PNC Financial Services Group Inc (PNC) 2004 Q2 法說會逐字稿

Good morning.

My name is is Jamie, and I will be your conference facilitator today.

At this time I would like to welcome everyone to the PNC Financial Services Group second quarter 2004 earnings 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 period.

If you would like to ask a question during this time, simply please press star then the number one on your telephone key pad.

If you would like to withdraw your question, please press star then the number two on your telephone keypad.

As a reminder, this call is being recorded.

I will now turn the call over to the Director of Investor Relations, Mr. Bill Callahan.

Please go ahead, sir.

Thank you, operator.

Good morning all.

Welcome to today's conference call for the PNC Financial Services Group.

Participating in in this morning's call will be PNC's Chairman and Chief Executive Officer, Jim Rohr, and Bill Demchak, the Company's Vice Chairman and Chief Financial Officer.

As a reminder, the following statements -- the following comments and statements contain forward-looking information.

Actual results and future events could differ possibly material due to a variety of factors including those described in this call, in today's earnings release and supplementary information, and in our 2003 form 10-K and other SEC reports.

These statements speak only as July 21, 2004, and PNC undertakes no obligation to update them.

The following comments also include a discussion of non-GAAP financial measures, which to the extent not so qualified in the comments is qualified by GAAP reconciliation information included in our earning release financial supplement 2003 form 10-K and other documents available on our web-site at www.PNC.com in the core investor's section.

Now let me turn the call over the Jim Rohr.

Thank you, Bill.

Good morning, and thank you for joining us today.

Its been a busy week for us here at PNC.

As you know we announced last Friday that we have agreed to acquire the Riggs National Corporation, the Washington, D.C. based banking company.

The transaction was valued at $774 million in cash and stock at the time of the announcing.

We expect to at $5.6 billion in assets and $3 billion in deposits when we close to transaction early next year.

The combination with Riggs is a big step forward for us.

It gives us an immediate and substantial presence in one of the nation's most lucrative markets.

While we intend to build on the Riggs franchise to become a market leader a across products in Washington, Maryland, and Virginia.

I know a lot of you have questions about the risks associated with the regulatory issues at Riggs.

I'd like to reiterate a few points we made last week.

One, we engaged in extensive due diligence at Riggs.

We have 90 people there.

We have a good understanding of the issues they face.

Two, we expect the vast majority of the regulatory problems to be resolved through the sale, elimination or down sizing of the international and embassy businesses.

And three, we have good protections in the merger agreement if something unexpected should surface prior to closing.

What we will get when we close on Riggs is a retail market leader in one of the nation's best markets, and we're very excited about that opportunity.

Today's news is more normal course of business, but we are feeling very good about the earnings we reported today.

Before Bill takes you through some of the factors that affected our performance during the quarter, I would like to briefly cover two topics.

First, I would like to talk about our plan for growing PNC, what's working and where we go from here, and then I would like to give you my perspective on the current and near-term future for loan demand, which I believe is positive.

As we told you in the Riggs press release, we had a good quarter and we are very pleased with our positioning in a rising interest rate environment.

Our business segment earnings are growing, up 16% versus last year.

That means our strategy for customer customer growth is working.

In fact, we saw increases of customers across our businesses during the quarter, and the business mix is good, and we generated 65% of our revenues from non-interest income.

So while we've been very conservative in positioning ourselves for rising rates, we have continued to perform and grow on the fleet side, which indicates continued growth in customer franchise.

We made important progress.

Deposits are up 6% since last year, checking relationships are up 8%, and 43% of our customers now are banking with us online, up from 38% a year ago.

That is one of the highest penetration rates in the industry.

In the business banking area, our deposits were up 9% on annualized basis compared to first quarter, and we've seen seen and uptick in small business loans.

In wholesale banking, we are ahead of budget.

On the sales side, we have won a number of important new clients.

In fact, we just signed our largest treasury management client ever, a blue chip company where when we complete the -- have fully developed the relationship, we estimate we will receive $18 million in annual revenue.

The customer satisfaction side is also doing well.

Across PNC our customers and their satisfaction with our service is increasing, and we have had good validation for that because just recently we were named -- our treasury management area was named highest quality treasury management area by (INAUDIBLE).

The successes we're having having are reflected in customer retention numbers. 98% of PNC advisors primary clients, who are are top revenue producing clients are being retained, and 95% of our retail banking customers, which we think is best in class.

While those successes are important we're committing to doing a better job of winning market share.

And while those successes are important, we committed to doing a better job of winning market share.

