10-Q 1 d10q.txt FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------- FORM 10-Q X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2002 OR TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number 1-7273 ------------------------------ Allfirst Financial Inc. (Exact name of registrant as specified in its charter) Delaware 52-0981378 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) The Allfirst Building 25 South Charles Street Baltimore, Maryland 21201 (Address of principal executive offices) (zip code) 410-244-4000 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for at least the past 90 days. Yes X No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: All 597,763 outstanding shares of Common Stock of the registrant are owned by Allied Irish Banks, p.l.c., an Irish banking corporation. ALLFIRST FINANCIAL INC. AND SUBSIDIARIES FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2002 INDEX

2 Item 1. Financial Statements ALLFIRST FINANCIAL INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited)

See accompanying notes to consolidated financial statements 3 ALLFIRST FINANCIAL INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Unaudited) June 30, December 31, 2002 2001 -------- ------------ (in thousands, except per share amounts) Assets Cash and due from banks ........................................................ $ 808,195 $ 1,286,131 Interest bearing deposits in other banks ....................................... 4,641 4,869 Trading account securities ..................................................... 3,724 41,676 Federal funds sold and securities purchased under resale agreements ............ 736,805 922,675 Investment securities available for sale ....................................... 3,406,233 4,101,133 Loans held for sale ............................................................ 80,089 38,186 Loans, net of unearned income of $164,724 in 2002 and $185,601 in 2001, respectively: Commercial ................................................................ 4,000,286 3,930,556 Commercial real estate .................................................... 2,421,695 2,395,841 Residential mortgage ...................................................... 413,921 472,082 Direct retail ............................................................. 2,503,070 2,420,376 Commercial leases receivable .............................................. 658,190 679,554 Indirect retail loans and leases receivable ............................... 473,507 654,359 Foreign ................................................................... 195,553 201,103 ----------- ----------- Total loans, net of unearned income .................................. 10,666,222 10,753,871 Allowance for loan and lease losses ............................................ (181,039) (152,539) ----------- ----------- Loans, net ........................................................... 10,485,183 10,601,332 ----------- ----------- Premises and equipment ......................................................... 245,799 244,607 Due from customers on acceptances .............................................. 3,359 3,274 Intangible assets .............................................................. 17,033 19,825 Goodwill ....................................................................... 772,541 770,092 Other assets ................................................................... 747,317 784,131 ----------- ----------- Total assets .................................................... $17,310,919 $18,817,931 =========== =========== Liabilities and Stockholders' Equity Domestic deposits: Noninterest bearing deposits .............................................. $ 3,118,504 $ 3,848,733 Interest bearing deposits ................................................. 6,889,947 6,993,744 ----------- ----------- Total core deposits ............................................................ 10,008,451 10,842,477 Large denomination time deposits ............................................... 1,493,324 1,922,324 Interest bearing deposits in foreign banking office ............................ 95,763 305,490 ----------- ----------- Total deposits ....................................................... 11,597,538 13,070,291 Federal funds purchased and securities sold under repurchase agreements ........ 1,205,925 1,126,302 Other borrowed funds, short-term ............................................... 922,606 566,904 Bank acceptances outstanding ................................................... 3,359 3,274 Other liabilities .............................................................. 621,043 1,376,571 Long-term debt ................................................................. 1,209,270 1,010,116 ----------- ----------- Total liabilities ............................................... 15,559,741 17,153,458 ----------- ----------- 4.50% Cumulative, Redeemable Preferred Stock, $5 par value per share, $100 liquidation preference per share: authorized and issued 90,000 shares ......... 9,000 8,858 Minority interest .............................................................. 108 113 Stockholders' equity: Common Stock, no par value; authorized 1,200,000 shares, issued 597,763 shares ...................................................... 85,395 85,395 Capital surplus ................................................................. 582,816 582,816 Retained earnings .............................................................. 1,033,343 971,874 Accumulated other comprehensive income .......................................... 40,516 15,417 ----------- ----------- Total stockholders' equity ...................................... 1,742,070 1,655,502 ----------- ----------- Total liabilities, redeemable preferred stock, minority interest and stockholders' equity .................................... $17,310,919 $18,817,931 =========== ===========

See accompanying notes to consolidated financial statements 4 ALLFIRST FINANCIAL INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (Unaudited)

See accompanying notes to consolidated financial statements 5 ALLFIRST FINANCIAL INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

See accompanying notes to consolidated financial statements 6 ALLFIRST FINANCIAL INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) EXPLANATORY STATEMENT On February 6, 2002, Allfirst Financial Inc. and subsidiaries ("Allfirst") announced that its parent, Allied Irish Banks, p.l.c. ("AIB"), was undertaking a full investigation into fraudulent foreign exchange trading activities at Allfirst. This investigation was led by former U.S. Comptroller of the Currency Eugene Ludwig with Wachtell, Lipton, Rosen & Katz acting as outside counsel to Allfirst and AIB in connection with the investigation. The losses arising from the fraudulent activities were disclosed by Allfirst in an earnings release dated February 20, 2002. The financial statements and notes thereto for the first six months of 2001 are restated to reflect the effects of the fraudulent proprietary foreign exchange trading activities. The fraudulent trading activities and the resulting losses are referred to from time to time in this report as the "Fraudulent Activities" and the "Fraud Losses", respectively, and proprietary foreign exchange trading losses are referred to as "FX Losses". FX Losses include both authentic and fraudulent trading activity. For additional information on the Fraudulent Activities and the Fraud Losses, refer to the 2001 Annual Report on Form 10-K filed with the Securities & Exchange Commission on April 1, 2002. 1. Basis of Presentation The accompanying unaudited consolidated financial statements of Allfirst Financial Inc. and subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and Rule 10-01 of Regulation S-X. Accordingly, they do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The consolidated financial statements were compiled in accordance with the accounting policies set forth in Note 1 of Notes to Consolidated Financial Statements included in Allfirst's 2001 Annual Report on Form 10-K. In the opinion of management, all adjustments (which consist of only normal, recurring accruals) necessary for a fair presentation have been included. Certain prior years' amounts have been reclassified to conform with the presentation used for the current year. Operating results for the six month period ended June 30, 2002 are not necessarily indicative of the results that may be expected for the year ended December 31, 2002. These unaudited financial statements should be read in conjunction with the audited financial statements and related notes included in the 2001 Annual Report. 2. Recent Accounting Pronouncements SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections", was issued in April 2002. The Statement rescinds, amends, and clarifies existing accounting issues and is effective at various dates in 2002 and 2003, with earlier application encouraged. The impact of adopting the requirements of this Standard on Allfirst's financial position, results of operations, and cash flow is expected to be immaterial. SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities", was issued in July 2002. This Statement applies to costs associated with an exit activity, including restructuring, or with a disposal of long-lived assets. This Statement is to be applied prospectively for qualifying activities initiated after December 31, 2002. Allfirst is unable to determine the impact of this standard due to its prospective application. 7 ALLFIRST FINANCIAL INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Unaudited) 3. Acquisition On May 3, 2002, Allfirst completed the acquisition of Ketchum Canada, Inc. ("Ketchum") for $3.6 million. Ketchum is Canada's largest fundraising consultancy. Since its founding in 1984, Ketchum has provided fundraising assistance to more than 600 clients in the Canadian Not-for-Profit ("NFP") sector and will complement AIB's North American NFP business headquartered in New York. Ketchum operates across Canada with principal offices in Toronto, Montreal, Calgary, and Vancouver. Ketchum had net assets on acquisition of approximately $1.0 million. The acquisition was accounted for as a purchase business combination and the results of operations of Ketchum have been included in Allfirst's results since the acquisition date. 4. Goodwill and Other Intangible Assets On January 1, 2002, Allfirst adopted the provisions of SFAS No. 142, "Goodwill and Other Intangible Assets". This Statement addresses financial accounting and reporting for intangible assets acquired individually or with a group of other assets (but not those acquired in a business combination) at acquisition. This Statement requires that goodwill be allocated on a reporting unit level, which is either at the same level or one level below the operating segment. Additionally, goodwill and intangible assets that have indefinite useful lives will not be amortized but rather will be tested at least annually for impairment at the reporting unit level. Intangible assets that have finite lives will continue to be amortized over their useful lives. Goodwill and intangible assets acquired after June 30, 2001 are subject immediately to the nonamortization and amortization provisions of this Statement. Application of the nonamortization provision of this Standard is expected to reduce noninterest expense by approximately $40 million in 2002 as compared to 2001. For the three months and six months ended June 30, 2002, there was no goodwill amortization expense as compared to $9.7 million and $19.1 million for the three months and six months ended June 30, 2001, respectively. The following tables provide a comparison between reported net income adjusted to exclude the impact of goodwill amortization for the three months and six months ended June 30, 2002 and 2001.

