PNC Financial Services Group Inc (PNC) 2002 Q2 法說會逐字稿

Good morning and welcome to the PNC Financial Services Group conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question and answer session period. If you would like to ask a question during this time, simply press star and the No. 1 on your telephone key pad. If you would like to withdraw your question, press star then the number two on your telephone key pad. As a reminder this call is being recorded. Now I would like to turn the call over to the director of investor relations Bill Callihan. Please go ahead, sir.

Good morning and welcome to our call. Participating in the call today will be PNC's chairman, president and chief executive officer, Jim Rohr, Bob (Honschild), chief financial officer and Tom Woodford, PNC's chief risk officer. Jim will begin today's call with some prepared remarks regarding the regulatory agreements. Then Bob will review second quarter results. And after that Jim and others will take questions. The following comments contain forward-looking statements. Actual results could differ due to a variety of factors, including those described in these statements in today's releases and form 8-K and our 2001 form 10-Q and other SEC reports. These statements speak only as of July 18th, 2002. And PNC undertakes no obligation to update them. Let me introduce Jim Rohr.

Thank you, Bill and good morning. Thank you for joining us. Today we'll address two distinct issues. It's a very difficult day for us in the market, I see, so far. But hopefully we can bring some clarity to the releases we have this morning on this call. We will review the SEC and the bank regulatory announcements and then we'll discuss our second quarter results. Before I get into detail on these actions I want to put them in context for you. As you recall, last year we were down sizing our institutional loan portfolio and we did that by approximately 13 billion dollars. And during the course of that, PNC transferred some of the loans of venture capital investments to companies (inaudible) less than four percent of the total portfolio that was sold. We intended that the assets and liabilities of these companies would not be reflected on the balance sheet, and we accounted for the transactions in that way, in conjunction with our external auditor with whom we were working with the entire time. The FCC's order requires among other things that our accounting treatment was incorrect and the assets should have remained on our balance sheet. I'm disappointed by these events. This falls on my watch, and I regret the impact it's had on our employees and our investors. This is an issue that I sincerely do apologize for. We're going to make sure this doesn't happen again. But today's announcement really is about moving forward. We've got these disclosures and number one I would like to tell you they do not affect our ability to in any material way to perform for our customer or to do business. And that is clearly important. And secondly that none of these arrangements we're announcing today require us to take any material financial action. They're not financially oriented, as you can tell, from the ratings. Let me take them one at a time. As I mentioned, we reached closure in the SEC investigation that's been ongoing since the restatement. And referring to the review of the transfer of assets to companies formerly (IG.) On the 29th of January of this year, we reflect the consolidation of those entities in our financial statements, and the SEC found accounting record keeping and disclosure violations in connection with those transactions. We neither admitted nor denied the SEC findings and the finding and the remedy is that they have ordered us to refrain from future violations of these securities laws. I think it's important to note that there are no fines or monetary penalties that have been levied and there's no need for any further financial restatements related to this matter. With regards to the company, we've now put the SEC matter behind us. In addition, the federal reserve, as you're probably aware, was working with the SEC on this investigation. They actually, the SEC actually referred and complemented the federal reserve in their press release today, and as a result of these things we reached agreements with both the Federal Reserve of the Bank of Cleveland and the office of the controller of the currency that were announced today. And we worked closely with the regulators throughout the process to develop a board approved action plan which was designed to address the issues identified by regulators. And the build of the model (phonetic) financial control. An outlined number of these items in the news release, the management changes that have taken place and the actions we've already undertaken. And we will continue to work diligently to implement those steps. I believe Bill that they have those items listed. A lot of these items have been, we've made some significant change over the first six months of the year starting with the MacKenzie study going through reorganizing risk management, (inaudible) risk officer, having Deloitte work on internal controls, all of those things have been basically accomplished. We've got more to do and we have a plan to execute. Not the least of which is a new member of the management team that we announced today, regulatory relations obviously have not been particularly our strength and we named Jack Wixted, formerly senior vice president of the federal reserve bank of Chicago, the newly created position of chief regulatory officer pending regulatory approval. He's got a wealth of experience in this area and will coordinate all of our regulatory compliance activities and I'm very, very pleased and our bank regulators are pleased seeing Jack come on board. Clearly this whole thing is an opportunity to continue to further enhance our approach to risk management and we're confident that we're in a position to implement these measures. I think when we look at that competence it's really illustrated by our second quarter results. We have a very difficult environment. The market has been difficult. The economy certainly has been soft. But we're pleased with the solid results that we've announced today. And it's building clearly on the success we achieved in the first quarter. Bob will provide you with more details on the quarter. I'd like to share with you some highlights. WE reported second quarter earnings of 320 million dollars with a dollar twelve per diluted share. I'll be pleased to sign the certification of that, probably well in advance of the required date in August. I want to point out we didn't get there exactly how we thought we might get there. We did benefit from net gains on the excess evaluation adjustments related to the liquidation of the (held for sale) portfolio which is being liquidated well in advance of what we had anticipated before. We also had higher credit costs and noninterest expense. We built the reserve in the quarter. And we delivered very strong returns. Return on equity of 21 percent, compared with 18 percent the same time last year. In addition, we've strengthened our overall balance sheet. (Inaudible) of the ratio of 81 to 85 percent and frankly we have one of the strongest liquidity positions I've seen in my years here at the bank. I mentioned our (held for sale) portfolio. Those who might recall we had anticipated that we would liquidate that portfolio between 18 and 24 months. We reduced credit exposure in this portfolio by approximately 60 percent in the first six months of this year, well ahead of plan to two billion dollars. As I said, I'm pleased with these results. I'm not particularly pleased with where we are given the circumstances surrounding the reporting issue that I mentioned. I'm sure there will be many questions about that. We'll be happy to entertain any and all of those questions. But I'm pleased with the quarterly results in light of the current environment and I'd like to turn it over to Bob for more detail on the financial.

