PNC Financial Services Group Inc (PNC) 2007 Q4 法說會逐字稿

Good morning.

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

At this time I would like to welcome everyone to the PNC Financial Services Group fourth quarter and full year 2007 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.

(OPERATOR INSTRUCTIONS) As a reminder, this call is being recorded.

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

Bill Callihan.

Sir, please go ahead.

Thank you, and good morning everyone.

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

Participating in this call will be PNC's Chairman and Chief Executive Officer, Jim Rohr, and Rick Johnson, the Company's Chief Financial Officer.

In the following comments, we refer to adjusted results for the current period, as well as various prior periods.

We believe having these adjusted results in addition to our reported results, helps provide a clearer picture of PNC's results and trends.

In order to put all of the periods we discussed on the comparable basis, these adjustments report our investment in BlackRock, as if we had also recorded it on the equity method of accounting prior to closing the BlackRock/MLIM transaction on September 29, 2006.

We also adjust as applicable for the following types of items, in order to illustrate their impact on integration costs, net effects of our BlackRock LTIP share obligation, the Visa indemnification charge, our 2006 gain on BlackRock MLIM transaction, and the cost of our 2006 securities and mortgage loan portfolio repositionings.

In each case, as appropriate, adjusted for the impact of tax.

We provide details of the adjustments and reconciliations to GAAP of these and other non-GAAP financial measures that we may discuss in today's conference call, and our earnings release and financial supplement, and our presentation slide in the Appendix of this call, and in various SEC reports and other documents.

These are all available on our corporate website at PNC.com in the Investor Relations section.

The following statements also contain forward-looking information.

Actual results and future events could differ, possibly materially, from those anticipated in our statements and from our historical performance, due to a variety of factors, including those described in today's conference call, in our earnings release and related materials, in our 10-K, 10-Q and other SEC reports that are available on our corporate website.

These statements speak only as of January 17, 2008, and PNC undertakes no obligation to update them.

And now I would like to turn the call over to Jim Rohr.

Thank you very much, Bill.

Good morning everyone, and thank you for joining us today.

The last six months, I don't have to tell this group, has been an extraordinary time in our industry.

It has been marked by unprecedented volatility, and many of the financial services industries are reporting substantial losses, write-downs, and work force reductions.

It is interesting that after several mostly predictable years, we are seeing market conditions that no one could have predicted.

Credit losses, which were at historical lows are now increasing.

Liquidity at many companies is constrained, and the need for capital is driving consolidations and infusions from offshore investors.

Truly an unusual marketplace we are living in.

Given all of those challenges, we are pleased with where we are today, and we are satisfied with how our businesses are running.

The good news is we are growing our diverse revenue streams faster than our expenses, and we continue to deepen our customer relationships, and we are deploying capital to grow our businesses.

And we like our strategic decision-making, because we have avoided material exposures to subprime mortgages, and other issues that are currently plaguing the industry.

We had a good year in 2007, given the operating environment.

We delivered solid financial results.

We completed several significant acquisitions that will further the growth of our franchise, and at $139 billion, our assets are at record levels.

For the quarter and for the year, we saw significant increases in net interest income.

We saw strong fee growth excluding the CMBS and trading, which we will talk about in a moment, and we continue to manage our expenses effectively, and we expect these trends to continue in 2008.

However, we are not without disappointments.

PNC is not immune to the current market volatility, and our fourth quarter results did not meet our expectations.

As I shared with you in December, we experienced earnings pressure in two primary areas.

One, credit deterioration, primarily related to our residential real estate development portfolio, and the underperformance in our CMBS origination business and trading activities.

Today, we also reported charges for our share of the estimated Visa litigation exposure.

For several quarters, let's talk about the real estate piece first.

We have been experiencing a downturn in the credit cycle.

We have been saying for years that we were at unsustainable low levels of nonperforming assets.

Our nonperforming assets did increase to 0.34% of total assets, from 0.22 in the fourth quarter, still remarkably low levels.

And we bought a bank this year that had zero NPAs, obviously unsustainable as well, and we converted them onto our platform late in September.

And these combined with the deteriorating residential real estate market contributed to this increase in NPAs, but still again at a low level.

Our relationship managers are increasing their focus on at-risk credits to help us through this cycle, and we have a proven ability, we believe, to manage through these kinds of credits.

We have done them before.

Most of the credit quality issues we are hearing about today relate to residential real estate development.

This represents less than 2% of our assets, a very small percentage relative to many of our peers.

The other troubled area with regards to CMBS and trading, we are comfortable that that will, and we expect that to return to profitability this year.

Given our strong business model and our ability to create positive operating leverage, we believe we can continue to deliver solid results in this challenging environment.

Looking at our adjusted full year results, we achieved year-over-year adjusted net income growth of 12%, while our EPS on an adjusted basis was essentially flat due to the fourth quarter.

Rick will discuss our financial performance in more detail in a few moments, but let me offer some highlights from our business segment.

In Joe Guyaux' retail banking business, we continue to grow customers.