We simply cannot accept the notion that slower demographic growth in our primary geographic area justifies slow business growth.

We are identifying success there.

Another thing, it is also important to recognize that our mix of businesses is a mix of regional, national, and international business that differentiates us from other super-regional banks.

While if community bank operates in a six state footprint, our real estate, business credit leasing, and treasury management businesses are truly national, and PNC and (INAUDIBLE) are international.

So we operate not only in a great diversity of geographic markets, but also with the businesses.

I know you heard from Larry yesterday,but Black Rock's success is the best example of that where they are truly international.

While we've been successful in taking market share in many businesses, we've changed strategy in others.

First we are getting more feet on the street.

For example, we're adding people in business banking and private banking particularly in our higher growth markets.

For example, PNC advisors -- we're adding a number of people.

We're working hard at finding the best people, and we've revamped our compensation structure for advisors and we have changed the way we recruit.

We've had a lot of success already in this competitive market, and that is necessary so that we can accelerate our growth.

The second initiative is we've redefined the role of branch managers to give them them more decision-making power, and we're incenting them to generate new business banking opportunities.

Today we have 350 dedicated dedicated small business bankers, but the new job description for branch managers makes them part of that force.

So, we have today 770 branch managers who are now involved in business banking.

If you would assume that one third to 40% of their time would be involved in business banking, that would be the same effect of adding 250-300 new business bankers on the street.

We finished the training that we needed to do.

We have built in the incentives, and we are excited about the prospects for increasing this very profitable business.

And finally, we're continuing to improve our targeted marketing efforts by re-evaluating entire client lists, rating customers based on profitability and potential for risk adjusted growth and allocating our resources appropriately.

These initiatives are already making us bigger and stronger and more efficient in the areas that we have targeted and we are confident that that will help us increase market share across our business and generate strong returns.

We're also beginning to get help from the environment.

A quarter ago Bill and I told you we thought loan demand had begun to turn the corner and that we would soon be seeing the beginning of a rebound.

Clearly we are seeing that rebound now.

What's important is the trends.

Loan balances are up.

If you look at spot balances than averages, the increases are more dramatic.

Promotional balances are up 1.6 billion since the end of the first quarter.

Loan commitments are up over 1.2 billion, and this is the third straight quarter we have seen commitments increase.

Credit utilization rates have begun to come off their lows.

Our utilization rate was up versus first quarter, and it is our first increase in several years.

That indicates that business owners are utilizing their sources of liquidity to fund their growth.

Demand is increasing across products, too.

On a spot basis versus last quarter commercial loans are up in almost every industry sector while commercial real estate and consumer loans are up strongly.

For example, our two largest sectors, retail wholesale and manufacturing were up 7% and 5% respectively off the end of the first quarter.

If you look at page 13 in the supplement you can see how this loan demand increase is across the board.

We are pleased to see that.

Improvements we're seeing in real estate finance demand means that the commercial real estate market is improving and we're winning our share of business.

Now I should note that increasing loan demand has brought increasing competition.

We're seeing more bidders for every deal.

Overall we're seeing bids from our competitors that don't make economic sense.

I want to assure you we are committed to profitable risk adjusted lending and careful balance sheet management.

We will not buy deals at any cost.

That said, the future for loans look brighter.

We expect the rising tide of loan demand to continue in step with broad based economic growth, and as that happens we are also winning a greater share of deposits.

That's a good combination for us.

With that I'd like to to turn it over to Bill to talk about the quarter and balance sheet.

Bill?

Thanks, Jim.

I think we did have a good quarter.

As you'll see there isn't much noise in these numbers.

Business environment is beginning to playing out like we thought it would.

We see rates going up, credit utilization rates are up, and as Jim told you in some detail, loan demand is substantially better for us.

We like this environment because we positioned ourselves for it and because it give us a tailwind we need to execute our growth plan.

The release covers about the numbers, so I am going to talk about the important factors that affected second quarter performance of our business.

I will give you some insight into our balance sheet position and our asset quality.

First let me cover the loan significant special item in the results, which is the sale of our portfolio of auto leases during the quarter.

We completed this exit much earlier than we had anticipated.

The net effect of the sale was and $8 million pre-tax charge that was recorded in the other expense line and $5 million reserve reversal.

The significant thing to note is that we have now exited the auto lease business, which we did not view as profitable over the long term.

That business typically contributed about 4 million in net interest income per quarter and had about equal and offsetting expense base.

I'm sure you remember we sold assets that did not think generated appropriate risk adjusted returns.