Thank you, Jim. Overall results as Jim mentioned were in line with our expectations and what continues to be a challenging business and market environment. The company continues to make good progress on efforts to strengthen the risk profile of the balance sheet both in terms of balance sheet compensation and the net gains from the liquidation of health for sale loans as Jim just mentioned. The regional community bank continued to grow. Core transaction deposits (inaudible) turned in another strong performance for the quarter with a 33 percent increase versus last year and PFTC had sales successes for the quarter. Net income for the quarter was 320 million dollars and diluted earnings per share was a dollar and 12 cents. The quarter benefited from stronger than anticipated gains on the liquidation of (inaudible) for sale that was higher than anticipated credit card and expenses. Return continued to be strong at 21 percent on equity. And 1.93 percent on assets. Looking at revenues, consistent with our expectations in the current environment compared with the second quarter of last year, spread revenues declined with the reduction in earning assets while noninterest revenue for the quarter grew reflecting growth and asset management revenue, the benefit of net gains from resulting from the liquidation of loans held for sale and lower venture capital losses in the current quarter versus the comparable quarter last year. Spread revenues or net interest income declined in PNC continued to aggressively reduce lending exposure and down size the balance sheet. Earning assets declined to 4.4 billion on average in the comparison with the prior year quarter. And loans declined by 7.1 billion. The impact of these declines was mitigated by a stronger margin in our lower interest rate environment. Net interest income is expected to be flat (inaudible) for the remainder of the year as we continue to liquidate the held for sale portfolio and reduce the level of lending assets on our balance sheet combined with a somewhat narrower margin. Noninterest income growth from the businesses was modest during the quarter reflecting the sluggish economy and difficult capital market conditions. Asset management revenues grew based on strong performance in Blackrock that offset declines due to market valuations and PNC advisors. Assets under management were 294 billion at quarter end and we're up 13 percent from 260 billion a year ago. On servicing revenues were up modestly during the quarter. Although new business generation and retention efforts were strong in the quarter, equity market conditions and the impact of intensified competition will continue to be a challenge for this business. Consumer related reference were up modestly in the comparison with the prior year quarter reflecting the benefit of continued growth in core transaction deposits. Ultimately the revenues continue to be effected by weak business environment and capital markets. These revenues benefited by strong performance and liquidating the held for sale portfolio and higher treasury management fees that would have been down modestly otherwise. Equity management reflected loss of 13 million during the quarter, which was an improvement from 30 million in losses in the second quarter last year. In the current environment, (inaudible) revenues expected to decline somewhat in categories affected by market valuation and corporate business activity while consumer categories are expected to remain relatively stable. The provision for credit losses was 89 million compared with 45 million in the second quarter of last year. Charge offs for the quarter were 74 million and included 45 million related to a metals trading firm that was fully reserved at the end of the first quarter. The higher provision resulted in an increase in the allowance primarily related to business credit and corporate banking activities. Nonperforming assets were 500 million in quarter end, up from 438 million at the end of the first quarter. The increase was related to one large secured credit supported by a vocational student loans that are privately ensured. The insurer has instituted litigation in an attempt to rescind the coverage. We intend to contest that action and believe that PNC is entitled to payment in full. While loan losses for the second half of the year currently are expected to decline from this level, the economy and business conditions are unpredictable and could cause credit costs to go higher than the anticipated level. Expenses for the quarter were 824 million reflecting higher expenses to support growth at Blackrock PFPC and business credit and some higher other expenses. Expense levels for the remainder of the year will be impacted by costs to support the initiatives that Jim mentioned to enhance the infrastructure as well as higher deposit assessments and other costs. We will continue to strive to aggressively manage our revenue and expense relationship. As I mentioned, the significant focus this year has been the liquidation of (loan sale for sale.) Those efforts continue to go well. The held for sale portfolio of institutional loans was reduced to 1.1 billion at quarter end, a 60 percent reduction since december 31st, well ahead of our expectation. As a result of the efforts and attractive opportunities to invest on the balance sheet, average earning assets for the quarter were significantly below our expectations and are expected to decline for the remainder of the year in the absence of a change in business condition. We will continue to aggressively evaluate our businesses with a focus on developing value-added relationships and achieving our desired risk profile. Transaction deposits. The focus of our consumer business continue to grow during the quarter up five percent on average compared with the prior year quarter reflecting the continued success of our consumer marketing efforts. As a result, loans to deposit ratio declined again this quarter to 85 percent and deposits of a source of funding increased to 67 percent of our total sources of funds. Capital ratios also improved during the quarter reflecting a decline in the balance sheet and the retention of earnings. Those shares were repurchased under the share repurchase program and we currently do not expect to repurchase shares through the remainder of the year as we continue to strengthen our balance sheet in this difficult environment. The first half performance is satisfactory and the business has made progress on a number of fronts, strong performance at Blackrock and continued success in the regional community banks deposit initiatives, for example. And we are optimistic that the success in the first half on our balance sheet initiatives will position us for improvements in credit costs and expenses in the second half. However, we believe that the economic and market environment will continue to present challenges for at least the remainder of the year and limited opportunities for revenue growth. Actual results will be impacted by many factors, including the disposition of loans held for sale and continued balance sheet management, market conditions, the status of asset quality and the need to provide for potential credit losses. The ability to generate revenue growth and managing expenses while making investments to support organizational business growth and risk management objectives. For additional risks and other factors that may affect our future results, see the risk factors, risk management and forward-looking statements portion of our SEC filings. Back to you Jim.

