica Incorporated and Subsidiaries Consolidated Financial Information 1998 1997 1996 1995 1994 Average Rates (Fully Taxable Equivalent Basis) Short-term investments Investment securities Commercial loans International loans Real estate construction loans Commercial mortgage loans Residential mortgage loans Consumer loans Lease financing Total loans Interest income as a percent of earning assets Domestic deposits Deposits in foreign offices Total interest-bearing deposits Federal funds purchased and securities sold under agreements to repurchase Other borrowed funds Medium- and long-term debt Interest expense as a percent of interest-bearing sources Interest rate spread Impact of net noninterest-bearing sources of funds Net interest margin as a percent of earning assets Return on Average Common Shareholders’ Equity Return on Average Assets Efficiency Ratio Per Share Data Book value at year-end Market value at year-end Market value—high and low for year Other Data Number of banking offices Number of employees (full-time equivalent) 71 6.25% 6.59% 6.23% 6.61% 4.57% 6.81 8.04 7.97 9.24 8.74 7.69 10.20 7.65 8.34 8.17 3.91 6.71 4.02 5.44 5.40 6.10 4.52 3.65 6.94 8.25 7.07 9.38 9.08 7.90 9.81 7.48 8.53 8.29 4.09 5.68 4.17 5.49 5.45 6.26 4.65 3.64 6.79 8.21 6.64 9.22 9.29 7.83 9.88 6.82 8.54 8.20 4.04 5.46 4.11 5.31 5.36 6.22 4.51 3.69 6.72 8.75 7.06 9.52 9.40 7.80 10.10 6.65 8.90 8.35 4.05 6.07 4.27 5.88 5.87 6.41 4.95 3.40 6.15 7.38 5.58 7.85 8.52 7.46 9.44 6.48 7.84 7.28 3.14 4.28 3.26 4.31 3.92 5.46 3.57 3.71 0.92 0.89 0.85 0.79 0.61 4.57 4.53 4.54 4.19 4.32 22.54 21.32 15.98 16.46 16.74 1.74 1.52 1.22 1.21 1.23 49.39 51.04 60.36 60.09 61.28 $17.94 68.19 73-47 $16.02 60.17 62-34 $14.70 34.92 39-24 $15.17 26.67 29-16 $13.64 16.25 21-16 334 10,134 350 9,960 358 11,079 395 12,876 398 13,077 Comerica Incorporated Economic Outlook At year-end 1998, the current U.S. economic expansion broke a record for peacetime longevity, a record that dates back to 1854. The economy now is well on its way to break- ing the all-time record of 106 months for an unbroken peri- od of economic expansion—during peace or war. February of 2000 would mark the 107th month. What’s the bottom line on these faithful monitors of U.S. economic health? The Economic Vulnerability Sentinel can- not tolerate rising inflation, and the Recession Watch Index cannot bear rising expectations of inflation. Chances are the U.S. economy will continue being the envy of the world and will remain on an expansion track as long as business plans and consumer indebtedness are not thrown off course by the distorted and misleading signals of accelerating inflation. Can we sustain this growth mode for one more year and make economic history? Economic Enemy #1 72 Comerica has two gauges to address this question. One such measure is the Recession Watch Index, which forecasts the chance of a recession occurring in the next 12 months. The other gauge is Comerica’s Economic Vulnerability Sentinel, which tells us how healthy, or recession-resistant, the cur- rent expansion happens to be. A Seesaw Year During the first half of 1998, both of Comerica’s forecasting indices were giving strong signals for a favorable year ahead: Chances for a recession were only 28 percent through mid-year 1999, and the current expansion was shown to be the most durable since the good economic growth of the early and mid-1960s. Then came the third quarter, with a combination of major strike activity in the airline and auto industries, growing dis- tress in Asian and Latin financial markets, and accompany- ing contraction in U.S. equities markets. These events caused the Recession Watch Index to rise to 39 percent probability of recession for the coming year. Fortunately for 1999’s prospects, this index must exhibit readings in excess of 50 percent for at least a quarter before it makes the reces- sion call. Even more encouraging, the latest index readings have moved the index toward even safer levels. As for the Economic Vulnerability Sentinel, this measure of economic health is constantly taking the pulse of the econo- my’s real growth rate versus inflation. As long as real GDP growth