We have been doing that for some time now, and this divestiture of the auto lease portfolio essentially signals an end to that process.

We are very pleased with the risk returns on the balance sheet that we have now.

Now on to this quarters results.

I'm sure that the number that stands out most to you is the decline in net interest income, so let me talk about that first.

Our net interest margin fell to 3.18%, which is down 12 basis points versus the first quarter.

The margin end result in net interest income fell because of floors embedded in certain securities in our book matured, but importantly, also, because we sold fixed-rate securities to enhance our position for rising rates and because of spreads we earn on our loan book have declined.

On spot basis, our security balances decreased almost $2 billion or 12% since end of first quarter.

I should mention that the remaining securities booked includes unrealized losses of approximately 227 million, while the derivatives book includes unrealized gains of 211 million.

The numbers we reported in first quarter 10-Q showed small unrealized gains in securities and larger unrealized gains in the derivatives book.

The important message here is that we put ourselves in a position to be ready for rising interest rates, and we have resisted a lot of temptations along the way.

We purposely left money on the table by avoiding the risk of cash and carry trades, and we have not changed our essential philosophy just to bolster interest income for the short term.

You have heard this speech before, but we could have added securities to make this quarter's results look better, but that would have substantially increased the depreciation in our securities book.

Instead, we have chosen to position the balance sheet for strong returns in a rising rate environment, and we expect that that will differentiate our performance over time.

Now let me live me give you some guidance regarding what we expect in terms of net interest income over the next few quarters.

The third quarter NII is likely to be relatively flat compared with the second quarter.

It went up slightly when you adjust for the sales of the vehicle lease portfolio.

That is primarily because we don't want to leverage the investment book at the beginning of what we think will be a prolonged and volatile period of rising rates.

Also, as Jim said, loans are increasing, but income-wise asset origination.

None the less, clearly as loan demand continues to increase, we will see a positive impact on that NII.

So in the fourth quarter we expect NII ramp up as rate increases and asset levels ramp up.

Importantly -- and I think this is a differentiating item -- we expect the increases in net interest income to continue through 2005.

That's all good news for us.

We're being patient, and our patience will let us avoid major write offs from existing cash and carry trades.

Balance sheet is in great position, which is evident in the quality of our assets.

Asset quarter statistics are at best levels in long time, and they compare very favorably with banks rated two levels higher by the rating agencies.

Nonperforming loans to total loans stands at just .43% compared to .95 a year ago.

Net charge offs to average loan fell to .27%, down from .73% at this time last year.

These improvements in asset quality drove the provision down to 8 million and enabled reserve releases, which is which is why charge-offs are higher than the provision again.

If you take out the impact of the vehicle lease reversal of 5 million, I would expect loan loss provision to be moderately higher over the next two quarters partly because of rising loan demand and loan balances.

Of course, the increases in rates in loans and the outstanding asset quality are all very good for our businesses, not just for our balance sheet.

Business earnings were up, which means we are doing well at acquiring, growing, and retaining customers.

Business segment earnings totalled 330 million for the quarter.

The regional community bank, which accounted for 41% of consolidated net income earned 125 million for the the quarter, a 3 million increase over the second quarter of last year.

The RCB has made substantial progress this year.

Loans, deposits, checking customer relationships and retention are all up over a year ago.

Also notice that deposits were down this quarter for many of our peers, but that hasn't been our experience.

In fact, transaction deposits were up over 300 million.

That is a testament to the strength of our relationship-driven strategies.

Another good indication of that approach is customer retention which was at 95% at the end of the quarter, and we think that is at the top of industry.

RCB is also on track with its plan to open 30 new branches in the high growth market of New Jersey by 2006.

The wholesale banking earning increased versus the second quarter of '03 by 36%, primarily because of significantly improved asset qualities resulting a lower provision and because of growth in business loans.

I should note that linked quarter comparisons for both the regional bank and the wholesale bank are difficult.

In the RCB, in the regional bank, we have changed the charge off policy for small or non-performing commercial loans and incurred one-time acquisition expenses for United during the first quarter, and that change had a negative impact on the RCB's provision.

In the wholesale bank, we realized a significant benefit from the reduction of non-performing loans in the first quarter, and we told you the resulting level of negative provision would not be sustained.

These effects were one-timers, so this quarter's results are more reflective of normalized earning in that those segments.

PNC advisors earned 27 million for the second quarter, a 13% increase over the second quarter last year.

Earnings were down versus first quarter because of 10 million gain we recorded in the first quarter for bill of certain Hawthorne Consulting activities.