Thank you, Bob. Before taking your questions I'd like to briefly provide you with an outlook for the remainder of the year. Bob just reviewed a whole series of things that obviously could be impacted by a number of factors. Many of which you're very familiar with. But as I mentioned the first half of the year we clearly benefited from gains related to liquidation of our loans held for sale and offset by the higher credit costs and expenses. At this point I don't think we're going to be doing the - we won't have those level of gains in the second half of the year. But I also don't anticipate we will have the same credit costs and expenses in the second half of the year. So we're looking forward to a good second half of the year. We're not particularly optimistic about the market or the economy quite frankly. And I think there will be some challenges in that half. We think that the balance sheet and the business mix that we have clearly has the ability to give us the, deliver earnings in the $2.10 $2.2 range for the second half of the year. We will have some expenses, although I don't think that they'll be material related to our formal agreements. And we're not going to have the ability to be buying back stock in the second half of the year because - although we have the ability to request that from the regulators under the agreement I think we will probably not be doing it for the rest of the year, which will have some impact on our EPS. But relatively speaking we believe that we will be able to have a good second half of the year. Now I'd like to open it up for questions. I'm sure there are many.

This is Bill Callihan. Will you please give our callers instructions for asking their questions

Yes, sir. At this time I would like to remind everyone in order to ask a question please press star and then the number one on your telephone key pad. We'll pause for just a moment to compile the Q and A roster. Your first question comes from (Mar Mortari) of Ohio Futures.

(Mar Mortari) from Ohio Futures. In your press release you have comments about agreements with the regulators to enhance the risk management process and financial controls. Is that the transaction in question, did it occur without adequate approval or did it occur while violating some pre-existing internal controls that were already in place?

That's a fairly technical question, obviously. I will tell you that the transactions that we entered into were visible. We obviously renewed them with our outside - reviewed them with our external auditor, with our external law firms and there was an awareness in the company of the transactions. Really it was what we found out that the regulators disagreed with the reporting that gave rise to the tissue that we're bringing to conclusion today, I believe, with the SEC, with the SEC document that is in place now we're really drawing closure to this transaction and moving forward, really. I think the good news is that there's no fines or penalties that are involved in the SEC conclusion with regards to the company.

I guess it sounds as if perhaps it went higher enough up the food chain internally at PNC but perhaps the regulators weren't made aware of it as it was in process or as it happened?

I really can't comment on the regulatory examination process or the SEC findings because we didn't agree or deny with the SEC findings. We just were in a position to accept the consent decree to draw conclusion to this issue.

I guess I was really trying to - what are your strengthening and what's the benefit of strengthening those risk management processes and financial controls? I guess is really what I was getting at.

That's a very good point. And I appreciate it. The whole risk management process and the internal controls have been changed significantly in the last five months. In the press release - let me just put some color on it at least. We brought MacKenzie in January. Obviously we had some regulatory communication flaws. But we brought MacKenzie in to look at the entire risk management program we had in the company. And in the second quarter we implemented those organizational changes (inaudible) chief regulatory officer, all of the credit policy people and they'll report directly to Mike Hannan and we set up an organizational structure under Tom in the risk management area that really centralizes the function across the company. We also added another committee to the board that had nothing to do with the SEC filing but we added an operations risk and technology committee at the board level so that the board is now exactly lined up with the various risks that we have under Todd Woodford. So we've implemented a number of those changes already. Then at the same time we had the Deloitte and Touche internal control review that I mentioned before. And now we're adding, today we'll be adding Jack Wixted to enhance our regulatory communication. So I think the areas we're dealing with here really were enhancements to where we were before. And I think frankly they will benefit for the company in the long run. And the other item is that when you look at the bank, when you look at the bank regulatory agreements, those really relate to reviewing management and how we coordinate the risk management operation within the company. Which is exactly the same track we've been on for a number of months now and I think really regulatory agreements are right in line with where we want to take the company to become best in class in risk management as well. So I think they're very much in concert with where we're taking PNC.

The next question, please

Your next question comes from Mike (Holton) with (inaudible).