is out-pacing the inflation rate by a comfortable margin, there is both continuing strength and resilience in the recovery. GDP vs. Inflation For example, during the first quarter of 1998, real GDP growth was 5.5 percent. This covered the inflation rate— listed at 0.9 percent—by six-to-one. In the second quarter, real GDP growth slipped badly to only 1.8 percent, but hap- pily, the inflation rate remained at 0.9, yielding two-to-one coverage of inflation by real GDP. The third quarter was even more impressive, despite stock market volatility and interruptions to output due to work stop- pages. Real GDP was up 3.7 percent, and inflation inched up to 1.0 percent—still better than three-to-one coverage. The best performance was saved for the fourth quarter: 6.1 percent real growth and 0.7 percent inflation, an eight-to-one multi- ple. Comerica Incorporated Contrary to 1998’s conventional wisdom, the greatest threat to the continuity of the current eight-year expansion does not emanate from the so-called Asian implosion, the tortured mar- kets of Latin nations, the European slowdown, or computer glitches associated with the “Y2K” situation. The biggest threat always remains the monetary danger of rising inflation. Inflation is always and everywhere a monetary phenomenon. It typically is caused by a nation’s central bank (in the U.S., the Federal Reserve system). For the past two years, the Alan Greenspan Federal Reserve has been warning our financial markets about the dangers of “irrational exuber- ance” as a reason why the Fed might feel compelled to raise interest rates and slow the GDP. Instead, the Fed did pre- cisely the opposite last year. They lowered short-term inter- est rates by three-quarter percent and exceeded nearly every targeted growth range they themselves had set for safe money growth. An Exuberant Fed In fact, the expansion rate for new money has exceeded growth of real GDP by a factor of three and four times. This means that for the better part of 16 months, the Fed has been creating too much money chasing too few goods. This is a classic precursor of rising inflation if it is left unchecked. The Fed evidently felt compelled by the on-going weakness abroad and a high-profile failure at home related to hedge fund activity to provide “insurance” in the form of extra money stimulation to the very same financial markets it had six months earlier warned of exuberance. By November, the stock market was back in record territory. GDP growth Inflation (CPI) Car/light truck sales (in millions) Federal funds rate (year-end) U.S. unemployment rate Current account deficit (in billions) 1998 actual 1999 forecast 3.9% 4.0% 1.6% 15.6 15.6 1.4% 5.35% 4.75% 4.5% 4.3% $314 $245 Interest Rate Forecasts 2nd Quarter 1999 3rd Quarter 1999 4th Quarter 1999 1st Quarter 2000 2nd Quarter 2000 2nd Quarter 1999 3rd Quarter 1999 4th Quarter 1999 1st Quarter 2000 2nd Quarter 2000 2nd Quarter 1999 3rd Quarter 1999 4th Quarter 1999 1st Quarter 2000 2nd Quarter 2000 Fed Funds Prime Rate 3 Month LIBOR 4.75% 4.75 4.75 5.00 5.25 7.75% 7.75 7.75 8.00 8.25 5.25% 5.30 5.35 5.40 5.45 1 Month Commercial Paper 3 Month Treasury Bills 6 Month 1 Year 5.33% 5.40 5.45 5.55 5.60 4.70% 4.80 4.90 5.00 5.10 4.75% 4.85 4.95 5.05 5.15 4.80% 4.90 5.00 5.10 5.20 Treasury Notes Treasury Bonds 2 Year 3 Year 5 Year 10 Year 30 Year Corp Aaa A Utility Bonds Bonds 73 4.85% 4.95 5.10 5.25 5.35 4.90% 5.00 5.15 5.35 5.45 Home Mortgage Rates FHLMC 6.70% 6.80 7.00 7.30 7.50 4.95% 5.05 5.20 5.40 5.50 5.15% 5.25 5.40 5.60 5.70 5.65% 5.75 5.90 6.10 6.20 6.30% 6.40 6.55 6.70 6.90 6.60% 6.60 6.80 7.30 7.50 Federal Reserve Trade-Weighted Dollar Index Annualized Percent Changes Real GDP GDP Deflator CPI 90.0% 85.5 85.5 90.0 92.0 3.2% 2.7 3.0 2.5 2.0 1.0% 1.4 1.7 2.0 2.2 1.2% 1.6 2.0 2.5 2.5 Indeed, another such policy reversal could occur in 1999. The Fed at some point around mid-year 1999 could deter- mine that the greater threat is not recession, but rising infla- tion. After all, a dynamic U.S. economy has thus far shrugged off most economic problems of foreign origin. This is not surprising, given that foreign trade constitutes only 13 to 15 percent