We added more than 300,000 net new checking account relationships in 2007, and that includes the acquisition of Mercantile.

We also saw more customers using online bill payment, a key to increasing customer retention and profitability.

The percentage of consumer DDA households using the system in the fourth quarter increased year-over-year, from 23% to 33%, boding well for retention.

Regarding our acquisitions, we successfully integrated Mercantile in September, adding them to our industry-leading technology platform, and we captured the expected cost savings in the fourth quarter.

We are already seeing growth in our converted Mercantile branches, with a 60% increase in the production of consumer checking accounts in the fourth quarter, compared to the same period last year.

This increase reflects the opportunity we see for growth in the former Mercantile branches, and we are pleased that some 20,000 Mercantile customers now bank online with PNC.

Another item, our initial credit card mailing to Mercantile customers took place in the fourth quarter, and we achieved 140% of our goal.

Also with regard to a strategic decision in the fourth quarter for retail, we decided to focus our brokerage business on our input print activities, where we have a competitive advantage.

As a result, we announced the plans to sell Hilliard Lyons, and we expect the sale to close in the first half of this year.

Now turning to Bill Demchak's corporate and institutional banking business, they have made great progress this year.

This segment delivered good results on a relative basis, despite a challenging environment.

Our relationship approach, which is supported by a broad array of products and services, generated almost 50% of total revenue from non-interest income in 2007.

This segment with its national capabilities continues to deepen relationships with its middle market customers, providing them with a broad array of credit, liquidity and capital markets products and services.

In fact for 2007, we remained #1 in arranging middle market loan syndications in the Northeast, and in the U.S., we are #2 in both transaction and dollar buy.

Harris Williams was selected as the middle market investment bank of the year by a leading trade publication, and they had a record year.

And we had a record year in our national asset-based lending group, ending the year with loan outstandings of approximately $5 billion.

Not to be last, Treasury management revenue is up 14% year-over-year.

As we turn to PFPC, Tim Shack and his team have done a wonderful job.

Our global fund services provider reported revenue growth of 8% in 2007, driven by a robust sales pipeline.

Core earnings continue to show significant improvement, as we transform this business segment from an information processor to an information provider.

During the fourth quarter, we completed two acquisitions to further that strategy.

By adding the capabilities of Albridge Solutions and Coates Analytics, PFPC can now facilitate the flow of information, both to and from financial advisors, broker dealers, and fund companies.

PFPC continued its international expansion in '07, also by opening a sales office in London, and obtaining a license that allows it to provide depository service to the $1 trillion Luxembourg market, and as we know, our international services there are growing at approximately 40% per year.

Just earlier today, Larry Fink and BlackRock reported another very strong quarter of core earnings, with assets under management now at $1.4 trillion.

The strategic decisions being made to grow the distribution network, expand the product range, and their overall focus on investment performance in client service, should continue to benefit PNC.

As we look forward to 2008, we believe our industry will continue to face challenges from end market liquidity and credit deterioration.

We believe this is good and bad news for PNC, because of our relative strength position.

As a matter of fact, we look at it as a year of opportunity when we look at competition with our competitors.

As for the economy, we currently see growth in '08, albeit at a slower pace in '07.

Assuming a reasonable economy, we are focused on maximizing the strength of our franchise in 2008, at a time when others have lost significant revenue streams, or are laying off employees.

We look to execute our business plan this year by really taking advantage of PNC's products and services to new markets, as well as our existing markets, and as a result, we believe we are well-positioned for an even better year in '08 than '07.

Now Rick will provide you with more detail of our financial strategies and outlook.

Thank you Jim, and good morning everyone.

Overall this was a very good year for PNC, despite our fourth quarter challenges.

First, our business model with its diverse revenue streams, continued to deliver solid results.

Second, on an adjusted basis, our revenues continue to outpace our expenses, creating positive operating leverage.

And third, our moderate risk profile and flexible balance sheet position us well for the current environment.

Our reported earnings per diluted share in the fourth quarter were $0.52.

These results included a $0.24 charge related to our BlackRock long-term incentive plan obligation, a $0.16 charge related to Visa, and a $0.15 charge for integration costs, primarily due to the additional provision of 45 million related to our Yardville acquisition.

The Visa charge represents PNC's share of our estimate of Visa's litigation exposure.

We expect this loss to reverse on completion of Visa's pending IPO, and given the temporary nature of this charge, we excluded it from our adjusted results.

Our adjusted earnings per diluted share in the fourth quarter were $1.07.

This included 26 million of valuation losses for commercial mortgage loans held for sale, and trading losses of 10 million.

In the aggregate, these items were marginally better than what we disclosed in December, but significantly below our original expectations.

Adjusted earnings also included a 78 million increase to the provision for credit losses versus the third quarter, primarily related to residential real estate development.

This is a bit more than we disclosed in December, and I will have more to say about that later.

For the full year, our reported earnings per diluted share were $4.35, or $5.05 on an adjusted basis, when you exclude the BlackRock LTIP activities, integration costs, and the Visa litigation charge.