Actually two quick questions. The first one would be if you have the ability to request buy back, your stock is at 40 bucks, why wouldn't you make that request? And the second one would be in the earnings press release, there's mention of a lot of unusual gains, in fact I can't keep up with them all. Could you all maybe ago great that and talk about how much you consider unusual gains added to the earnings in the quarter?

First thing on the stock buy back, right now the anticipation is that we wouldn't request that for the next six months. However, the capital actually gets quite high over the course of the next six months in our projections. So we could actually in fact request that. But our primary objective over the next six months is to really kind of execute on the plans that were in place which I think will satisfy, we're certainly committed to satisfying the regulators in their formal agreements. And I think the issue there is related to - the number one priority will be to be in total compliance with those agreements and get those agreements lifted as soon as possible.

With respect to the gains, the two items that are really somewhat unique this quarter, the held for sale (inaudible) we mentioned a number of times it's about 55 million result. So a commercial - the interest we had in the commercial real estate property which we sold during the quarter, which added about 14 million. Other than that, the items in there are, while we have pointed them out for you, items that occur, the kinds of items that occur typically on a recurring basis, from various operations of the company.

We've been trying to sell that building for about five years, our interest in the building.

Next question, please.

Your next question comes from Roger (inaudible) with Morgan Stanley.

I understand it's difficult for the readers of the federal reserve board memorandum to understand whether or not these issues are broader than just the ratification of these transactions or whether they're in fact largely limited to the results of the transaction. So I don't know, when you look all the things involved, capital and other rules, seems to be much bigger than the transaction, but is this just the fact that the transaction ramifications were fairly broad? When you go through the board order it deals with a lot of topics in terms of risk management that seem to go in a lot of different directions. But when you think about that in transaction, of what is involved in terms of subsidiaries, nonbank subsidiaries and things like that. Is this all related to the transactions that were reversed?

There's a couple of things with regards to - I think when you combine the items in the 8 K, there's a lot of things that really aren't material to PNC that have to be described there. I think that probably the best way to perhaps the best way to answer your question is that the document, the review of management and the risk management policies and procedures that the Fed document relates to are quite directly that. And I think the document speaks well for itself. I think they looked at - I think they looked at the two restatements that we had in the first quarter. One created by simply an accounting error. The other created by the issue that the SEC document relates to. And I think the agreements, quite frankly, point us to make sure that we're looking at all of our risk management programs seriously, so that they are the regulator, frankly, and they're looking for the safety and soundness for the company. And I think that's exactly what they mean to say and that's exactly what they mean for us to to do and that's what we're going to do. I think it is broader than the transaction, clearly. But I think it speaks for itself and we've got on the board and ourselves are very actively pursuing being in compliance with those agreements.

Next question, please

Your next question comes from (inaudible) Dixon with Lehman Brothers.

Two things I'd like you to touch on. Talk about your remaining telecom exposure, what the composition of the health for sale piece is. And also talk about, if you would, this one nonperformer that went bad and the outlook, the student loan thing and the outlook for that, how long it's probably going to take to settle that. And then any comments you can make on the shared national credit exam.

Okay first one is our telecom portfolio (inaudible) telecom portfolio. Tom Woodford.

In terms of the held for sale and the concentrations, we made tremendous focus on the larger holdings, many of those were in the telecom that we've eliminated. We still have right under 300 million dollars in the telecom. But I think more importantly when you look at the entire remaining exposure in the asset held for sale portfolio, 83 percent of it is in the pass grade. 40 percent of it in total is investment grade, credit. So again it is a portfolio that is not low quality credit. It's very diverse in terms of the quality of the portfolio. We've been making significant progress that Jim and Bob have mentioned. We eliminated it and we've been eliminating both investment grade as well as noninvestment grade credit.

I don't think we have any large telecom exposure for bankrupt companies at this point; is that right? .

I think that's right.

With respect to the question about the one credit we described in the, responsible for the nonperforming increase, as we indicated in our disclosures there's litigation involved in that one and as always litigation can take some time to point out. We obviously will aggressively pursue our claims there. As we indicated we believe we're entitled to be paid in full and we are going to aggressively pursue that.

Next question, please

Your next question comes from Mark (Mccoviak) with John Levin.

Two questions. One is related to what you talked about in the press release a little bit on the call on the changes in some of the custodial relationships. And I was curious, given the fact you kind of walked through the second half and given us comfort on the two dollars, roughly, of earnings power, just taking that forward a little bit, can you talk about further drill down in the relationships that you talk about and where might be the strength in some of the other businesses to offset perhaps the weakness in what the competitive environment on the custodial side. That's question one, just talking about earnings power. Number two, I'm sure there's going to be speculation in the marketplace given that some of the language in the 8-K related to safety and soundness, with the regulators. Could you just touch on the ability of the PNC bank to still dividend up to the holding company and pay the dividends out to the shareholders. Some folks look at it perhaps as support to the valuation in the stock.

First of all, the guidance we gave in the second of the year was 210 to 220. Bob, do you want to make a comment?

With respect to the item you mentioned with regard to PFPC C and the level of business, actually the declined in the custody business you see there was due to the change in the product mix with the customer. We actually picked up some additional revenues from other products for that customer. In terms of its overall impact on that business, that's not where we make most of our money in that business. As you can tell from the size of those custody numbers, we're not a large custody bank. Most of our money in that bank would be transfer east and fund accounting businesses so that would not have a, be expected to have a significant impact on it. And your last question with respect to the dividend capacity from the bank to the holding company at the end of the quarter, that would approximately 350 million dollars.