(1) Goodwill related to Community Counselling Services, Inc. ("CCS"), which was acquired in May 2001, is tax deductible. 8 ALLFIRST FINANCIAL INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Unaudited) 4. Goodwill and Other Intangible Assets (continued) As part of the implementation of SFAS No. 142, a transitional impairment test was required to be applied to all goodwill and other indefinite-lived intangible assets within the first half of 2002. For purposes of testing for impairment, goodwill was allocated to reporting units at the acquisition date or to the reporting unit originally intended to benefit from prior acquisitions. As of June 30, 2002, Allfirst has completed the impairment analysis, and no transitional impairment charge is required. However, the future impact of this statement could result in income statement volatility due to the potential recognition of impairment losses for goodwill, as opposed to the reduction of goodwill through recurring amortization. The net carrying amount of goodwill at June 30, 2002 was $772.5 million, an increase of $2.4 million from December 31, 2001. This increase was due to goodwill recorded related to the Ketchum acquisition. Goodwill was allocated to Allfirst's reportable segments for purposes of testing for impairment as follows: (in thousands) Regional Banking ........... $ 606,534 Capital Markets ............ -- Asset Management ........... 120,505 Treasury ................... -- Other1 ..................... 45,502 --------- Total ...................... $ 772,541 ========= (1) CCS and Ketchum goodwill. Allfirst continues to amortize other intangible assets over their remaining useful lives. The net carrying amount of other intangible assets, excluding goodwill at June 30, 2002, are as follows:

9 ALLFIRST FINANCIAL INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Unaudited) 4. Goodwill and Other Intangible Assets (continued) Estimated annual amortization for the second half of 2002 and future years for amortizable intangible assets is as follows: (in thousands) Six months ending December 31, 2002 $ 2,972 Years ending December 31, 2003 4,817 2004 3,769 2005 2,525 2006 2,041 2007 909 -------- Total $ 17,033 ======== 5. Investment Securities The amortized cost and fair value of available for sale securities at June 30, 2002 are as follows:

During the three months ended June 30, 2002, Allfirst recorded a $13.8 million other than temporary impairment loss on marketable equity securities arising from continued declines in the U.S. equity markets. 10 ALLFIRST FINANCIAL INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Unaudited) 6. Line of Business Reporting Allfirst has determined that its major lines of business are those that are based on Allfirst's method of internal reporting, which separates its business on the basis of products and services. Allfirst's reportable business lines are Regional Banking, Capital Markets, Asset Management, and Treasury. Regional Banking provides loans, deposits, letters of credit, derivative financial instruments, cash management products and services, mutual funds and credit life insurance to consumers, small businesses, and middle market corporate customers. Capital Markets provides commercial loans, construction and property loans, letters of credit, derivative financial instruments, FX and cash management products and services to large corporate customers. It is also involved in mortgage banking activities related to multi-family housing loan programs. Asset Management provides investment advisory, investment, and fiduciary services to individual, institutional and corporate clients. The Asset Management Group also manages the ARK(R) Funds, a family of proprietary mutual funds. Treasury is responsible for managing and controlling the liquidity, funding and market risk needs of Allfirst. Other includes residential mortgage lending which was formerly included in Capital Markets and indirect lending which was formerly included in Regional Banking. The activities in both of these businesses were curtailed prior to 2001. Other also includes the fundraising / consulting activities conducted through CCS and Ketchum. FX Losses, including the Fraud Losses, are included as a component of Other. Several smaller business units, inter-segment income elimination and unallocated income and expenses, including goodwill and other intangible asset amortization are included in Other as well. Allfirst's internal accounting process is based on practices which support the management structure of Allfirst, and the resulting data is not necessarily comparable with similar information from other financial institutions. Net income reflects costs directly associated with each business line including centrally provided services which are allocated based on estimated usage of those services. Each business unit's assets and liabilities are match-funded with interest rate risk centrally managed within Treasury. Loan loss provisions and the allowance for loan and lease losses are allocated based on a process that incorporates the loan's risk rating and current economic trends for commercial loans and leases and historical loss experience adjusted for current conditions for retail loans and residential mortgages. Line of business results are presented on a shareholder value based management ("SVBM") basis. Under SVBM, capital is allocated to each line of business based on the inherent risks within the business, primarily credit and operational risk. SVBM allows management to: (1) manage capital more efficiently; (2) reduce earnings volatility and enhance shareholder value; (3) compare businesses with different risk characteristics on a like-for-like basis; and (4) systematically address the risks inherent in Allfirst's businesses. 11 ALLFIRST FINANCIAL INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Unaudited) 6. Line of Business Reporting (continued) The following tables present operating information about each of Allfirst's business lines for the three months ended June 30, 2002 and 2001.