Now, I would like to focus the remainder of my comments on our key business strategies, delivering diverse revenue streams with a high concentration of fee income, creating positive operating leverage, and maintaining a moderate risk profile.

Now as it relates to our moderate risk profile, we will also comment specifically on today's priorities.

Managing asset quality, maintaining our strong liquidity profile, and building our capital strength.

As Slide 5 shows, we continue to grow high quality diverse revenue streams.

Overall adjusted revenue for 2007 grew 18%, a significant achievement in this environment.

We are differentiated by our high quality diverse revenue streams, which require relatively less credit capital than our peers.

Our fee-based businesses account for 50% of total revenue.

On an adjusted basis, they grew 10% on a year-over-year basis, despite the challenges in our CMBS and trading activities.

Asset management revenue increased 10% on a linked-quarter basis, due to BlackRock and our wealth management businesses, which continue to deliver record results through strong revenue growth, and disciplined expense management.

Fund servicing revenue grew 3% on a linked-quarter basis, driven by our merging products, primarily offshore activities, and our Albridge acquisition.

On the Consumer side, our consumer service fees and deposit service charge revenues increased 3% on a linked-quarter basis, and were up 12% for the full year, due to organic growth and the addition of Mercantile and Yardville.

In addition, brokerage revenue remains strong with full year growth of 13%, driven by the strong performance of our in-footprint brokerage business, and Hilliard Lyons.

On the Corporate and Institutional side, the fourth quarter returned to more normal levels following an outstanding third quarter.

For the full year, they grew 14% due to strong results by Treasury management services, Midland Commercial Mortgage Servicing, and Harris Williams M&A advisory services.

Now let's take a minute to talk about our commercial mortgage origination business.

We had about 2 billion in held for sale loans at year end.

While we clearly understand the risks involved with this business, our decision early in the quarter not to fully hedge our inventory, in an environment when credit spreads were widening, cost us 26 million.

Since then, we have hedged all new originations, and currently have several securitizations in the pipeline.

Our intent is to significantly reduce our inventory in the first half of 2008.

Now this is a good business for PNC, and we will continue to be active in originating, securitizing, and servicing commercial mortgage loans.

Business in our trading business is very similar.

We simply took positions that were adversely effected by unprecedented widening of credit spreads.

I should point out that our customer-related trading business met expectations for the quarter.

Despite these challenges, the diversity of our fee income sources, enabled us to grow these revenues by 10% over the prior year on an adjusted basis.

Our next largest contributor to revenue is our deposit franchise, which accounts for 27% of adjusted revenue, growing 5% on a linked-quarter basis, and 34% for the full year.

We are differentiated by our ability to gather low cost deposits through multiple channels, including consumer, small business banking, corporate banking, Treasury management, and Midland loan servicing.

We were successful in growing our average non-interest bearing deposit base by more than 250 million on a linked-quarter basis.

On the interest bearing side, revenue growth was enhanced by our strategy of focusing on relationship customers, rather than pursuing higher rate single-service products.

Our strategy is to remain disciplined on pricing, while targeting specific markets for growth as opportunities arise.

Consequently our results this quarter benefited from lower deposit costs associated with lower rates.

We are seeing some price easing in certain geographies, however, overall, this remains a competitive market.

Our smallest contributor to revenue is credit, which represents 6% of adjusted revenues, and grew 25% for the full year, primarily due to Mercantile, and growth in our commercial client base.

We continue to deploy credit capital to service our customers, and where it meets our risk return criteria.

As a result, we saw average total loan growth of about 2.3 billion over last quarter, primarily driven by loan demand in our corporate and institutional segment, and our Yardville acquisition.

We are very comfortable with the diversification of revenue resulting from our business mix.

Overall this approach delivered 18% growth in adjusted revenue for the full year.

Now as you can see on Slide 6, we created a positive operating leverage on an adjusted basis in 2007.

This was accomplished with 18% growth in adjusted revenues, and a 15% growth in adjusted expenses.

Overall, adjusted net interest income growth was 12%.

In the fourth quarter, we saw incremental savings and operating expenses related to the Mercantile integration.

We said we expected a reduction in operating expenses of 108 million annually, and we have met that goal.

You might notice that our effective tax rate for the quarter was approximately 21%, but this simply reflects the impact of lower reported earnings, while our permanent tax credits remain consistent with expectations.

Now PNC is well-positioned from a risk perspective because of the strategic choices we have made, and our operating discipline.

Let's start with asset quality.

Strategically, we have substantially avoided many exposures, subprime mortgages, high yield bridge and leverage finance loans, that are creating challenges for some of our peers.

And our commercial real estate portfolio is relatively small compared to the peer group.

On a daily basis, we make credit decisions based on our assessment of risk adjusted returns.

And as a result, our asset quality continues to be strong with nonperforming assets representing only 0.34% of total assets at quarter end.

However, we did see a sizable quarter-over-quarter increase in nonperforming assets, but it was in-line with our expectations for this stage of the cycle.

Our exposures continue to be very granular.