Just to clarify, the regulators are, there's no reason the regulators are asking you to stop the dividend for safety and soundness reasons?

No.

And then just going forward on the more of the earnings power issue. Can we kind of look at that 220ish number as kind of a even going past 2002, that you'd have comfort with?

I think it's too early to give guidance on that right now.

Thanks.

Next question, please.

Your next question comes from (inaudible) Cassidy with RBC capital markets.

Good morning. The question I have you touched upon the gains which I think totaled about 69 million dollars pretax that may be looked at as one time in nature. We have a tax effect (inaudible) divide it by shares outstanding looks like it comes out to about 16 cents per share, which if we back that a way from the dollar 12 we come in with under a dollar for the quarter. Were there expenses in this quarter that you view as one time in nature or are we just going to see a dramatic decline in possibly the loan loss provision in the second half of the year to get that 210, 220 number that you guys are referring to?

I think that's probably a good analysis of what the second half of the year will look like what we anticipate. The (inaudible) will not repeat I guess in the second of the year. We're anticipating more credit quality and lower credit costs of all our expenses.

Then one follow-up. Getting back to this agreement, it's pretty broad as everybody has been referring to. Is there any issues regarding the way the credit has been monitored or credit quality is reviewed as part of this agreement?

I think there's no mention of asset quality in the third agreement. There is mention of the review of asset quality in the OCC agreement. The OCC does monitor, does regulate the bank. And I think this is an item that we've been changing and monitoring over time. (Inaudible) the situation is one we don't find particularly attractive and we get through that and dealt with that. The asset quality pieces ever since we've been revamping and changed Mike Hannah's role has centralized all the credit quality we've been tempted to get out in front of credit and deal with it more aggressively than we had in the past. If you look at what we did with Hampton lane in the first quarter, we disclosed that. We were very transparent about (inaudible) more so than - more so than the industry at large we dealt with it and still had a very good first quarter. This withstood the funding situation, stood (inaudible) loan company. I think we're being as transparent as we can be. We're dealing with it. In the second quarter. We want to be in position so we have a very aggressive asset quality group that's very transparent to the marketplace. I think we're working very much in concert with the regulators on that issue.

Thank you.

Next question, please

Your next question comes from (Vegas Hilda) with Bear Sterns.

Thank you, good morning. Two topics. First is the review you mention in your press release being conducted by the board of directors of senior management. Could you tell us which director or directors is leading that effort? Could you talk about the timing of it? Could you talk about the scope of what that group will look at and give us some sense of what kind of consultant will be engaged? Is it MacKenzie, for example? And then on PSPC, looks like if you adjust out the gain in this quarter and the amortization a year ago, it looks like earnings at PSPC went from 25 million down to eight million in the most recent quarter on a two percent increase, two million increase in revenue. Could you talk about whether that's a fair analysis and what's going on in the business to produce that?

With regards to management review, I believe it's fairly well documented in the documents, the Board has formed a special economy. I don't know that we've disclosed that special committee of the Board. But they will be hiring an outside consultant. I think that will probably be disclosed next week if it has been finalized. But they're all external directors. As you know we only have two (inaudible) directors anyway. But they're all external directors. They're on a special committee and they'll be announcing I believe next week the hiring of a consultant to pursue the review of management. The (inaudible) agreement asks for the outside consultant, the OCC does not, obviously the board will be using the consultant, there a the OCC uses as well, reflection. Their intent is to get that behind them in relatively short order. So I think you'll see an aggressive approach to that management review. Bob you had some answers to some other questions?

Sure you had a number of the factors that impacted PFPC in this quarter as it related to the fee recognition item you saw that was somewhat offset by some expense items during the quarter of relocation of the facility, for example. And some other items. But you as you do indicate, the earnings when you take into account the change in goodwill because in that business we do have the impact of goodwill amortization in the prior year from the ISG acquisition, the earnings on that comparative basis would be down which would reflect the challenges we see in that business, the impact of the markets, principally on MABs and the intense competition. We do point out we have a number of customer successes in the quarter. Some of those are large customers where we maintained our business. The biggest piece, however, over half of those wins relates to new business. And will be some technology and investment in staffing up front which will continue to impact those numbers because as you know as you transfer that business it takes, there's a lag between the time you make the investments to support the business and when it does come on board. So we will see a bit of a variation there. But overall the business had a pretty good quarter with the biggest impact being the market impact in the down draft of the market.

Could you just indicate how much in on one time expenses we should offset against that 13 million dollar gain?

My recollection, David, it's about two-thirds of it.

Next question, please

Your next question comes from (inaudible) with Sonoma Capital. Your line is open.

I think my question was answered. Thank you.

Next question.

Your next question comes from Mike (Maya) with Prudential.

I just wanted some more clarification on the expenses. In your opening comments you said expenses should be higher for the rest of the year for Blackrock PFPC (inaudible) initiatives and later on you said you thought expenses might decline. Then separately I think you had a gain on a put option of ten million. Are there any one time expenses that offset that?