Three Months Ended June 30, 2001 (As Restated) ----------------------------------------------

(1) Includes tax-equivalent adjustment for tax-exempt interest income. (2) The term "FX Losses" means all FX trading losses both authentic and Fraud Losses. 12 ALLFIRST FINANCIAL INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Unaudited) 6. Line of Business Reporting (continued) The following tables present operating information about each of Allfirst's business lines for the six months ended June 30, 2002 and 2001. Six Months Ended June 30, 2002 ------------------------------

Six Months Ended June 30, 2001 (As Restated) --------------------------------------------

(1) Includes tax-equivalent adjustment for tax-exempt interest income (2) The term "FX Losses" means all FX trading losses both authentic and Fraud Losses. 13 ALLFIRST FINANCIAL INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued) (Unaudited) 7. Restatement of Second Quarter 2001 Financial Statements As a result of the Fraudulent Activities described in the Explanatory Statement, Allfirst has restated the financial statements for the three months and six months ended June 30, 2001. Amounts affected are presented on the following tables. For The Three Months Ended June 30, 2001: -----------------------------------------

At And For The Six Months Ended June 30, 2001: ----------------------------------------------

(a) Other assets reduced as a result of the deletion of fictitious FX Option Assets, an overstatement of Due from Brokers - FX Options and by the restatement of income taxes receivable. (b) Other liabilities increased as a result of unrecorded FX Option Liabilities, an overstatement of Due to Brokers - FX Options and by the restatement of income taxes payable. (c) Retained earnings reduced as a result of restatements to the Income Statement for current and prior periods resulting from the Fraud Losses. This adjustment consists of both the first six months of 2001 income statement effect of $(101.7) million and the cumulative effect of restatements attributable to years 1997 - 2000 of $(195.5) million. (d) Trading income reduced due to the overstatement of income resulting from the fictitious FX Option Assets and the unrecorded FX Option Liabilities. This line item also includes both FX Loss and Trading Income - Other within the current 10-Q presentation. (e) Income taxes and net income reduced due to the overstatement of income as a result of the Fraud Losses. The restatement adjustments were tax effected at a rate of 35.0%. 14 ALLFIRST FINANCIAL INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (concluded) (Unaudited) 8. Litigation Allfirst and its subsidiaries are defendants in various matters of litigation generally incidental to their respective businesses. In the opinion of management, based on its review with counsel of the development of these matters to date, except for the matters discussed below, disposition of all pending litigation will not materially affect the consolidated financial position, results of operations or liquidity of Allfirst and its subsidiaries. Shareholder Class Actions. On March 5, 2002, a class action lawsuit was filed in the United States District Court for the Southern District of New York by Walter P. Linn against AIB, Allfirst and several current and former officers of Allfirst and Allfirst Bank (the "Defendants"). On April 26, 2002, an amended complaint was filed by Mr. Linn. Mr. Linn purports to represent a class of all purchasers of the securities of AIB from February 6, 1999 through February 6, 2002 (excluding the named Defendants and any officers or directors of AIB and their immediate family members). The suit alleges violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder arising out of the $691 million of foreign exchange currency trading losses at Allfirst Bank (the "FX Trading Losses"). On April 24, 2002, a second class action lawsuit was filed in the United States District Court for the Southern District of New York by Rodger D. Koons against the Defendants. Mr. Koons purports to represent a class of all purchasers of the securities of AIB from January 1, 2001 through February 6, 2002 (excluding the named Defendants and any officers or directors of AIB and their immediate family members). The suit alleges violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder arising out of the FX Trading Losses. On May 3, 2002, a motion to consolidate the Linn case and the Koons case and to appoint a lead plaintiff was filed with the court. Shareholder Derivative Action. On May 13, 2002, Tomran, Inc., a holder of 4800 AIB ADRs, filed on behalf of Allfirst Bank a derivative action in the Circuit Court for Baltimore City, Maryland against certain current and former directors and officers of Allfirst Bank. Allfirst, Allfirst Bank and Allied Irish Banks, p.l.c. were named as nominal defendants. The complaint alleges negligence and gross negligence by the defendants in the management and oversight of the foreign exchange trading activities at Allfirst Bank and seeks recovery of the full amount of the foreign exchange trading losses. The current and former directors and officers moved to dismiss the action as did the nominal defendants. The likely disposition of the lawsuits and their effect on Allfirst cannot be determined at this time. 15 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations FORWARD-LOOKING STATEMENTS Certain information included in this report, other than historical information, may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. The forward-looking statements are identified by terminology such as "may", "will", "believe", "expect", "estimate", "anticipate", "continue", or similar terms. Actual results may differ materially from those projected in the forward-looking statements. Factors that could cause actual results to differ materially from those in the forward-looking statements include, but are not limited to: global, national and regional economic conditions; levels of market interest rates; credit or other risks of lending and investment activities; changes in accounting rules and policies; legal and regulatory proceedings; competitive and regulatory factors; and technological change. ANALYSIS OF RESULTS OF OPERATIONS Performance Overview Allfirst reported net income to common stockholders for the three months ended June 30, 2002 of $23.8 million, compared to a restated net loss to common stockholders of $23.0 million for the three months ended June 30, 2001. Net income to common stockholders represents net income after deducting preferred stock dividends. Return on average assets and return on average common stockholder's equity were 0.56% and 5.52%, respectively, for the three months ended June 30, 2002 compared to (0.53%) and (5.48%) for the three months ended June 30, 2001. Net income to common stockholders for the six months ended June 30, 2002 was $61.6 million, compared to a restated net loss to common stockholders of $4.3 million for the six months ended June 30, 2001. Return on average assets and return on average common stockholder's equity were 0.71% and 7.25%, respectively, for the six months ended June 30, 2002 compared to (0.05%) and (0.51%) for the six months ended June 30, 2001. Both periods include the effect of the previously announced Fraudulent Activities that were more fully disclosed in Allfirst's 2001 Annual Report on Form 10-K filed on April 1, 2002. In addition, Allfirst recorded a $13.7 million pretax charge (the "FX Related Charge") during the first half of 2002 to cover the costs associated with the special investigation into the Fraudulent Activities as well as other incremental direct costs associated with the Fraudulent Activities. Allfirst's results for the six months ended June 30, 2002 include FX Losses of $17.0 million as well as the FX Related Charge of $13.7 million. The first half results also include a $13.8 million other than temporary impairment loss on marketable equity securities (included in securities gains (losses), net) arising from continued declines in the U.S. equity markets, a $25.0 million increase in the provision for loan losses attributable to one large telecommunications loan that was placed on nonaccrual during the period, and an increase of $10.4 million to the automobile lease residual valuation allowance. The impact of the change in accounting for goodwill amortization (reduces expenses by $19.1 million from 2001) is also reflected in the first half 2002 results. Additionally, Allfirst's results for the half year 2002 include the results of CCS and Ketchum from the acquisition dates of May 17, 2001 and May 3, 2002, respectively. For comparative purposes, the revenues and expenses of CCS and Ketchum, as well as the FX Losses, the FX Related Charge, goodwill amortization, the change in the automobile lease residual valuation allowance and securities gains (losses) have been excluded from the analysis in the following paragraph. Allfirst's adjusted total revenues grew by 2.3% in the first six months of 2002 compared to the first half of 2001. Net interest income was unchanged over the same period last year with higher loan product margins offset by lower earnings from a reduced investment securities portfolio and the impact of lower interest rates on deposit margins. The net interest margin decreased to 3.51%, down 3 basis points from the first half of 2001. Revenue growth was driven by an increase in adjusted noninterest income of 5.4%, with a 14% increase in deposit service charges and a 10% rise in electronic banking fees. Adjusted noninterest expenses increased by 6.5% in the first half of 2002 compared to 2001. 16 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Nonperforming assets at June 30, 2002 were $135.5 million, or 1.27% of loans, other real estate and other assets owned, a $46.8 million increase from the December 31, 2001 level of $88.7 million, or 0.83% of loans, other real estate and other assets owned. The allowance for loan and lease losses at June 30, 2002 of $181.0 million increased by $28.5 million over the December 31, 2001 level and represented 143% of nonperforming loans and 1.70% of period end loans. Asset quality is discussed in more detail on page 27. Net Interest Income Net interest income is the difference between the interest and yield-related fee income generated by earning assets and the interest expense incurred on interest bearing liabilities. The amount of net interest income is affected by both changes in the level of interest rates and the amount and composition of earning assets and interest bearing liabilities. When net interest income is presented on a tax-equivalent basis, interest income from tax exempt earning assets is increased by an amount equivalent to the Federal income taxes that would have been paid if this income were taxable at the statutory Federal income tax rate of 35%. Net interest margin represents net interest income on a tax-equivalent basis as a percentage of average earning assets. The net interest income that is presented on pages 18 and 19 is on a tax-equivalent basis. Net interest income as presented in the Consolidated Statements of Income on page 3 is on a non tax-equivalent basis. Net interest income on a tax-equivalent basis for the three months ended June 30, 2002 was $125.5 million, a decrease of $8.1 million when compared to net interest income of $133.6 million for the three months ended June 30, 2001. The net interest margin was 3.41% for the second quarter of 2002, down sixteen basis points from the same period last year. The decline in net interest income was partially attributable to a smaller investment portfolio in the 2002 period combined with higher levels of earning assets invested in low-rate Federal funds sold. The decline in net interest margin was primarily attributable to the lower contribution of net free funds as a result of the low interest rate environment. Net interest income on a tax-equivalent basis for the six months ended June 30, 2002 was $263.2 million, a decrease of $0.7 million when compared to net interest income of $263.9 million for the first six months of 2001. The net interest margin was 3.51% for the first half of 2002, down three basis points from the same period last year. Net interest income and net interest margin were essentially unchanged over the same period last year with higher loan product margins offset by lower earnings from a reduced investment securities portfolio and the impact of lower interest rates on deposit margins. Loan product margins, which represent the difference between the interest yield on loans and the cost of funding loans under the Allfirst internal funds transfer pricing system, increased from first half 2001 levels with commercial loans up 19 basis points and direct retail loans up 26 basis points. 17 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) The following tables provide additional information on Allfirst's average balances, annualized interest yields, rates, and net interest margin for the three months and six months ended June 30, 2002 and 2001. Average Balances, Interest Yields and Rates and Net Interest Margin (Tax-Equivalent Basis)