Our largest nonperforming asset is $20 million, and our average nonperforming commercial loan is less than 500,000.

That being said, we do expect nonperforming assets to increase in the first quarter, but at a slower pace than what we saw in the fourth quarter of 2007.

We recorded a provision of 188 million, which includes a provision of approximately 45 million related to the Yardville acquisition.

The remaining increase in the provision over the third quarter was primarily related to deterioration in our residential real estate development portfolio.

Our commercial real estate portfolio is well diversified.

The outstandings as a percent of Tier 1 capital remains relatively low compared to our peers.

Our outstandings in the residential real estate development sector is only $2.1 billion, which represents only about 4% of total loans.

The majority of this exposure is in our footprint.

Overall, our portfolio continues to be very granular and manageable, and the average size of these exposures is about $2 million.

We recognize this is an area of heightened concern, and we remain diligent in our underwriting practices, and in our ongoing credit assessments.

Next let's talk about interest rate risk management.

Our duration of equity at the end of the year was 2.1 years positive, providing us with continued flexibility to invest opportunistically, and benefit from lower rates.

Our net interest margin was essentially flat, as the decline in deposit rates kept pace with asset repricing.

The reduction in the Fed rates were marginally beneficial to net interest income, but the more significant benefit will take effect when first, the spread between Fed fund's rate and LIBOR eases, as it is beginning to do, and you are seeing that in the market today, and second, when our deposit base reprices, and this will take some more time to work its way through.

From a liquidity perspective, PNC's loan to deposit ratio of 83% is among the lowest of our peers, and from a contingency perspective, we have unused borrowing capacity of more than $30 billion.

So we are very comfortable with our overall liquidity position.

Next, let's talk about capital.

We are adopting the Tier 1 capital ratio as our primary metric for capital management.

This metric provides better alignment of capital management with our balance sheet risk.

We are doing this for a number of reasons.

First, we believe Tier 1 provides a better measurement of risk, and is more consistent with our economic capital methodologies.

Second, Tier 1 is a regulatory capital concept, and is better aligned with capital approaches used by the rating agencies.

And third, it allows us to access the hybrid capital markets as a recognized part of our capital structure.

Our Tier 1 capital at year end was 6.8%.

That is above the well capitalized level from a regulatory perspective.

However, this level of capital is a little thinner than I would like in this environment.

This happened because we grew our balance sheet more than expected, and we closed an acquisition earlier than expected.

That being said, our focus in 2008 will be on building our capital ratios, and I am confident in our ability to do so.

This is why.

First, we have the ability to grow earnings.

Second, we can access the hybrid capital market without diluting earnings per share, and third, we do not plan to use our capital to repurchase shares for the foreseeable future.

As a result, our Tier 1 capital ratio target for year end 2008 and potentially sooner, is between 7.5 and 8%.

On a final note, I would like to report that we have resolved our cross-border leasing issue with the IRS, with an additional charge of a nominal amount of 7 million after taxes, this significant uncertainty is now eliminated from our balance sheet, a major accomplishment.

If you look to full year 2008 compared to 2007 on an adjusted basis, and based on our economic forecast of 2% GDP growth in 2007, we expect to see loan and deposit growth percentages somewhere in the mid-single digits.

Total revenue growth will exceed 10%, driven by strong net interest income growth, as well as solid growth in non-interest income.

We continue to expect to create positive operating leverage, with expected non-interest expense growth in the high-single digits, and given our mid single-digit loan growth expectation, we expect the provision in 2008 to be between 400 and 500 million, depending on the pace of change in the credit cycle.

We also expect our effective tax rate to be approximately 32%.

In summary, we believe our industry, including PNC, will continue to face challenges for market volatility and credit deterioration.

Even so, as we seek to maximize the value of our franchise in 2008, this business model and our business strategies should serve us well.

With that, I will turn it back to Jim.

Thank you, Rick.

In closing, it was another solid year for PNC.

I believe our performance validates our approach, and reinforces our commitment to the key strategies that we have delivered these results.

Most importantly, we believe we are well-positioned for the current environment.

As we continue our efforts to build a great company, we will focus on the revenue side of growing high quality revenue streams through a diversified business mix.

On the expense side, we believe that we will achieve positive adjusted operating leverage, through growing the businesses with disciplined expense management, and maintaining a moderate risk profile.

Given what we see now, I am assuming a somewhat stable economy, we expect '08 to be better than '07, and we are comfortable with the range that First Call has for our '08 expectation.

With that, we would be happy to take your questions.

Operator, if you could give our participants the instructions, please.

Thank you.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of John McDonald with Banc of America Securities.

Good morning, John.

Good morning, John.

Hi, good morning, guys.

Question for Rick, and maybe Jim on capital.

Rick, would you say buybacks look like they are on hold for 2008, and would that also mean acquisitions probably also on hold for 2008, and then secondarily, might you consider some kind of debt issuance, or other kind of capital enhancement activity this year, to get your capital levels up to where you want them?

Yes, I think in terms of buyback, at least for the first half of the year, no doubt, I think we will be on the sidelines as it relates to that, and we will have to reassess our capital position at mid year.