Advisors are retaining clients very well, and we are managing costs with discipline, and we are making progress in bringing in priority clients.

But we need to accelerate trends.

(INAUDIBLE) earned 17 million for the quarter, a million more than both the linked quarters -- I'm sorry, than both the linked quarter and second quarter last year.

While pricing pressure and mutual fund industry turmoil continue to impact this business, we have continued to take out expenses, and we've won some valuable new clients.

In fact, sales for if first half of '04 have already surpassed sales for all of 2003.

As you might expect Black Rocks fixed income business was impacted by higher rates, but Black Rocks produced another very strong quarter with earnings of 48 million.

Earnings increased 24% compared with the second quarter of 2003.

And we are down compared to the linked quarter due to a one-time tax benefit Black Rock recorded during the first quarter.

Assets under management decreased compared with the first quarter due to the challenging conditions in fixed income markets, but despite the modest decline in assets Black Rock continues to deliver excellent results.

I should note, too, that equity management activities which encompass our private equity investment capital business recorded 23 million in after-tax gains during the quarter.

We're obviously pleased with these strong results, but we don't necessarily view these level of gains as sustainable through the remainder year.

Quick note on expenses.

We continue to as exert strong control over expenses with only significant increase occurring in staff expense.

That increase is primarily because we are a bigger company.

We added United National, and we've been growing organically.

Total expenses are coming in about where we said they would, basically flat to last year, and we will continue to manage to that goal.

Finally a comment on capital.

We have a great deal of excess capital, and our top prior priority is to re-invest in our high-return businesses.

The Riggs acquisition is good evidence of our capital position.

Even after closing that deal we expect to be in a very solid capital position, but we are keeping an eye on the relationship between tangible and common equity.

And our tangible capital level would be some pressure on this with addition of good will coming on the books from the Riggs deal.

As a result we expect to be at lower end of our previously announced share repurchase guidance of 250 million to 750 for the year, and we've already done 190 million through the first half of year.

So overall we are feeling very good about our position.

The businesses are growing their customer bases, and as Jim said, they have been challenged to increase market share, and we think we are in a great position to ramp up net interest income over the next eight months So long term looks good for us -- next 18 months.

Long term looks good for us as well.

We're coming into the Riggs acquisition in a position strength, and we are excited about the opportunities we see before us across our expanding geographic reach.

Before we take your questions, I think Jim would like to make a few closing remarks.

Well thanks, Bill.

As you were saying, we're feeling very good about the quarter and feeling very good about the rest of the year.

Increasing loan demand coupled with the increases in net interest income that we expect in a rising rate rate environment and the positive effects of our initiatives to grow market share should create -- should continue to create strong momentum for PNC.

So we're optimistic about the remainder of the year.

We'd be happy to take any of your questions.

Operator, could you give our callers the instructions, please.

Yes, sir.

At this time I would like to remind everyone, in order ask a question please press star one on your telephone key pad.

We will pause for just a moment to compile the Q&A roster.

Your first question comes from Tom McCandless with Deutsche Banc Securities.

Good morning, gentlemen.

Bill, thanks for addressing net interest income.

But could we add a few more questions on that?

Sure.

And that is, to what degrees is contemplated loan growth critical to driving net interest higher?

Generically obviously, loan growth is going to help net interest income.

We don't think in our plans we have sort of outlandish assumptions with respect to how we can grow those balances.

If you look quarter to quarter, page 13 of the financial supplement, the spot balances increases quarter to quarter in the CNI sector are stunning.

We're doing a real solid job on that, and we feel pretty good about our ability to continue to execute on that.

It is not tied to any one business, Tom.

Probably the fastest growing is secured lending business where you have seen commodity prices increase and customers are utilizing -- manufacturing customers are utilizing higher valued inventories, and it is showing up in increased loan demand.

What kind of utilization range do you have in asset base lending versus other commercial businesses, out side of real estate?

It is kind of -- asset based lending is somewhat unique because the commitment you put out and the amount you will lend is a function of available receivables that you get as collateral, so utilization doesn't play into it, per se.

It is kind of how much collateral do they have on the line at any given point in time.

I think what we're seeing, though, I guess across all of wholesale is increases on average in utilization and in some businesses real estate, for example, utilization rates are up close to 2 1/2% from prior quarter.

Okay.

Another question, if I may.

There were some opening comments with respect with rescoring and reallocation of, I guess, of equity on a risk adjusted to customer base, going through the whole client base one more time.

What should we look for as investors as to what that means?

What is going to come out of that?

What should we anticipate?

What should should we be thinking about?