----------------------------- (1) Interest on loans to and obligations of public entities is not subject to Federal income tax. In order to make pre-tax yields comparable to taxable loans and investments, a tax-equivalent adjustment is used based on a 35% Federal tax rate. (2) Yields on investment securities available for sale are calculated based upon average amortized cost. (3) Nonaccrual loans are included under the appropriate loan categories as earning assets. (4) Net interest spread is the difference between the yield on average earning assets and the rate paid on average interest bearing liabilities. (5) Net interest margin is the ratio of net interest income on a fully tax-equivalent basis to average earning assets. 18 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Average Balances, Interest Yields and Rates and Net Interest Margin (Tax-Equivalent Basis)

----------------------------- (1) Interest on loans to and obligations of public entities is not subject to Federal income tax. In order to make pre-tax yields comparable to taxable loans and investments, a tax-equivalent adjustment is used based on a 35% Federal tax rate. (2) Yields on investment securities available for sale are calculated based upon average amortized cost. (3) Nonaccrual loans are included under the appropriate loan categories as earning assets. (4) Net interest spread is the difference between the yield on average earning assets and the rate paid on average interest bearing liabilities. (5) Net interest margin is the ratio of net interest income on a tax equivalent basis to average earning assets. 19 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Noninterest Income The following table presents the components of noninterest income for the three months ended June 30, 2002 and 2001. Noninterest Income

Allfirst's noninterest income of $97.6 million for the quarter ended June 30, 2002 increased by $115.5 million over the same period last year due to lower FX Losses of $112.5 million and an increase in consulting income of $8.1 million related to CCS and Ketchum. The three months ended June 30, 2002 includes a $13.8 million other than temporary impairment loss on marketable equity securities arising from continued declines in the U.S. equity markets. This loss, included in securities gains (losses), is partially offset by $5.6 million in debt securities gains resulting from the reduction in Allfirst's investment portfolio. Excluding the FX Losses, consulting income, and securities gains (losses), adjusted noninterest income was $92.8 million, representing a $3.2 million or 3.6% increase over the same period in 2001. Service charges on deposit accounts were $31.1 million, up $2.8 million from the prior year. Corporate deposit service charges were up $2.0 million primarily as a result of cash management customers paying for more of their services in fees than in compensating balances. Retail deposit service charges increased $0.8 million from the second quarter of 2001 due to growth in free checking accounts that generally result in higher non-sufficient funds fee activity. Trust and investment advisory fees of $21.2 million increased slightly compared to 2001 with fee declines driven by weak equities markets offset by new sales activities and corporate trust growth. Electronic banking income, consisting of fee income from automated teller machines and interchange income from VISA debit card transactions, increased $0.8 million in the second quarter of 2002 compared to 2001 as debit card usage continues to expand. Mortgage banking income decreased $0.7 million. The second quarter of 2001 included a $0.7 million gain on the sale of residential mortgages. Other trading income decreased $1.8 million primarily as a result of lower sales of securities and derivative products to customers. Other income, which consists primarily of bank owned life insurance income, unused line of credit fees, standby letter of credit fees, merchant income, and fees from the sale of other bank products and services to customers, was $24.6 million for the second quarter of 2002 compared to $22.8 million for the second quarter of 2001. The growth in this category was driven by growth in standby letters of credit. 20 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Noninterest Income The following table presents the components of noninterest income for the six months ended June 30, 2002 and 2001. Noninterest Income