Relative to your first question, what you're referring to is the second quarter impact, what impact is of the second quarter. That's the growth in Blackrock and PFCP and business credit including the national bank of Canada transaction coming on board that drove that. With respect to business credit in particular and the benefit of that put option, when we do have in there are the costs for servicing the service portfolio which we are managing down as we've indicated. In fact, we had a good quarter and that was reflective in the put option valuation as well as some continued integration costs related to that acquisition.

Next question.

Do you expect that put option gain to continue then or does something else offset that?

To the extent we have continued success in bringing those service to assets down the way we have, we would expect that liability as you may recall was 112 million when it was initially established. And with the passage of time, if we are successful in continuing to bring that book down, there will be further recognition of portions of that liability.

And lastly on expenses, higher deposit insurance is it assumed in the 210 to 220 guidance in the second half.

Yes.

Next question

Robert (Smally) with HSBC.

Couple of questions. And I think that there's a bit of confusion going through the 8-K and maybe you can help a number of us out. There are a number of dates in the 8-K that have requirements. Could you give us a time line, a little bit of how and when things are going to happen, what's been done already to comply with the agreement, what's left and how you're going to report on that going forward.

The regulatory agreements I don't believe we will be having report, external reporting on our progress in terms of the are meeting the goals and the deadlines of the regulatory agreement. Just as I would like to mention. We have a number of things we have to do. Someone asked about asset quality and working with the OCC. I mean we have a series of things, credit quality, procedures and processes that we still have to complete that are underway. We've got things we need to do. We're committed to making those deadlines at this point in time. I don't see any reason why we wouldn't.

What's the best way for those of us outside the company to track that progress so we can report to respective investors that in fact you're achieving the deadlines?

I think the issue really is probably (inaudible) we continue to proceed and deliver strong investor results, deliver investor returns, is the best way for you to be able to tell that we're doing the right stuff. I think you will have an announcement over the completion of the announcement of the management board I think that will be a public statement because I think there will be a public statement of the hiring of the consultants. I think that will a public issue. The rest of the items I believe will be relatively straightforward between ourselves and the regulators. And those relationships are typically confidential.

Next question, please.

Hello. And also somewhere in the document it says that there are a number of things that you may have to ask, number of activities that you'll have to ask approval to engage in on merchant banking securities underwriting and insurance. Is this really the big issue in terms of crimping earnings with respect to this going forward or is there other things that -

That's a very good question. And Bob has some clarification on really what that means to PNC or could mean to PNC.

You put your finger on the three issues. All of those activities were activities that we engaged in prior to the evolution of the top financial holding company structure under (inaudible) for us to continue to conduct those activities we may have to revise the way we do this. For example, in our insurance agency activities, we previously engaged those in a different form and a subsidiary where we had an authority to do that under grant which was simplified. We may simply have to go back and conduct those activities in a manner similar to what we did previously. Similar paradigm applies to the merchant banking activities and the underwriting and dealing activities as well. So some effort to reconfigure it but in terms of its materiality of its impact there shouldn't be any.

Can you give us an idea.

Can you repeat that last comment.

I said the terms of the impact on the performance or financial results of the company should not be a material impact.

Can you give us an idea what as a percentage of revenues, for example, what those activities were? Just in a rough range.

It's going to be five percent or less.

So it's - I think this has caused a lot of consternation in the market, even away from the idea that the agreement was announced. I think that clarification there is important. Thanks.

Thank you.

Next question

Your next question comes from John McDonald with UBS Warburg.

Good morning. I apologize if I don't understand this correctly. Could you clarify where those restrictions show up. I don't see it in the fed agreement. Is that in the OCC agreement?

I think John those are specified, the potential impacts are specified at more length in the 8-K document that we filed announcing the agreements.

I think what happens is that there are some legal ramifications to the formal agreement that come along with the (inaudible) agreement and those are reflected in the 8-K.

Because you have an agreement with the fed and the OCC you have to change your practices and it's not stated in the agreement with the regulators.

We may have to change our practices in time.

Thank you. Also, could Bob just give a little color on, a little more precisely where you see credit losses for the second half of the year.

Maybe what I'll do is put it again in the context John of what I mentioned. In the first half we saw higher levels, over 80 million dollars in each of the first two quarters in what we had anticipated. I think in this environment it's difficult to predict. And based on what we currently see right now, we don't see that kind of level for the second half. If that's not as precise as you know ,I apologize.

Earlier in the year you talked about 45 to 55 basis points. Is that still in the range that normalized losses should be in terms for the second half.

I think those are possible outcomes, yes.

Next question

Comes from Jim (AGa) with Millennium Partners.

The question has been answered, thank you.

Next question, please

Your next question comes from Ronald (Tibell) with Lassard Asset Management.

Simple question, do you have approval to pay dividends from the bank up to the holding company? Or do you anticipate that you might have to have approval?

The payment of dividends from the bank to the holding company is subject to statutory limitation. As I indicated earlier, under the calculation that is, that you do to determine the capacity to pay dividends from the bank to the holding company without prior regulatory approval is one you do every quarter. At the end of the first quarter that capacity for PNC's bank NA was about 350 million dollars.

Secondly, who -

At the end of second quarter.