I think as it relates to issuing and accessing the capital markets, we certainly feel that we have access to that and as I mentioned, I think we will be strongly considering some kind of Tier 1 capital issuance, which is not dilutive to earnings per share.

And we have done that throughout 2007, and we will be looking at that in 2008.

Okay, and then maybe Jim's comments on acquisitions given the capital levels now?

The acquisitions, I think it is important to note, John, I think we have tremendous opportunity just by, you know, operating our business as we see.

I think in the last presentation we made, we talked about how much opportunity, upside opportunity there is in the new markets that we have entered, and we like the success that we are having in Mercantile and Yardville already.

And so I think our focus really this year is going to be to continue getting some of those cost saves out of there, and drive revenues through our existing and our new franchises.

Acquisitions I think at this point in the credit cycle are kind of interesting to do.

As we know in real estate, in the past it takes probably three years to work its way through the cycle.

That is why we are glad we have a lower relative percentage than our peers.

You know, so I think we would rather just run our business.

Okay, and then just to follow up, Rick, on the margin and NII, did you give an outlook for the early '08, or '08 at all on margin or NII growth?

Growth?

No, I think as it looks, NII, clearly we see growth in NII.

I mentioned that we will see strong growth through the entire year.

On the margin, I would say it will be stabled up throughout the year, given what we are seeing right now, in terms of Fed easing throughout the year, as well as our expectation of a little bit steeper curve than what we are seeing today.

Okay.

Thanks.

Next question, please?

Your next question comes from the line of Ed Najarian with Merrill Lynch.

Good morning, Ed.

Good morning, Ed.

Ed?

-- on the 400 to $500 million provision, if we look at that level, does that include some additional reserve building, and not just reserve building on a dollar basis, but reserve building on a reserve to loans outstanding basis as well?

Yes, I think so, Ed, because I don't expect charge-offs to reach that level through the course of the year.

I think absolutely it would result in some reserve building over the course of the year.

We are talking about loan growth in the mid-single digits.

It will be tied to that.

Right.

So I guess the question I am asking is would you expect your dollar reserve to increase faster than a mid-single digit pace?

Yes, yes, I would.

Okay.

As a combination of loan growth, as well as to the extent that there is some further deterioration, there will be probably some excess reserving over charge-offs in the near term.

And then secondarily, I know this is kind of a hard thing to look out on.

You mentioned you expect NPAs to increase in 1Q, but increase at a slower pace than they increased in 4Q.

Any outlook for credit quality beyond 1Q, or any kind of tentative outlook, do you think that pace of NPA growth will continue to decelerate?

The challenge there, Ed, is everything is based upon our view of the economy, what we think is going to happen over that period.

And based upon the economic forecast of our economists and where that's at, I think you see it building Q1, maybe a little bit in Q2, leveling off maybe through the second half of the year.

But, boy, that is based upon a forecast, and those forecasts are changing pretty rapidly.

So suffice it to say if that is sort of the tentative outlook, that would not really be a recession scenario outlook?

No, no, that is the 2% GDP growth outlook.

Okay.

Thank you very much.

Next question, please?

Thank you.

Your next question comes from the line of Mike Mayo with Deutsche Bank.

Good morning, Mike.

Good morning, Mike.

I have five little questions.

One is where is consensus that, you know, you are saying is okay?

First Call consensus for us in '08, is $5.94 to $5.35.

Sorry, 5.94 to--?

Low end is $5.35, and the upper end is $5.95.

Okay.

That is a wide range, I guess.

Agreed.

And then second, Mercantile call savings, you got what you wanted.

Is there more to go, or is that pretty much it?

There will be more to go.

About how much more, do you think?

We haven't given an estimate on that, but I think we are continuing to see opportunities for cost savings on Mercantile.

But we are also investing in Mercantile, in terms of hiring people that produce fee income.

So, you know, there will be, but there will be more cost saves coming out.

And then third, Yardville, how much did that add in different categories, like NPAs, revenues, expenses?

It was, in terms of NPAs, it was pretty marginal.

17.

17 million.

I think in terms of overall loans, it was about 1.3 billion.

What other categories are you looking for, Mike?

Revenues and expenses.

If you want to back out Yardville to look at linked-quarter revenue expense growth?

Talking Yardville's revenue number is about $10 million.

And the expenses?

$10 million.

Okay.

And that is the impact in the fourth quarter, or would that be the whole quarter?

That's the impact in the fourth quarter and we closed, it is two months worth.

And then fourth, the new capital issuance, is that fact toward into your expectations for 10% revenue growth?

Because if you issue, say, some preferred with the dividend rate, that would be a drag on revenues.

So is that in your numbers already?

Absolutely.

It is, okay.

Absolutely, yes.

And then lastly, I guess your home loan bank borrowings went up 4 billion this quarter, and 6 billion in the last two quarters, at the same time I guess securities are up also.

So to get back to your capital targets, do you think about maybe downsizing the balance sheet in that area?