Allfirst's noninterest income for the six months ended June 30, 2002 was $185.9 million, a $158.5 million increase from noninterest income for the first six months of 2001 due to lower FX Losses of $134.3 million and higher consulting income of $20.4 million related to CCS and Ketchum. The six months ended June 30, 2002 includes the $13.8 million other than temporary impairment loss on marketable equity securities that is included in securities gains (losses). This loss is partially offset by debt securities gains of $8.7 million driven primarily by the second quarter reduction in Allfirst's investment portfolio. Excluding the FX Losses, consulting income, and securities gains (losses), adjusted noninterest income was $182.7 million, representing a $9.3 million or 5.4% increase over the same period in 2001. Service charges on deposit accounts of $61.2 million were up $7.4 million from the prior year. Corporate deposit service charges were up $5.4 million primarily as a result of cash management customers paying for more of their services in fees than in compensating balances. Retail deposit service charges grew $2.0 million due to higher levels of non-sufficient funds activity and improved fee waiver management. Trust and investment advisory fees of $43.1 million were essentially unchanged from 2001, with fee declines driven by weak equities markets offset by new sales activities. Electronic banking income grew in 2002 to $17.3 million, an increase of $1.6 million due to increased fee income from automated teller machines and interchange income from VISA debit card transactions. Mortgage banking income for the first half of 2002 increased slightly from the prior year as commercial mortgage banking originations and placements remain strong. Other trading income decreased $2.8 million primarily as a result of lower sales of securities and derivative products to customers. Other income was $46.5 million for the first half of 2002 compared to $43.7 million for the same period in 2001. Growth in other income includes higher standby letter of credit fees of $2.0 million and increased bank owned life insurance income of $1.5 million. 21 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Noninterest Expenses The following table presents the components of noninterest expenses for the three months ended June 30, 2002 and 2001. Noninterest Expenses

Allfirst's noninterest expenses for the quarter ended June 30, 2002 were $156.4 million, a $12.7 million increase from noninterest expenses for the quarter ended June 30, 2001. As described in Note 4 of the Notes to Consolidated Financial Statements, the change in accounting for goodwill amortization is reflected in the 2002 results. The second quarter of 2002 also includes the expenses of CCS and Ketchum. An additional FX Related Charge of $3.7 million as well as an increase in the automobile lease residual valuation allowance of $9.0 million due to continued weakness in user car prices were recorded during the quarter. Excluding goodwill amortization, CCS and Ketchum expenses, the FX Related Charge, and the change in the automobile lease residual valuation allowance, adjusted noninterest expenses were $132.4 million, representing a $3.2 million or 2.5% increase over the second quarter of 2001. Excluding CCS and Ketchum for purposes of comparability, salaries and other personnel costs increased to $79.9 million in the second quarter of 2002, a $3.2 million increase resulting primarily from an increase in pension expense. Pension costs were $3.0 million higher in 2002 due to the impact of weak financial markets on plan asset values. Equipment costs increased $1.9 million due to higher depreciation. Occupancy costs increased by $1.0 million primarily as a result of higher property rental expense. The FX Related Charge represents the costs associated with the special investigation of the Fraudulent Activities discussed in the Explanatory Statement, as well as other incremental direct costs arising from the Fraudulent Activities. Other incremental direct costs include legal fees, consulting fees associated with risk management processes, and additional Federal Deposit Insurance Corporation ("FDIC") premiums. Other operating expenses for the second quarter of 2002 were $28.7 million, up $6.7 million from the second quarter of 2001. The $9.0 million increase in the automobile lease residual valuation allowance, partially offset by declines in professional services fee of $2.9 million, accounts for the growth in this expense category. 22 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Noninterest Expenses The following table presents the components of noninterest expenses for the six months ended June 30, 2002 and 2001. Noninterest Expenses

Allfirst's noninterest expenses for the six months ended June 30, 2002 were $316.9 million, a $37.4 million increase from noninterest expenses for the six months ended June 30, 2001. As described previously, the change in accounting for goodwill amortization as well as the expenses of CCS and Ketchum are reflected in the 2002 results. In addition, the first half results include the FX Related Charge of $13.7 million and an increase in the automobile lease residual valuation allowance of $10.4 million. Excluding goodwill amortization, CCS and Ketchum expenses, the FX Related Charge, and the change in the automobile lease residual valuation allowance, adjusted noninterest expenses were $272.1 million, representing a $16.5 million or 6.5% increase over 2001. Excluding CCS and Ketchum, salaries and other personnel costs increased to $161.3 million in the first half of 2002, up $8.2 million with $7.0 million of the increase attributable to higher pension costs. The pension cost increase is due primarily to the lower earnings on plan assets resulting from the weak financial markets. Equipment costs increased $3.3 million due to higher depreciation and maintenance and repairs expense. Occupancy costs exhibited an increase of $1.2 million primarily due to higher property rental expense. Advertising and public relations costs were $9.2 million, an increase of $2.1 million due to the acceleration of marketing campaigns in the first half of 2002. Other operating expenses for the first six months of 2002 were $56.8 million, up $14.4 million from 2001. Expense growth was driven by the $10.4 million increase in the automobile lease residual valuation allowance and higher deferred compensation expenses of $3.8 million. 23 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) MARKET RISK MANAGEMENT Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates and equity prices. The effective management of market risk is essential to achieving Allfirst's objectives. As a financial institution, Allfirst's primary market risk exposure is interest rate risk. Interest Rate Risk Management Management of interest rate risk is effected through adjustments to the size and duration of the available-for-sale investment portfolio, the duration of purchased funds and other borrowings, and through the use of off-balance sheet financial instruments such as interest rate swaps, interest rate caps and floors, financial futures, and options. At June 30, 2002, Allfirst's equity at risk and earnings at risk remained in compliance with Allfirst's policy limits. As a result of the Fraudulent Activities, it is intended that AIB Group Treasury will play the principal role in managing elements of interest rate risk on behalf of Allfirst in the future. The implications of this change on Allfirst's financial position and results of operations cannot be quantified at this time. Fixed Income and Derivative Trading Risk Management Allfirst maintains active securities and interest rate derivative trading positions resulting from transactions on behalf of corporate customers. There has been no material change in the market risk of these portfolios during the first six months of 2002. As a result of the Fraudulent Activities, Allfirst has ceased all proprietary fixed income and derivative trading risk management activities. Foreign Exchange Risk Management In 2001 and prior years, Allfirst maintained active FX trading positions to service the needs of its corporate and retail customers as well as for its own trading account. As a result of the Fraudulent Activities, Allfirst has ceased all proprietary FX trading activities. However, Allfirst will continue to meet the FX needs of customers. LIQUIDITY RISK MANAGEMENT Liquidity refers to the ability of Allfirst to meet current and future financial obligations as well as to take advantage of investment opportunities in a timely and cost effective manner. These financial obligations include but are not limited to deposit withdrawals, loan funding, liability maturities and general corporate requirements. Liquidity needs are met through the issuance of liabilities at acceptable costs within an acceptable period of time, through the maturity or sale of assets, and through funds provided by operations. Refer to the Consolidated Statement of Cash Flows for an analysis of cash flows from operating, investing and financing activities. The ability to maintain regular access to competitively priced wholesale funds is dependent on strong credit ratings from the major credit rating agencies (Moody's, Standard & Poors ("S&P"), and Fitch). At August 14, 2002, the Allfirst parent company and Allfirst Bank's short-term and long-term ratings are as follows:

24 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Shortly after Allfirst announced the Fraudulent Activities in February 2002, Moody's confirmed the long-term and short-term credit ratings of the Allfirst parent company and Allfirst Bank but lowered Allfirst Bank's strength rating from C+ to D+. The strength rating is a rating that represents Moody's opinion of a bank's intrinsic safety and soundness. Banks with a D rating possess adequate financial strength that may be limited by a factor such as an unstable operating environment while banks with a C rating possess good intrinsic financial strength. Moody's ratings outlook is stable. On April 15, 2002, S&P downgraded the long-term and short-term credit ratings of the Allfirst parent company and Allfirst Bank. At the same time, S&P removed the ratings of the Allfirst parent company and Allfirst Bank from CreditWatch, where they were placed on February 6, 2002. S&P's ratings outlook is stable. Fitch Ratings downgraded the long-term and short-term credit ratings of the Allfirst parent company and Allfirst Bank on May 9, 2002. At the same time, Fitch removed the ratings from Negative Rating Watch, where they were placed following Allfirst's announcement of the Fraudulent Activities in February 2002. Fitch's ratings outlook is stable. Allfirst maintains a contingency funding plan to prepare for the possibility of a liquidity crisis and to establish a framework for dealing with such a crisis. Since the announcement of the Fraudulent Activities, Allfirst has managed liquidity in accordance with its contingency funding plan. Since that time, Allfirst Bank has experienced a slight increase in core deposits and approximately 40% of its unsecured Federal funds purchased capacity, which was temporarily lost, has returned. Moreover, Allfirst Bank has been a net seller of Federal funds as a result of actions taken under the contingency funding plan, which have included the funding of investment securities through repurchase agreements, the sale of investment securities and acquisition of short-term funding from AIB. At June 30, 2002, AIB had provided $250 million of short-term funding with maturities of less than 30 days priced at LIBOR. At June 30, 2002, Allfirst Bank, serving in the capacity of remarketing agent, was holding $57 million of variable rate demand bonds ("VRDBs") within investment securities available for sale. The VRDBs, which are enhanced by a direct-pay letter of credit provided by Allfirst Bank, are an attractive credit product for Allfirst's corporate customers by providing direct access to the capital markets. This results in lower funding costs by replacing the customer's credit rating with Allfirst Bank's credit rating. Investors generally have the right to sell the bonds to the remarketing agent with seven days notice. The typical interest rate reset is weekly and is based primarily on Allfirst Bank's credit rating. Allfirst will continue to externally remarket the VRDBs currently held. As of June 30, 2002, the total amount of VRDBs outstanding backed by an Allfirst Bank letter of credit was $1.2 billion. Dividends from subsidiaries are generally the primary source of funds for the liquidity requirements of the Allfirst parent company. However, in light of current dividend restrictions at Allfirst Bank arising from the FX Losses, the Allfirst parent company's funding requirements will be managed through funding provided by AIB. AIB has provided $400 million of funding to the Allfirst parent company. The long-term portion of this funding consists of $200 million of debt with a term of five years (maturing in February 2007) priced at LIBOR + 40 basis points plus $100 million of debt with a term of five years (maturing in May 2007) priced at LIBOR + 75 basis points. The $100 million long-term debt was provided on May 14, 2002 to cover a $100 million subordinated debt issue maturing on May 15, 2002. The short-term portion of this funding, $100 million with a six-month term (maturing in August 2002) priced at six month LIBOR, was rolled over at maturity on August 7, 2002 for an additional three-month term (maturing in November 2002) with pricing at three month LIBOR. At June 30, 2002, approximately $2.4 billion of loans and investment securities available for sale were pledged as collateral for securities sold under agreement to repurchase transactions, collateralized deposit programs, FHLB borrowings, and at the Federal Reserve discount window. On July 12, Allfirst finalized a secured credit facility that results in an additional $0.7 billion of consumer loan assets pledged as collateral. In addition, Allfirst is currently negotiating a secured credit facility that, if completed, would result in an additional $1.8 billion of assets, primarily loans secured by commercial real estate, pledged as collateral. 25 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Large denomination certificates of deposit (excluding AIB funding) have declined by $482 million to $1.7 billion from March 31, 2002 to June 30, 2002. Allfirst has utilized other unsecured funding sources to replace these maturing deposits. Since Allfirst's short-term ratings are still satisfactory, access to all wholesale funding sources is gradually returning. ANALYSIS OF FINANCIAL CONDITION Allfirst's total assets at June 30, 2002 were $17.3 billion, a $1.5 billion decrease from total assets of $18.8 billion at December 31, 2001. The decrease was primarily due to a decrease in cash and due from banks of $478 million, as well as decreases in investment securities available for sale of $695 million and federal funds sold and securities purchased under resale agreements of $186 million. Investment securities available for sale of $3.4 billion at June 30, 2002 decreased $695 million from the December 31, 2001 level of $4.1 billion, as a result of net portfolio sales to enhance Allfirst's liquidity position as well as to reduce optionality risk. At June 30, 2002, the investment securities available for sale portfolio had net unrealized gains of $66.8 million as compared to $26.3 million at December 31, 2001. The taxable equivalent yield on the entire securities portfolio for the six months ended June 30, 2002 was 5.57% compared to 6.35% for the same period in 2001. Investment securities sold in the first six months of 2002 totaled $2.2 billion and generated pretax gains of $9.1 million, while purchases totaled $2.1 billion and maturities, calls and paydowns of securities totaled $655 million. Total loans and leases of $10.7 billion at June 30, 2002 decreased $88 million when compared to December 31, 2001. Excluding curtailed portfolios, loans and leases increased $151 million compared to December 31, 2001 with increases in commercial loans of $70 million, commercial real estate loans of $26 million, and direct retail loans of $83 million. Curtailed or runoff portfolios, consisting of indirect retail lending / leasing and residential mortgages, decreased $239 million from year end levels. Indirect retail loans and leases of $474 million at June 30, 2002 decreased $181 million compared to December 31, 2001 as a result of portfolio runoff. Allfirst continues to service its existing indirect loan portfolio. Residential mortgage loans declined $58 million due to the sale of $25 million in residential mortgage loans during the first quarter of 2002 as well as portfolio runoff. At June 30, 2002, core deposits of $10.0 billion were down $0.8 billion from year end with noninterest bearing deposits down $0.7 billion. The decline in noninterest bearing deposits was driven primarily by the daily volatility of commercial demand deposits, which are historically higher on Mondays (as at December 31) and decline throughout the week with lows generally on Fridays (as at June 28, the last business day in June). In addition, commercial demand deposit balances are normally higher at year end. Core interest bearing deposits decreased $104 million to $6.9 billion due primarily to a $162 million decline in money market deposit balances partially offset by an increase of $74 million in savings balances. Excluding the daily volatility impact of commercial demand deposit balances, core deposits have increased approximately $200 million since the Fraudulent Activities were disclosed on February 6, 2002. 