Who at senior management is being held accountable for the disasters this year?

I think we made a number of changes in the management structure. So far in terms of risk management. We changed a number of the responsibilities. And I think the whole idea I think is to be able to build a management team that really develops the best in class in a number of areas. I think we've added a good group of people and restructured it with the company some. I think you'll continue to see changes where we can add value.

Should we expect to see changes in the board or management going forward.

We have a management review that will be going on externally. But I think whatever whenever we have the opportunity to improve the management team for the best interests of the shareholder that's exactly what we're going to do.

Look forward to seeing it.

Next question, please

Your next question comes from mark Lynch with Wellington management.

Two questions. One financial one, the other regulatory. The financial question is, is my math correct that long losses in the second quarter without the metal trading company were only 29 million? The regulatory question: Is the reason not to ask for permission to buy back stock that you think you won't get it because they don't feel they owe you any favors at the moment?

Your calculation on the first one is exactly correct.

Secondly, I think I think the regulatory program really isn't about failure. Failures. I think the regulators and their agreements really have asked us for some qualitative things, reviews to take place, which I don't disagree with, and quite frankly embrace. And I think at the end of the day we'll be a better company. Doesn't mean I'm happy to have them. I would rather not. I would rather not have had this whole circumstance take place, but we have and I think the issue is we have to make the best of it. We have to be a better company as a result of it. And to the extent we comply with those agreements that they, that the regulators have put in place I think it will be a better company for us. With regards to the dividend, I think their objective really right now is to be totally in compliance with those agreements and then do whatever we can to achieve that and then come back and continually be looking at the capital levels, make sure they're not inappropriate. But to then come back to the capital level after we've done what we need to do for the agreements.

To clarify the cease and desist is only the SEC and it's an agreement with the bank regulators, which (inaudible) which is (inaudible) cease and desist.

The cease and desist order is an SEC finding. That's different than - if I understand it I'm not an attorney, but I believe that's what they do. I think that's the form it takes. We have not agreed nor denied their findings. We have simply accepted their order in order to put this behind the company. From PNC's point of view we've been able to put the SEC investigation behind us. The two agreements with the fed and the OCC are formal agreements and not cease and desist orders

Next question comes from (inaudible) (ocline) with (inaudible) O'Neal.

One question has been answered. But in the second half of your guidance, are there any gains that you're going to rely on for the 210 to 220? And also the size of the student loan I just missed that when you went over it before.

I think that Jim indicated in his comments that in our outlook for the second half we don't see the same kind of - we're not anticipating the same kinds of gains that we saw obviously in the first half and likewise we're optimistic here that we.Won't see the same kind of - likewise we're optimistic here that we won't see the same kind of impact on credit costs and expenses that we saw as we try and aggressively manage those.

I'm just referring maybe to securities gains or things like that to try to get to the numbers. So it should be clean results.

Yeah, you always have some of those kinds of things. But in terms relative to the size again that we're talking about this quarter where we had 55 million held in sale for gains we're not counting that level of activity.

Student loan exposure.

Student loan exposure is guaranteed by quality insurance company. We don't expect at this time to have any loss from that credit.

How big is the credit?

62 million. Next question, please

Next question from Ted (Paluzak) with Deutsche Asset Management. Just a different variant on the dividend question. Your comments on capacity and the capital levels and the (inaudible), could you comment on the board's willingness to maintain the dividend at the 38 cent level.

At this point I can't comment on behalf of the board but to my knowledge the board hasn't had any questions about maintaining the dividend. We just declared the dividend. (Inaudible) based on the results we see and what we're expecting we don't see any reason that we wouldn't plan to recommend that to the board.

Thank you very much.

Next question, please

Your next question comes from Sally (Poet) Davis with Goldman Sachs asset management.

Two questions. One, wow, this is an unpleasant 00:59:08 message to deliver. It's probably going to be more unpleasant to 00:59:12 read it tomorrow in the newspapers. 00:59:14 What are you doing internally when you get off this call to talk 00:59:18 to your employees about what to say to your customers, what 00:59:21 message are you empowering them to tell the customers because both 00:59:58 your commerce both corporate to a lesser extent retail won't be thrilled to read this. Second, can you give us an update to the extent you can on your discussion with (Wamoo) and have you provided any two-year litigation reserve in that respect?