Does this mean you will need to fortify your efforts to cross sell?

Does this mean you have customers you are loosing patience with?

What should we make of that?

I think the strongest message is just that we are going to be disciplined about it.

I think if you go back in time, you know, any bank that has really gotten itself in trouble with credit in a big way typically got there because it was lending money to people it didn't know and wasn't sort of looking at total return of the relationship risk adjusted.

All we are talking about is making sure that our customer relationships look at total profitability.

So we do try to cross sell, we do try to measure that.

We try to measure the return on equity associated with that individual relationship and put our money with people people that are paying us returns for it.

And we are doing that today, and we're growing value with that approach, and we're growing fee income as we we sign up those customers, huge percentage increases.

Its working.

And currently the prospects is probably the most important factor there, Tom.

I know we talked in the past of how you get -- you get tired of trying to get incremental fee income out of old customers.

One of the best best ways to utilize is to really look at the risk adjusted potential with a given customer and make sure officers are targeting the right people that have the right opportunity.

Finally, net interest income question.

Bill, do you contemplate net interest income for 2004 for the the calendar year will be above or below 2003 as reported?

I don't know the answer to that off the top of my head.

We basically plotted it out where, you know, as I said third quarter will be roughly flat and then start to wrap up in the fourth quarter and out through '05.

The real issue is the speed of rate increases.

We're obviously, and have been getting hammered because our margin is down because we haven't chosen to sort of lever up the margin is down because we haven't leveraged up the securities book.

It is frustrating because you see people who take a one-time massive charge, sell off their securities book and say they will grow income in the future, and, you know, they take a one-time charge out of operating income.

We haven't haven't done that.

We haven't needed to do that.

We are basically going to grow income without taking that charge.

That seems to be missed on people.

Thank you.

As I was going on there, I have some people scribbling numbers.

The '04 will be below '03 number in total, not by a material amount, though.

And '05, we would suspect, will be higher.

Next question, please.

Thank you.

Your next question comes from John Kline with Sandler O'Niell.

Hi, guys.

Bill, I would applaud you to to resist the temptation to throw that cash and carry trade down.

We've seen companies trying to do that, and I think investors see right through it.

I think their valuations are suffering because of that.

My question centers more along the lines of asset sensitivity.

Your balance sheet was asset sensitive.

I got the sense when we met a month or two ago, that you folks were striving to be become more asset sensitive.

Can you quantify that in any way?

If you ran your analysis now, kind of what the effects would be to net interest income given one hundred basis points change this rates?

I don't have the numbers in front of me.

But I'll tell you that we were pretty accurate during the second quarter.

If you remember, we went into the first day of quarter with two year rates down around 145 or something.

Then they backed up immediately after that.

We've been -- we shortened up even more early on, and then we sort of releveraged somewhat during the quarter to take away some of the open position we had sort of created.

We're still asset sensitive.

The real issue for us is you guys measure asset sensitivity largely with respect to is your net interest income going to go up or down if you hold asset portfolio.

That is true for us.

The other issue for us is we haven't leveraged the balance sheet out right.

So we haven't chosen at some point of time there will be and opportunity to extend and invest more aggressively than we have, which isn't measured in that asset sensitivity number.

It is a long-winded way of saying depending how rates play out here, you know, we can do substantially better, but we don't need dramatic increases in a hurry to necessarily make that happen.

Just in terms of the earning assets, you know, for a long time they kind of declined.

You see the long growth numbers starting to -- they were very, very solid this quarter.

Do you see that really as a catalyst to start driving your average earning asset growth going forward?

I think certainly with the sale of the auto lease portfolio, sort of the down sizing of things it is over with.

I think the help for sale portfolio has a number in it of like 25 million.

We are basically done.

Now it is about growth.

As you point out, the success thus far in that front has been strong.

One last question centering in on that.

If you would attempt to quantify the lift that you are getting from the United -- the UNBJ acquisition in terms of the loan growth this quarter; was it a significant contributor?

John, I would say the loan growth came from across the whole franchise.

I think page 13 in the supplement really kind of shows that we enjoyed loan growth across all the businesses.

You can -- if you you back out the, clearly adding United helped balance sheet or increased loan balances out right.

But we've groan loan balance substantially beyond just that acquisition.

The income, by the way, for United, we had planned -- just to give you and idea of how well that is going, we had planned a $10 million income number year to date for that acquisition, and they are at 14.

They came out of the box slow in the first quarter, but really have ramped up, and trends there look great.