26 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) ASSET QUALITY Nonperforming assets were $135.5 million at June 30, 2002, compared to $88.7 million at December 31, 2000, an increase of $46.8 million. During the first half of 2002, nonaccrual loans increased $49.9 million, due primarily to a $50 million loan to a large telecommunications customer that was placed on nonaccrual during the second quarter. Total additions to nonaccrual loans in the first six months of 2002 aggregated $91.1 million, while reductions in nonaccrual loans totaled $41.2 million, comprised of paydowns and payoffs of $26.0 million, chargeoffs of $8.3 million, loans returned to accrual status of $5.1 million and transfers to other real estate and other assets owned of $1.8 million. The allowance consists of three elements: (1) specific reserves for individually impaired credits; (2) general reserves for types or portfolios of loans based on historical loan loss experience, judgmentally adjusted for concentrations and the current environment; and (3) unallocated reserves. Combined specific reserves and general reserves by loan type are considered allocated reserves. All outstanding loans, leases, letters of credit and legally binding commitments to lend are considered in evaluating the adequacy of the allowance. The allowance does not provide for the estimated losses stemming from uncollectible interest because Allfirst generally requires all accrued but unpaid interest to be reversed once a loan is placed on nonaccrual status. The process of establishing and managing the allowance with respect to Allfirst's commercial portfolios begins when a loan officer initially assigns each loan or lease a risk rating, based on a ten-point numerical scale and using established credit criteria. Risk ratings are reviewed at least annually and are also validated periodically on a selective basis by the independent Credit Review Department. Management meets quarterly to discuss current conditions that affect various lines of business and that may warrant adjustments to historical loss experience; adjustment factors that are considered include: trends in the economy, the levels and trends in past due and non-accrual loans; trends in loan volume; effects of any changes in lending policies and procedures; changes in underwriting; and the experience and depth of lending management. Historical factors by risk rating are carefully adjusted each quarter based on documentation reflective of management's seasoned judgment. Management also evaluates credit risk concentration, including trends in large dollar exposures to related borrowers, shared national credit exposure and industry concentrations. Experience has demonstrated that concentration risk has the potential to increase loan loss risk when influenced by external industry factors. All nonaccrual and classified loans in the commercial, commercial real estate (construction and mortgages), foreign and commercial lease categories above certain defined thresholds are analyzed individually to confirm the appropriate risk rating and accrual status and to determine the need for a specific reserve. During 2000, management introduced enhancements to support the calculation of the general reserves for loans and leases in the commercial portfolios not specifically reserved. Each risk rating is assigned a graduated risk factor based on probability of default and loss in event of default reflective of historical loss rates over a full economic cycle. The cycle currently being used covers the last 10 years. Management believes that use of the graduated risk factors allows it to further refine the determination of the allowance for this group of loans. Reserves for the retail and residential mortgage portfolios are intended to absorb approximately twelve months of inherent losses. These loans and leases are segregated into homogeneous pools with similar risk characteristics and the rolling twelve month historical loss experience for each pool is updated quarterly. Trends in each retail and residential pool are analyzed and adjusted to reflect current conditions. Adjustment factors for the residential and retail portfolios are consistent with those for the commercial portfolios. 27 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) The unallocated portion of the allowance is not attributable to any specific components of the loan portfolio, but is available to support losses that are probable within the high end of the range of losses that management has identified when establishing the specific and general portions of the allowance. Allfirst has risk management practices designed to ensure timely identification of changes in loan risk profiles; however, undetected losses may exist within the loan portfolios. The judgmental aspects involved in application of risk rating criteria, the quality of individual loan analyses and initial assessments of collateral values can also contribute to undetected, but probable, losses. Management uses quantitative tools to assist it in evaluating the overall reasonableness of the unallocated reserve. The unallocated reserve protects Allfirst from errors or subjectivity that might occur in establishing the allowance. The provision for loan and lease losses for the first six months of 2002 was $41.2 million, an increase of $25.7 million from the $15.5 million provision for the first six months of 2001. The provision increase was primarily attributable to the $50 million telecommunications credit placed on nonaccrual during the second quarter. The provision covered net chargeoffs of $12.7 million and provided for a $28.5 million increase in the allowance from $152.5 million to $181.0 million. Concurrent with the quarterly application of quantitative empirical methodologies and a conservative judgmental process, senior management determined that a $28.5 million increase in the allowance was warranted due to the increase in criticized assets and specific reserves. At June 30, 2002, unallocated reserves totaled $35.3 million, representing 19.5% of the total allowance for loan and lease losses, compared to $28.4 million, or 18.6% at year end 2001. The increase in unallocated reserves is warranted given the uncertainty about the impact of the volatility in the capital markets and concern about accounting irregularities at other public companies on Allfirst's commercial portfolio. From December 31, 2001 to June 30, 2002, specific reserves increased by $34 million to $44.9 million due to the increase in nonaccrual loans with $25 million of the increase attributable to the $50 million telecommunications credit previously discussed. Total allocated reserves for all portfolios increased by $21.6 million to $145.7 million. Higher reserves in the commercial portfolio resulted from increased criticized exposure, primarily in the communications sector, and higher specific reserves. In the commercial real estate portfolio, continuing strong asset quality was balanced with some weakening in the regional commercial real estate markets, resulting in slightly higher reserves. The level of reserves for the $79 million commercial aircraft leveraged lease portfolio were unchanged. Reserves on that portfolio were substantially increased in the third quarter of 2001 reflecting the vulnerability of the airline industry post September 11th. Overall reserves for retail loans and leases were stable. Reserves on the curtailed indirect portfolios decreased by $900 thousand due to accelerated runoff, somewhat offset by increased loss rates on those portfolios. Changes in reserves for other direct retail portfolios were modest, reflecting stable and strong asset quality. 28 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) The following tables detail information on the Allowance for Loan and Lease Losses and Net Loan Losses for the six months ended June 30, 2002 and 2001 and Nonperforming Assets at June 30, 2002 and December 31, 2001.