Not downsizing.

I think what you saw there was we just saw a great opportunity in the market to be able to borrow cheap and invest, right, and enhance earnings.

I think over the long haul though, we don't want to be as dependent on those kinds of borrowings, and I think we will probably be taking a look at that over time and converting that back into some longer-term funding.

One last one, I keep reading the name of PNC in the paper as a takeover target, and I haven't heard you guys say that, but just Jim, how do you respond?

I don't see us as a takeover target.

Okay.

Thank you.

Next question, please?

Yes, your next question comes from the line of Bob Hughes.

Good morning, Bob.

Good morning, Bob.

Bob?

Bob?

With KBW, Bob, your line is open.

Bob has withdrawn his question.

Your next question comes from the line of Jason Funk with Ferris Baker Watts.

Mike had five questions, so go right ahead, Bob!

Good morning, Jason.

How are you?

Good.

Couple questions, one, you guys adopted FAS-159, but you did not do so for your BlackRock investment.

Could you comment on that?

Yes, I think we adopted, we will adopt January 1 159 and we have got two very small strategies, structured repos, and CMBS where we are going to go to fair value.

It is not going to have that big an impact on our results overall.

If we were going adopt 159 on our BlackRock investment, we would have a wonderful capital ratio immediately, and then we would have a tremendous amount of volatility in our overall earnings stream over time, and we just didn't think that was reflective of our view of our investment in BlackRock, which is a long-term investment.

Okay, great.

Another question about credit moving forward, in light of the multi-family default that you had on the CMBS, and the litigation in the matter, what do you see for commercial real estate credit quality in general for the industry moving forward?

Well, generally speaking, our commercial credit quality is doing extraordinarily well and with regards to that one customer, although we don't make customer contacts, we have no economic risk there, and we don't have any comments on the litigation there either, but we are comfortable with the credit quality in the commercial space at this point.

And what is your view moving forward for the industry as a whole?

Do you think it is going to hold up?

I think it will hold up fairly well.

I think, you know, it depends on the economy.

If the economy grows at 2%, I think the commercial real estate market will hold up much better than the residential piece, which we clearly have overbuilt, and enjoyed the subprime problems, and the rest.

Commercial really doesn't have those kinds of issues.

All right, thank you.

Sure.

And your next question comes from the line of Nancy Bush at NAB Research, LLC.

Good morning, Nancy.

Good morning.

Couple of questions here, Jim, I was intrigued by your comments about taking products to new markets and by you other comment about no acquisitions, so can you just kind of flesh that out a little bit, what new products to what new markets?

In our most recent presentation, we showed, for example, Yardville I think was probably the easiest example.

Our bank X BlackRock, if you just take the bank itself is 50% fees, with all the various products and services that we deliver to customers through the bank.

Yardville, which is the #1 market share player in three of the 10 richest counties in America, has 29% fees.

They don't have any private banking activity.

They have no credit card capability.

They have no brokers, no branches.

They don't do merchant servicing for their small business customers in the region.

They didn't have remote deposit, and so we look at opportunities like that, and to put those products in the hands of those sales people in that region, to the extent we reported that we expected at a 15% IRR by taking the costs out, to the extent that you don't give us any credit for the revenue stream, any growth in revenue, but if we can drive that revenue from 29%, to 40 or 50 like we can the rest of the company, the rest of the bank, you know, we can truly enhance that acquisition.

We look at the same issue as at Mercantile, they have a little bit higher component of fees and then when we look at greater Washington with the Riggs acquisition, we have been able to increase their percentage of fees and their fee growth by over 10 full percentage points in a year and a half, or two years I guess now.

So those are the kinds of things we think we can do in those new markets and, you know, it is a tremendous opportunity for us without having to do an acquisition.

The acquisition environment, your second question, you know, it is going to be interesting to watch.

Credit quality is clearly going to be an issue for the next year or two, and I am sure there will be opportunities.

You know, our first and foremost issue is just to run our business.

I think we have a great opportunity.

And the markets we are in are doing very well.

I mean the Maryland market, the New Jersey market, eastern Pennsylvania, and even the stability that we have in the Midwest.

We don't have a Northern Ohio or Michigan, where the default rates are so high.

I mean we have got stable markets and growing markets and, you know, I think that gives us a real opportunity.

So you are talking about enhanced delivery within the footprint, not outside the footprint?

Yes.

Well, some of our businesses are outside of the footprint.

Our Treasury business, our real estate business, you know, our Midland, our secured lending business with business credits.

So some of our businesses are outside the footprint, but the branch business we will just, you know, mind the existing footprint for a while.

And on the residential real estate front, I am assuming that most of the issues that you are seeing right now are related to Mercantile.

Are they mostly Northern Virginia/metro DC issues, or are there some outside that area?

Well, it is across the board, but our residential real estate is concentrated in that region, so, you know, when we announced the Mercantile deal, they had no nonperformers at all.

That was an unsustainable comparison.

The nonperformers today would be less than 50% Mercantile, but they were a larger real estate lender than PNC was.