I guess, what I was really trying to drive at, Bill, is how much lift you are getting from all the different products that you offer that maybe they didn't, the ability to extend more credit to better qualifying customers.

Things like that.

Sounds look it is going well.

It is going very well, John.

The conversion was was seamless that took place at the end of the first quarter.

We've hired a number of private bankers, obviously, that didn't get to the swing of things until the second quarter, and they are increasing.

We have hired a number of brokers who, again, are coming on training at the end of the second quarter and into the third.

I think we we would do that United National deal every day if we could.

That thing has been a wonderful success.

We're just looking at deposit numbers for example, versus what we had sort of planned going into the acquisition, they are up 12% over our planned number.

We like this idea of high growth markets, obviously, the differentiation we see there versus some of the rest of our footprint.

Great.

Thank you.

Next question please.

Next comes from Kevin Bankberry of Stanford Burns.

Hi, Kevin.

Good morning.

A little more touching on interest rate sensitivity.

You showed, as you mentioned you showed strong deposit growth in quarter both in interest bearing and non-interest bearing.

As you move forward and as loan demand seems to be improving particularly by period end balances, I like your outlook on your ability to generate sufficient deposit funding and how that might impact the margin going forward.

Well our loan deposits are growing nicely, particularly our checking accounts.

We're now starting to become more competitive in the money market and CD space that has been a space in the declining interest rate environment the only way you really have an opportunity to make much money in that space is to go on the curve.

In an rising interest rate environment and increasing loan demand, that that becomes more attractive funding source.

You can see deposit growth that we had in the quarter.

I think it will be able to fund a significant portion of the loan growth.

Plus, we're -- our loan deposit ratio, I believe, is the second lowest loan deposit ratio in industry.

So our core funding will certainly be able to take care of even very robust loan growth going forward.

If you look at page nine, when you get around to it on the financial supplement -- we're getting an echo here.

Operator?

Is everyone still there?

Yes, sir.

Okay, it went away.

Page nine on the supplement actually gives a break down on where income came from on our balance sheet, and you will see that the drop is all on the securities line, and that is sort of protecting for the future.

You will also see that the cost of our funding during the quarter is only up marginally.

We grew the deposits without chasing hot money, without staying up for, and maybe now those trends continue, so we feel pretty good about it.

On the deposit side on -- absent the hot money.

Do you feel that much -- the current growth or the growth in the current period has been market-driven.

Are you gaining share?

And if you are gaining share, how do you think think you are doing that?

We believe we are gaining share significantly in the checking accounts base.

The checking account number is up 8% in terms of checking accounts.

We have a number of things, not only work place banking, University banking, we have a thing called Chairman's challenge which I think differentiates us from our competitors in the market place.

We are growing checking accounts, and I think it has worked out very well.

We have not chased the hot money.

So deposit growth that you see is primarily driven off of customer growth as opposed to having the highest priced money market account.

Over the last three years heard from our customers that we wouldn't have the highest money market account.

Our corporate customers, we sweep a great deal of their deposits in black Black Rock liquidity fund.

So you are really talking about core growth of customer deposits.

Okay, thank you.

Next question, please.

Thank you.

Your next question comes from Gerard Cassidy of RBC Capital Markets.

Good morning.

Good morning.

Couple of questions on credit quality.

In your guys' experience, credit today in the industry is phenomenally strong.

As evidenced on your page one, if you look at loan loss provision or you look at your non-performing assets outstanding, the trend lines of the last five quarters.

Everything goes in cycles, and this is a great cycle we're in right now in credit.

When do are you think we see a stabilization in that credit just doesn't improve any more more? and when do you think provisions would creep up to capture growth in loan portfolio that you where seeing today and I expect you will see in second half of the year?

You're absolutely right, it does go in cycles.

The loan losses usually show up, you know, six to 18 months after economy turns down.

Hopefully we are not anywhere near that space.

Our credit quality, as you mentioned, is probably as good as it is in the industry.

We are going to stay focused that.

One of the issues for us, I think is sometimes lost, is we are 65% fee.

So we don't have to reach for credit at this point.

We are very focused on that.

The other part is that has allowed us to not reach in the cash and carry trade as well.

So whether it is credit or interest rate risk, we have elected not to take that risk.

It is often the performance over the last couple of years because we have them.

Quite frankly, I think we are extraordinarily well positioned going forward.

As Bill said, we would expect that provisioning would start to pick up in second half of the year because of loan growth, but in terms of the industry we really have a hard time predicting what they will do.

Have your loan officers indicated that underwriting standards are softening a little bit?

One or two of your large competitors have suggested that this might be the case in their markets.