-------------------- (1) Other real estate and assets owned represent collateral on loans to which Allfirst has taken title. This property, which is held for resale, is carried at fair value less estimated costs to sell. 29 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations (concluded) CAPITAL ADEQUACY AND RESOURCES The Federal Reserve Board's regulatory capital guidelines require a minimum total capital to risk adjusted assets ratio of 8.0%. One-half of the 8.0% minimum must consist of tangible common stockholders' equity (Tier 1 capital). The leverage ratio measures Tier 1 capital to average assets less goodwill and other disallowed intangible assets and must be maintained in conjunction with the risk-based capital standards. The regulatory minimum for the leverage ratio is 3.0%; however, this minimum applies only to top rated banking organizations without any operating, financial or supervisory deficiencies. Other organizations (including those experiencing or anticipating significant growth) are expected to hold an additional capital cushion of at least 100 to 200 basis points of Tier 1 capital and, in all cases, banking organizations should hold capital commensurate with the level and nature of all risks, including the volume and severity of problem loans, to which they are exposed. At June 30, 2002, Allfirst's Tier 1 risk based capital ratio was 7.94% ($1.2 billion of Tier 1 capital) and its total risk based capital ratio was 11.81% ($1.8 billion of total regulatory capital). Tier 1 capital consists primarily of common stockholders' equity and qualifying amounts of subordinated capital trust preferred securities less goodwill and certain intangible assets, while total regulatory capital adds qualifying subordinated capital trust preferred securities, the allowance for loan and lease losses, and other off-balance sheet reserves, within permitted limits, to Tier 1 capital. Risk weighted assets are determined by assigning various levels of risk to different categories of assets and off-balance sheet activities. The leverage ratio was 7.37% at June 30, 2002. Substantially the same capital requirements are applied to Allfirst's banking subsidiaries under guidelines issued by the Federal Reserve Board and the Office of the Comptroller of the Currency. As illustrated in the following table, at June 30, 2002, the capital ratios of Allfirst Bank, Allfirst's principal banking subsidiary, compare favorably with the "well capitalized" standard as defined by regulatory authorities. Capital Adequacy Ratios Regulatory Capital Ratios ------------------------------- Tier 1 Total Leverage ------ ----- -------- Allfirst ................................ 7.94% 11.81% 7.37% Allfirst Bank............................ 7.86 11.44 7.16 Regulatory Guidelines: Minimum............................. 4.00 8.00 3.00 Minimum to be "Well Capitalized".... 6.00 10.00 5.00 In November 2001, U.S. banking regulators adopted revised rules concerning regulatory capital standards. The new rules amend the regulatory capital treatment of recourse arrangements, direct credit substitutes, residual interests in asset securitizations, and asset and mortgage-backed securities to better align regulatory capital requirements with the risk associated with these positions. This rule became effective January 1, 2002, and any transactions settled on or after the effective date are subject to the capital requirements of this rule. Companies that entered into transactions which settled before the effective date that result in increased capital requirements may delay the application of this rule until December 31, 2002. A nonbank subsidiary of Allfirst originates, sells and services loans in conjunction with the Federal National Mortgage Association ("FNMA") Delegated Underwriting and Servicing ("DUS") program. Under this program, loans are sold by Allfirst with recourse. The application of the new capital rule will reduce Allfirst's regulatory capital ratios by adding up to $1.5 billion in risk adjusted assets related to loans sold with recourse. The capital ratios of Allfirst Bank will not be impacted by this rule. Additionally, in January 2002, U.S. banking regulators adopted rules governing the capital guidelines to establish special minimum capital requirements for equity investments in nonfinancial companies held by banks, banking holding companies, and financial holding companies. This rule became effective April 1, 2002 and is not expected to have a material impact on Allfirst's capital adequacy. 30 EXECUTIVE MANAGEMENT CHANGE Susan C. Keating, president and chief executive officer of Allfirst, resigned effective July 31, 2002. Eugene Sheehy, Chairman of the Board of Allfirst, assumed the added responsibilities of president and chief executive officer. STRATEGIC DEVELOPMENTS A range of initiatives is currently being considered to accelerate delivery of the growth potential of the franchise. A plan is under development, completion of which is expected before the end of the third quarter. A restructuring charge is likely to be incurred in order to achieve efficiencies. WRITTEN AGREEMENT On May 16, 2002, Allfirst, Allfirst Bank and Allied Irish Banks, p.l.c. entered into a written agreement with the Federal Reserve Board, the Federal Reserve Bank of Richmond, the Maryland Commissioner of Financial Regulation and the Central Bank of Ireland (the "Written Agreement"). The Written Agreement requires Allfirst, among other things, to: (a) submit a management plan to strengthen management and improve the board of director's oversight of Allfirst's officers and operations; (b) prepare written findings and conclusions regarding management's adherence to established risk management policies and procedures; (c) establish policies acceptable to its supervisory authorities to enhance the risk management, internal controls and management information systems of Allfirst; and (d) enhance the written internal audit program for Allfirst in a manner acceptable to its supervisory authorities. Compliance with the terms of the written agreement is not expected to have a material impact on Allfirst's consolidated financial position or results of operations. POTENTIAL REGULATORY ACTION A potential enforcement action by the U.S. Securities and Exchange Commission ("SEC") could be imposed with respect to the Fraudulent Activities. However, at this time there have been no discussions between Allfirst and the SEC regarding this issue. The nature and effects of any potential SEC enforcement action cannot be predicted. Item 3. Quantitative and Qualitative Disclosures about Market Risk Information required by this item is under the caption, "Market Risk Management". Part II. - Other Information Item 1. Legal Proceedings Allfirst and its subsidiaries are defendants in various matters of litigation generally incidental to their respective businesses. In the opinion of management, based on its review with counsel of the development of these matters to date, except for the matters discussed below, disposition of all pending litigation will not materially affect the consolidated financial position, results of operations or liquidity of Allfirst and its subsidiaries. Shareholder Class Actions. On March 5, 2002, a class action lawsuit was filed in the United States District Court for the Southern District of New York by Walter P. Linn against AIB, Allfirst and several current and former officers of Allfirst and Allfirst Bank (the "Defendants"). On April 26, 2002, an amended complaint was filed by Mr. Linn. Mr. Linn purports to represent a class of all purchasers of the securities of AIB from February 6, 1999 through February 6, 2002 (excluding the named Defendants and any officers or directors of AIB and their immediate family members). The suit alleges violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder arising out of the $691 million of foreign exchange currency trading losses at Allfirst Bank (the "FX Trading Losses"). 31 On April 24, 2002, a second class action lawsuit was filed in the United States District Court for the Southern District of New York by Rodger D. Koons against the Defendants. Mr. Koons purports to represent a class of all purchasers of the securities of AIB from January 1, 2001 through February 6, 2002 (excluding the named Defendants and any officers or directors of AIB and their immediate family members). The suit alleges violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder arising out of the FX Trading Losses. On May 3, 2002, a motion to consolidate the Linn case and the Koons case and to appoint a lead plaintiff was filed with the court. Shareholder Derivative Action. On May 13, 2002, Tomran, Inc., a holder of 4800 AIB ADRs, filed on behalf of Allfirst Bank a derivative action in the Circuit Court for Baltimore City, Maryland against certain current and former directors and officers of Allfirst Bank. Allfirst, Allfirst Bank and Allied Irish Banks, p.l.c. were named as nominal defendants. The complaint alleges negligence and gross negligence by the defendants in the management and oversight of the foreign exchange trading activities at Allfirst Bank and seeks recovery of the full amount of the foreign exchange trading losses. The current and former directors and officers moved to dismiss the action as did the nominal defendants. The likely disposition of the lawsuits and their effect on Allfirst cannot be determined at this time. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits None. (b) Reports on Form 8-K (1) Allfirst Financial Inc., dated and filed April 25, 2002 (item 5) (2) Allfirst Financial Inc., dated April 24, 2002 and filed May 1, 2002 (item 4) SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Allfirst Financial Inc. August 14, 2002 By /s/ Maurice J. Crowley ---------------------------- Executive Vice President and Chief Financial Officer August 14, 2002 By /s/ Robert L. Carpenter, Jr. ---------------------------------- Executive Vice President and Controller 32

ALLFIRST FINANCIAL INC 10-Q