of U.S. GDP. Watch the Dollar Another worrisome facet to Fed exuberance is that as mone- tary stimulation causes short-term interest rates to fall, the dollar weakens against foreign currencies, leading to the rise in import prices. Once import prices begin rising, it becomes considerably easier for U.S. retailers to raise prices. If domestic firms raise prices and financing rates, then the pur- chasing power of households will shrink, leading to a pro- nounced slowdown of the economy. The parade of good consumer news about the falling cost of vehicles, gas, oil, food, clothing, credit and electronic equipment would end. Fed stimulation already has sown the seeds of rising infla- tion in late 1999. As a consequence, the environment of lower interest rates will be limited to the first half of 1999. By year-end, long-term interest rates will be on the uptick. For the year, the economy will slow to 3.4 percent GDP growth, down from 3.9 percent in 1998. Comerica Markets Here’s how Comerica’s primary domestic regional markets of Michigan, California, Texas and Florida are expected to fare in 1999, along with Canada and Mexico: Michigan’s interest-rate sensitive economy, already constrained by exceptionally tight labor markets, should remain in growth mode during 1999, albeit lagging the national growth rate. California’s economy seems to be quite balanced in its expansion and has prospered from the boom in imports. This has offset some declining demand for exports from the beleaguered nations in Asia and Latin America. Texas has a rapidly expanding labor market and an increasingly vibrant construction sector. However, Latin economic recessions will temper growth this year. Florida’s labor markets are expanding, and more growth is expected in technology, tourism and construction. Canada’s ongoing fiscal reforms are driving unemploy- ment rates lower and keeping inflation rates below U.S. rates. Lower interest rates and stability in world commodity prices will accelerate Canada’s GDP in 1999. Mexico will experience the adverse impact of Latin economic weakness and Brazilian recession in 1999, and the peso will weaken. Fortunately, U.S. economic growth and Canadian acceleration will expand Mexican exports. n n n So, can we keep the economic party going strong? Prospects for economic stability in the years ahead depend upon a more proper and logically consistent mix of policies from Washington. If policy makers truly want to guard against the twin evils of inflation and recession, then, in stark contrast to recent initiatives, they would lower tax rates and curb monetary stimulation. David L. Littmann and William T. Wilson, Ph.D. Comerica Economics Department Comerica Incorporated Shareholder Information Stock Comerica’s stock trades on the New York Stock Exchange (NYSE) under the symbol CMA. Shareholder Assistance Inquiries related to shareholder records, change of name, address or ownership of stock, and lost or stolen stock certificates should be directed to the transfer agent and registrar: 74 Norwest Shareowner Services P.O. Box 64854 St. Paul, Minnesota 55164-0854 1-800-468-9716 Elimination of Duplicate Materials If you receive duplicate mailings at one address, you may have multiple shareholder accounts. You can consolidate your multiple accounts into a single, more convenient account by contacting the transfer agent shown above. In addition, if more than one member of your household is receiving shareholder materials, you can eliminate the duplicate mailings by contacting the transfer agent. Dividend Reinvestment Plan Comerica offers a dividend reinvestment plan which permits participating shareholders of record to reinvest dividends in Comerica common stock without paying brokerage commis- sions or service charges. Participating shareholders also may invest up to $3,000 in additional funds each quarter for the purchase of additional shares. A brochure describing the plan in detail and an authorization form can be requested from the transfer agent shown above. Dividend Direct Deposit Common shareholders of Comerica may have their dividends deposited into their savings or checking account at any bank