So they have contributed significantly to the increase in the NPAs.

Great, thank you.

Next question, please?

Your next question comes from the line of Bob Hughes with KBW.

Welcome back!

Hi, guys.

Yes, sorry, I flailed reaching for the mute button.

(laughter) Was there any impact on the quarter in the income statement or your book basis of BlackRock associated with the [Cuellis] acquisition in the fourth quarter?

No, actually there wasn't because what BlackRock ended up doing was the shares they were planning to issue actually went into trust.

So there was no underlying write-up with respect to our investment in BlackRock.

Okay.

That won't occur until those shares actually come out of trust and actually get delivered to the third party.

Okay.

I was hoping you might be able to provide a little bit more color on your actions against the construction book.

Obviously we don't really see the delinquencies, but I think you said a lot of the 190 million increase in NPLs was related to construction credits.

Can you give us a little bit more color on what you are seeing, or have those loans actually gone delinquent.

Have you run through interest reserves, or is this reflective of a reassessment of collateral values?

It is really a reassessment of the collateral value.

You know, it's a very interesting portfolio, Bob.

Frankly it's lots and lots of small loans.

I think the average NPA's is $500,000.

The largest deal is $20 million in the whole NPA portfolio.

So what you need to do in those cases, you really need to work with those borrowers in some cases, they are people we have done business with for years and years, and you want them to stay friends for life, just because there is a residential real estate downturn doesn't mean, you know, you throw everybody out.

So it is a real opportunity to make a customer for life, but you have to be careful.

You know, you work with those people that you are talking about small loans, 500,000, 1 million, 1.5 million apiece, so there is terrific, there is more opportunity to resolve those issues, than there would be for real large loans, which is good.

But the other end, you know, it takes a lot of shoe leather to work with $500,000 loans, so we are just going to be very aggressive in pursuing those.

Could you guys give an indication of what your total reserves are now, set aside against the residential development portfolio?

Yes.

We don't have a specific on residential.

I don't have that for you.

Okay.

We we do the reserving, we do it by customer, but we just don't have it broken down.

Yes.

Okay.

And Jim, when you talk about comfort with the range of Consensus, and expecting a better year in '08, that is off of the 505 basis, adjusted basis for '07?

Yes.

Okay, and if we think about this quarter's results, say ex the cross-border lease charge of $1.09, and you normalize some of the trading results, and commercial mortgage backed activities, you know, maybe you get to a run rate that is closer to $1.30.

At the same time I think a lot of investors might view the 2% GDP growth assumption as somewhat optimistic next year.

What else is going to help you get to better results that way?

I think we see, I think we see net interest income growing nicely next year.

You know, I think with a reasonable economy, the fee income pieces, especially some of the things I was talking to Nancy about, I think will do well.

You know, BlackRock ought to have another good year, I would think.

So when you look at the revenue side, whether it's net interest income or fees, I think with just a reasonable economy, I think we are going to see nice growth there.

We have been pretty disciplined on the expense side, so I think the expense piece, I think the expense piece is okay, and I think Rick talked about a 400 to $500 million provision, and you know, I think that leads us to another solid year, and if we are able to do some other things, then you know, and be a little more aggressive and have a little luck here and there, I think we can have a real good year, but I think at this point we are comfortable with the range.

Okay.

Thanks, guys.

Next question, please?

Yes.

Your next question comes from the line of Matthew O'Connor with UBS.

Good morning, Matt.

Good morning, Matt.

You guys run a lot of sensitivity to the credit costs and the macro assumptions, and can you just give us a sense of if GDP is flat for the year, or maybe 1%, you know, how much increase would there be in the credit costs versus the 400 to 500 million that you are assuming?

I am not certain.

I think one of the things that is an advantage to us is that the, you know, 1 and $2 million loans aren't so sensitive to, you know, GDP growth.

You know, you are talking about local loans that get handled differently than 40 and $50 million developments.

I don't think we are as sensitive to other people.

It obviously wouldn't be positive, but I don't think we are as sensitive as other people.

The other thing is that most of our real estate issues are all concentrated, most of our real estate in general is concentrated in the Mid-Atlantic states, where the real estate market has held up better than the rest of the country.

So, you know, using a GDP number across the nation probably isn't fair, I don't think, to compare that to what might happen in the Mid-Atlantic states.

So, you know, I am not as concerned as I might be if I had a national franchise or, or if that was a very large portfolio.

It is only 2% of our total loans.

Okay.

I mean if we have a mild recession for this year, and it impacts many markets, there is some concern that the markets that we are in, it is just taking a little bit longer for the slowdown to occur.

Is there, have you run some sensitivities to that?

We run sensitivities, but again, I think it would be worse, but not significantly.

Okay, and then just separately, of the $2 billion of residential construction that you just disclosed, you said most of those were small.

Should we assume from the vast majority of that are smaller builders versus bigger ones?

Yes, that is correct, yes.