Those are very good questions, Sally. We've had all of our employees received an e-mail this morning. All of our employees received a voice mail this morning. All of our managers and customer contact people now have in their hands talking points around this issue. We have a concentration point for feedback from customers and employees. I had a meeting this morning with all the senior managers. We will be doing a debriefing this afternoon and this evening at two different levels to find out what levels of communication, what items are coming back that are particularly of interest. Then we have - I think we'll have the press issue tomorrow that we have to deal with and then we've scheduled a satellite broadcast early Monday morning so that we can collect the data from the media over the weekend and then rebroadcast to about 4,000 employees on Monday morning, along with there will be another voice mail and e-mail going to the employees. With enhanced messaging depending on what kind of feedback we get today, tomorrow and over the weekend. So we have a very aggressive communication program. All of us have assignments to pro actively call customers on the phone and we're very active in doing that. As well, we have senior managers in the company visiting all of our significant employee concentration, so there's openness in conversation about this issue. I think, quite frankly, the conversation we had this morning, I think we'll see what happens with the media. We're not expecting anything but the worst. That having been said, the company is a very well capitalized company, more liquid than we ever have been before just reported a solid quarter. There's no restrictions in these agreements to keep us from doing business with the customers, quite frankly. I think that was never the intent of the regulators anyway and the positive thing is we put the SEC investigation behind us in regards to the company. So I think those are the messages that we've got to get out to the employees and quite frankly our customer satisfaction numbers are at an all time high. Our employee satisfaction numbers prior to today were at an all time high. And our sales across the various businesses were very consistently up from where we were a year ago. So there's a lot of positive things that have been going on which allowed us to deliver this quarter in not such a hot economic growth environment so we need to make sure that this thing turns into a bump in the road and not a ditch. We've got to make sure we've got to work hard to make sure that our employees, who are - that is our business. There are 24,000 employees, people who make it happen. And we've got to get over this. Good news they haven't been involved in this for the last six months. They've been taking care of the customer.

With respect to the (inaudible) situation that's in litigation. The litigation involves both the items of underclaim and the next step in that process will be a determination of the venue that the issues there will be decided in, the contract that we had with (Wamwoo) called for that resolution to be in arbitration. Wall into has taken it to court. In August I believe is the next step in that process to determine which venue that issue will be resolved in. And as we have indicated in our disclosures, the amount that we have, (inaudible) that we think we're entitled to, we think we have a portion of that reserved.

Next question, please.

Clarence (inaudible) with Montgomery Scott.

Would you comment on what's going on trend wise for asset quality in market street funding? I do want to get clear on this draw down, if this is anything new. And what's going on with credit quality in the corporate loan book and in business credit? Thanks.

In terms of market share we've done a strategic review of the relationship and we're in the process of actually shifting how we do business in the market street arena in terms of which customers will be in the process of exiting many of the nonstrategic relationships over the next several months,. Just in the last quarter we reduced our liquidity by over 10 percent, and we've reduced our (inaudible) or (inaudible) by almost 20 percent. We will continue to review each of the underlying credits and work them very closely with that given on the exposure that's there. In terms of the overall credit quality, we continue to make progress. I think you've heard a lot of the statistics. Given that we do have a difficult economic environment, we have seen a very positive thing. Jim and Bob have both mentioned some of the progress on the held for sale access. We've made significant progress in reducing our watch list by over 15 percent. The other thing that's important in our watch list, if you look at the top 20, it is no large exposures. The largest one is 100 million dollars in fact just slightly over 75. When you get to number 20 you're already down to 25 million dollars. We have reduced significant exposures in our portfolio and continue to make strides in that direction. And we continue to see positive trends in terms of improving the credit quality based on the new business we're bringing in and continuing to reduce exposures on the business we already have.

We'll take one last question

Your next question comes from Dennis (Laplant) with Fox-Pitt (Kelson).

On the national bank of Canada, I just want to make sure I understand the size of the amount of the assets you're down to in terms of what you're servicing right now. I have a follow-up from there.

As you know, Dennis, that started out at around 650 million dollars. Over half of that approximately half of that has now been liquidated.

In terms of the reserves that you have set aside, is that basically the put option you have?

The put option liability was designed, we tried to articulate in the disclosures, which are somewhat complex about that transaction, that that is what would be necessary to bring those assets on a forward basis since it is a put option. Those assets to market, if they come on to our balance sheet at the end of term. That liability includes, as you know, a lot of factors including time value of money and those kind of things over the term of the option. And so as we saw in the first two quarters, is those assets come down and with the passage of time a portion of that put option liability has been reversed.

Why would you try to reverse any of that until you are closer to the end? Because you have until, as I recall, middle of 2003 to get those off and cleaned up before they come back on balance sheet, correct?

Yes that's essentially market value determination that we're required to mark once a quarter. It's an valuation that's done by an independent consultant. So we are bound to mark that to market in accordance with our procedure.

Good.

Let me wrap up. Thank you for joining us today. As you heard we've announced a number of important regulatory matters here and also I think a solid second quarter and a good first half. If I could just quickly point out from our point of view, we're putting the SEC investigation behind us in regards to PNC. We consider that to be a positive development in this announcement. The two regulatory plans that we have with our bank regulators we believe really will further enhance our internal controls and our risk management processes. As I mentioned a number of times we've begun to implement a whole series of things. We've got more to do. I feel confident we'll be able to do that. In the meantime the company remains strong as you see in the second quarter results. We're very well capitalized excellent liquidity we deliver excellent returns in the quarter. The first half of our number of business, particularly on the consumer side, Blackrock, posted strong sales in customer satisfaction is the highest it's been in five years. So there's a number of very positive things happening. We've also got a challenging environment going forward in the second half of the year. But we're fairly confident that we can deliver good solid second half of the year as well. So thank you very much. We're going to go back to paying attention to the customers now. But bill and myself and Bob will be around all afternoon by the telephones. As Sally said the most important thing today we'll be talking to yourselves and customers and employees all day long. If you would like, if you have further questions, please call us

This conclude's today's call. Thank you

This conclude's today's PNC Financial Services Group conference call. You may now disconnect.