Are you guys seeing anything like that?

It is more pronounced the larger the transaction, so large corporate deals have gotten very aggressive.

The large syndicated high-yield deals have gotten very aggressive.

Most of our growth, though, is kind coming from smaller middle market, business credit, specialized lending stuff, that while we've seen it, and you will see in our numbers a drop in our average spread, it isn't as pervasive as what you are seeing in large syndicated deals.

It is sort of the institutional investors chasing those deals.

Actually, the only business we have on loan outstanding is large corporate business.

It is meaningfully behind plan in the loan outstanding.

We are not sure we are sad about that right now.

Returns aren't great in the first place.

One final question,and I had to jump off, so possibly you have addressed this.

Your equity management gains in the quarter of 35 million, can you give us some color on what was included in that?

There were a number of transactions in there.

It would only count on the equity management end, on the course of the first half of the year out of 40 odd million dollar return, 40 odd million dollars in earnings in and equity business business.

On and annualized basis that is about a 12% return on equity books.

While we are pleased to have it profitable again, it is not an outsized return from investments we had on equity management.

Is that a number we should look for in the second half as well?

It is not not our plans for the second half to be as large as what we saw in the second quarter, which is why I mentioned it in my comments.

We would obviously love to see it that big and larger larger, but we are not planning for it to be that that high.

As you know, It is not a predictable revenue source.

Correct.

Thank you.

Next question, please.

Your next question comes from John McDonald with Banc of America Securities

Hi, Bill.

On expense guidance, you are shooting for year-over-year flat '04 versus '03.

Am I correct?

Does that imply a good deal of sequential improvement in the second half from this quarter?

What is driving that down in the second half?

Is that cost saves from United or other stuff?

I think it is roughly flat out through the remainder of the year.

The guidance on that, we've try to be clear, but basically what we said is look at reported expenses last year and reported expenses this this year and they will be roughly flat, and that is what we are tracking to.

There is piles of noise in last year's expense line, and there is some noise in the front half of this year's expense line.

If you look at report to report it will be flat or close to it.

Okay.

And the way you interpret that, if we look at 9 to 10 million million in this quarter it is pretty flat there there?

Yes.

Okay.

And could you repeat what you said quickly about the buy back expectations, the low end?

Just remind us again what these numbers were.

We've done this for a couple of years now where we go out with a pretty wide range.

I guess this year we talked 250 to750 as a function of other opportunities that we saw in market to invest capital or just grow in business.

Partly because we've seen seen the big growth in in loans that we have seen, but also because of Riggs acquisition we would expect we would be at the lower end of that range rather than higher end.

Okay.

You did a certain amount already this year?

I think we are 190 million.

Okay.

And just a clarification on the credit provision. 8 million this quarter then 5 million that you didn't do on the auto lease.

So usually you would be up a little bit from 13 or 8.

How should we think about that?

Up from 13.

Okay, thanks.

Next question please.

Thank you.

Your next comes from Joe Dwain with Fox-Pitt.

Good morning.

You answered my question on equity gains, but I might ask about bond gains of 14.

That is pretty much in line with what you think is a normalized number.

But with the unrealized losses in bond portfolio, is that still realistic?

I think so.

We move around stuff in that portfolio, particularly, as you see the volatility we've seen with rates this quarter.

I think that a number of ten to 15 as we said before is sustainable.

Remember, it is individual positions that need to have a gain not the total, right.

Right.

All right.

Thank you.

Next question please.

Your next question comes from Claire Percarpio of Janney Montgomery Scott.

Hi.

First were there any loans purchased in the quarter that loan growth is so terrific.

Second, I want to clarify -- are you considering sort of the clean operating earnings number to be $1.01 or $1.02?

Well, first I would say that we had no loan purchases in the quarter, so the growth that you are seeing quarter to quarter is customer loan growth that came out of customers.

The question on $1.01 or $1.02 --

I'm not sure how you are getting to $1.02.

Maybe if you could --

Actually I wasn't really considering capital gains sustainable, I guess, when I did did it.

If you are not assuming them in the second half, and I took took the $1.07 minus 8 cents of equity gains, but also subtracted the two cents from auto vehicle and got $1.01.

Is that fair?

Well, a couple of things.

First, we are expecting continued gains from venture book, just not at the level we saw this quarter.

The other thing, in terms of of this normalization table, and it is a point we have been meaning to make, we put that out there and show you how we look at things, but add or subtract, as everybody does, whatever you think is appropriate and realizable through through time.