Okay, and then just lastly, you know, I think almost every conference call you are asked about PFPC, but as I look back over the last several quarters, the earnings have been roughly flat in that business, and I am just wondering, 1) what the prospects are going forward there, and then, 2) the question you always get, do you reevaluate, keeping this business as part of PNC overall?

Well, we like it as part of PNC significantly.

I think we are doing a very good job.

Tim and his group have done a very good jobs in terms of diversifying the revenue stream of that company.

Over the last five years, they have grown the relative net income substantially, and now with these two new acquisitions, it really differentiates them in a way that they never were before, in terms of in the past they were an information processor, and now they are becoming an analytical provider for their customers.

And it opens up a whole new customer base, especially in the separate account and the managed account area.

So I think we are optimistic that once those two organizations really get integrated into the systems, there is a tremendous growth opportunity for PFPC.

So I didn't imagine that the Albridge Solutions could do for us what I think it will do.

And it has brought a lot of customers to us, too.

So I think there is a really, really good future for PFPC.

Matt, actually if you look to what happened in 2006, we had about a $14 million tax credit in that business.

So the actual, if you adjust for that, the actual growth in PFPC year-over-year in net income is about 17 %.

So while, and it is kind of a step to business, big clients come on, some clients go up.

So it just keeps reaching new levels of overall earnings growth.

All right.

That is helpful.

Thank you very much.

Next question, please?

Your next question comes from the line of David Hilder with Bear Stearns.

Good morning, David.

Good morning, David.

Good morning, and I think Matt actually touched on the first part of my question.

I guess the second part would be just wondering how you arrived at the 2% GDP number, as the one to base your forecast around, because that would seem to be perhaps more optimistic than others, especially given the outlook for the first half of the year?

Well, we have a fellow here named Stuart Hoffman who has been named the economist of the year by the "Wall Street Journal" a number of times, as the most accurate forecaster, and that is his number.

So that is how we came to that number.

He can talk about that at great length.

And I think the other thing, too, is the GDP forecast isn't as critical.

You know, if our GDP growth was actually lower than that, my guess is our net interest income growth is going to be even stronger than what we expect it to be, there will probably be a little bit of an impact on fee income growth, and then separately you probably have a higher provision, but I still think in most environments we are still going to be able to deliver good earnings growth in the new year.

Thanks very much.

Next question, please?

Yes, your next question comes from the line of [Matt Boteen] with Highfields Capital.

Good morning, Matt.

Good morning, Matt.

Hi, it is actually John Jacobson, Highfields Capital.

Let me walk you guys through a few numbers, which may not be 100% accurate but sort of directionally correct, and then I want to ask the question.

So with PNC stock right now last sale, sort of $58, over the last year, stock is down roughly 20% from market capital, roughly 25 billion to a little under $20 billion today, $20 billion today.

At the same time, your 43 million shares of BlackRock have appreciated from $150 a share to $210, roughly 40% over that time period, so that's $6.5 billion investment at market a year ago is now worth over 9.

So sort of putting those two numbers together, the non-PNC part, the non-BlackRock part of PNC has declined in market value from roughly $18 billion a year ago, to just under 11 today, or something like 40%.

So here are the questions.

The first question is do you think that is appropriate, particularly given that you guys have done a much better job sort of managing your business than virtually all your competitors, #1.

And second question is, does this bother you as much as it bothers us?

And then I guess the punch line question is, do you think it is incumbent upon the management to sort of take actions to sort of rectify sort of this disconnect, and create value for shareholders?

Well, one, we certainly are disappointed in the valuation of PNC.

We think we have done a much better job than our peers in this environment.

And I think, so I agree with you on that and that is true whether it is corporately or personally.

So, you know, because we all are big investors in PNC, and we spend a lot of time managing the risk here, and we do agree that we have done a better job.

I think the issues that face the industry are also faced, face PNC as a financial services company, and although we have not been impacted by subprime and others, we are not immune to the fact that the entire industry's share price performance is down substantially, you know, across the industry.

As a matter of fact, I think our peer group was down 27% last year.

I think we were down 11 last year.

Excuse me just a moment.

John, are you still on?

I am.

Okay, because we are hearing from some place that the call went dead.

I just wanted to make sure we are still on.

No, I am still on.

Okay.

Thank you.

Thank you.

We are disappointed the share price has done better than our peers, but we are still disappointed in that as well.

So I think, you know, to answer your question, yes, we are disappointed.

And the third question?

The third question in terms of trying to do what we can to get the share price back I think communicating with our shareholders as best we can, in order to let them know how the franchise is operating, we have taken some actions on the risk side where the fourth quarter was disappointing, but frankly the year wasn't.

And I think when we look ahead to 2008, we can make statements about 2008 that I believe other people can't.

So I think that is important for us to keep working and keep delivering.

Okay, thanks.

Thank you.

Next question, please?

There are no further questions in the queue at this time.

All right.

Jim, do you have some closing--?

No, thank you very much for joining us this morning.

I think as we have mentioned, 2007 was a good year for PNC, not a great year.

We are looking forward to 2008 being better.

Thank you for joining us.

Thank you.

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

You may now disconnect.