that is a member of the National Automated Clearing House (ACH) system. Information describing this service and an authorization form can be requested from the transfer agent shown above. Dividend Payments Subject to approval of the board of directors, dividends customarily are paid on Comerica’s common stock on or about January 1, April 1, July 1 and October 1. Annual Meeting The Annual Meeting of Shareholders of Comerica Incorporated will be held on Friday, May 21, 1999, at 9:30 a.m. at the Detroit Institute of Arts, 5200 Woodward Avenue, Detroit, Michigan. Form 10-K A copy of the Corporation’s Annual Report on Form 10-K, as filed with the Securities and Exchange Commission, may be obtained without charge upon written request to the Secretary of the Corporation at the address listed under Corporate Information. Comerica Incorporated Stock Prices, Dividends and Yields (adjusted for stock split) Quarter 1998 Fourth Third Second First 1997 Fourth Third Second First High $69.00 71.94 73.00 72.13 $61.88 53.25 46.75 42.08 Dividend Low Per Share Dividend* Yield $46.50 51.00 61.94 54.33 $50.17 45.04 35.92 34.17 $0.32 0.32 0.32 0.32 $0.29 0.29 0.29 0.29 2.2% 2.1 1.9 2.0 2.1% 2.4 2.8 3.0 * Dividend yield is calculated by annualizing the quarterly dividend per share and dividing by an average of the high and low price in the quarter. At January 31, 1999, there were approximately 17,030 holders of record of the Corporation’s common stock. Corporate Information Comerica Incorporated Comerica Tower at Detroit Center, MC 3391 500 Woodward Avenue Detroit, Michigan 48226 1-248-371-5000 (metro Detroit) 1-800-521-1190 (outside Detroit area) www.comerica.com Investor Relations on the Internet Go to www.comerica.com to find the latest investor relations information about Comerica, including stock quotes, news releases and customized financial data. Product Information Center If you have any questions about Comerica’s products and services, please contact our Product Information Center at 1-800-292-1300. Year 2000 Updates Call 1-877-789-2573 or go to www.comerica.com for the latest information about Comerica’s year 2000 program. Community Reinvestment Act (CRA) Performance Comerica is committed to meeting the credit needs of the communities it serves. Following are the most recent CRA ratings for Comerica subsidiaries: Comerica Bank (Michigan) Comerica Bank–Texas Comerica Bank–California Comerica Bank, N.A. Outstanding Outstanding Satisfactory Satisfactory Equal Employment Opportunity Comerica is committed to its affirmative action program and practices which ensure uniform treatment of employees without regard to race, creed, color, age, national origin, religion, handicap, marital status, veteran status, weight, height or sex. Media Contact Sharon R. McMurray 313-222-4881 Investor Contact Allison T. McFerren 313-222-6317 1982 Corporation name changed to Comerica Incorporated to reflect national scope of company. 1982 Comerica entered Florida market. 1988 Comerica entered Texas market. 1991 Comerica entered California market. 1992 Comerica merged with Manufacturers National Corporation. 1999 Comerica marks the 150th anniversary of its founding. Company Milestones 1849 Comerica forerunner Detroit Savings Fund Institute founded by Elon Farnsworth, March 5, 1849, in the building at the rear of the original location of Mariners’ Church at Griswold and Woodbridge. First day of business was August 17. 1871 Name changed to The Detroit Savings Bank. 1933 Manufacturers National Bank of Detroit founded; Comerica 1992 merger partner. 1936 Detroit Savings Bank name changed to The Detroit Bank. 1956 The Detroit Bank & Trust Company formed through consolidation of The Detroit Bank, Birmingham National Bank, Ferndale National Bank, and Detroit Wabeek Bank & Trust. 1973 Holding company DETROITBANK Corporation formed. Design and production: The Davis Design Group Historical text and photography: PROMISES KEPT The Story of Comerica 1849-1999 Photography: Frenak Photo & Imaging Jim Secreto Photography Baditoi Photographic Printer: Wintor-Swan Associates Printed on recycled paper 

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