All we really try to do in that table is to show you things that are sort of noncore business and you can include it or not not at your pleasure.

Okay.

Thanks.

Next question please.

Your next question comes from Dennis Laplante of KBW.

Good morning Dennis.

Good morning, Jim.

Thanks for taking the call.

I have two or three questions.

First, is there any tail on the sale of vehicle leasing?

Is there any liability on your part?

No.

Okay.

Good.

Point two, on securitization, did you have any gains on your corporate services line?

It seemed to be a little above run rate, even adjusting for the held for sale gains.

We did have CMBS deals that went through this quarter.

Do you know what the gains were?

Those gains would have been about 15 million.

I'm sorry.

Yeah, 15 million.

How did ha compare to last quarter?

They were ten.

Okay.

Should we count on say, a low double-digit number?

Is that a pretty good number quarter to quarter, or is there seasonality there?

I think you can sort of count on it.

You might see -- what happened the first quarter, for example, we had a deal slip a month.

And so you might see some lumpiness, but on average that is probably not bad.

Okay.

And I think I caught from comments that the held for sale portfolio is finally down to about 25 million dollars, and you have been getting gains from that every quarter.

Is there any other movements or adjustments you plan out of the corporate portfolio?

No, not really.

We would say the portfolio is pretty much where we want it to be, Dennis.

Great.

Last question I have.

The timing of vehicle sales portfolio, the leasing portfolio, did that occur early, late in the quarter?

About the middle of the quarter.

Yeah, about the middle.

Okay.

Great.

Thank you.

Next question please.

Thank you.

Again, if you would like to ask a question please press star one on telephone key pad.

Your next question comes from Robert Rutschow of Prudential.

What impact of deduction of (INAUDIBLE) commitments have on earnings this quarter?

What?

I'm sorry.

We can't hear you too well.

What impact?

The reduction in unfunded commitments have on expenses this quarter?

The reduction in unfunded commitments?

Unfunded commitments went up in the quarter.

The reserve for unfunded commitments.

Oh the reserve.

Well, banks do do it differently.

We actually break out our reserve for our commitments separate from the reserve for the loans, but when we talk about provision we talk about about combined.

It has no impact on earnings, Mike.

Okay.

And then one separate question related to the Riggs acquisition.

I'm not sure if I got this in the conference call.

What is the efficiency ratio of Riggs if you were toll exclude all the businesses to be and asset?

I would love to be able to know.

For years they had the highest operating ratio in the entire industry.

Our intent is to convert that into a very low overhead ratio.

As I mentioned, we would expect that to be primarily a reason of community bank kind of balance sheet by the time we acquire it.

In the the Riggs disclosures we showed how the company is being transformed by the time we take it over.

They are in the process of selling G5 right now, artwork, and condominium, and a number of other things that really aren't germane to the business that we'll be acquiring.

Okay.

Thank you.

Next question, please.

Thank you.

Your next question comes from Jennifer Thompson of Oppenheimer.

Good morning.

Good morning, Jennifer.

Couple of question on net charge off ratio.

Given business model, can you give us a sense of what you think a normalized net charge off ratio would be through the cycle and the net charge off ratio came down dramatically this quarter even backing out some of the one-time impact in the first.

Is that something we should consider a good run rate at least in near term?

We talked about a 40 to 45 basis point charge off ratio sort of throughout the cycle.

We are going to run below that for some period of time.

At this point in the cycle we would expect that, you know, if and when things turn or go bad, we will be marginally above it.

The important thing is we are sort of managing the overall portfolio to that sort of expectation and totality through the cycle.

Okay.

So there wasn't really anything unusual this quarter, this was sort of a clean -- The 25 basis points is a clean number?

Yes.

Great.

Thank you.

Before we wrap up, I wanted to go back to, I think it was John's question on expenses .

And I might have misunderstood, John, where you were coming from, if you are still on.

The second half expenses will in fact be, in fact over a hundred million lower than what we did in the first half.

They will be roughly equal to expenses in second half of last year.

The reason they are down, the incremental cost saves that continue to roll through.

Obviously the UNB one-time costs that we had in the first quarter.

We had, for a bunch of various reasons, higher incentive comp in first year, a lot of that coming through Black Rock than we would expect to have in the second.

If you do the math, the total year to year will be the same, but in order for that to work, our second half expenses will be in excess of a hundred million lower than what we actually recorded in the first half.

Very important point.

Yeah.

Any other questions operator?

There are no further questions at this time.

Okay.

Thank you very much for joining us today.

Thank you for participating in today's PNC Financial Services Group earnings conference call.

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