PNC Financial Services Group Inc (PNC) 2008 Q2 法說會逐字稿

Good morning.

My name is Felicia 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 2008 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 conference over to the Director of Investor Relations, Mr.

Bill Callihan.

Sir, please go ahead.

Thank you and good morning.

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

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

The following statements contain forward-looking information.

Actual results and future events could differ, possibly materially, from those that we 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, and in our 10-K, 10-Q and various other SEC reports available on our corporate website.

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

We also provide details of reconciliation to GAAP and non-GAAP financial measures we may discuss in today's conference call in our earnings release, and financial supplement, in our presentation slides, appendix of this call, and various SEC reports and other documents.

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

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

Thank you, Bill, and good morning everyone and thank you for joining us today.

We are very pleased to be reporting what we believe is an excellent quarter for PNC, particularly in such a challenging environment.

Before Rick and I get into the details, let me start by saying that we've always believed that at some point in the future, every company will meet its balance sheet.

In recent years, you've been able to syndicate or sell all types of products and assets, but this hasn't come to pass.

Clearly, the recognition today is that past decisions eventually become apparent in the company's financial results.

We at PNC, we've always managed the company for the long-term.

Our focus has been on positioning our balance sheet, emphasizing risk adjusted returns.

We feel the results of these efforts are apparent in today's earnings performance and this gives us the strength to continue to invest in our businesses and growing our customer relationships, which is working very well.

During this call, Rick and I will review our second quarter earnings results and I will close by discussing our plans for growth.

We're changing the presentation a bit, and Rick will give you more detail about our balance sheet which I think is most appropriate in this environment.

This is a strong quarter financially for us and we're very pleased with our performance.

And we're optimistic about the rest of the year.

During the quarter, we continued to grow our business as evidenced by gains in customers along with average loans and deposits.

We posted strong year-over-year revenue growth, while managing expenses, resulting in positive operating leverage.

When we look at our balance sheet, we are uniquely liquid and we're very liquid with an excellent loan to deposit ratio and I think that will enable us to continue to support our customer growth.

Rick will review this in some detail.

Our asset quality, while it deteriorated as we had indicated before, it continues to reflect our disciplined approach and the results demonstrate that our portfolio remains manageable, even in this challenging environment.

Moving on to net interest income, as we had told you, we generated strong growth as our team had our balance sheet well-positioned to take advantage of the Federal Reserve rate reductions with high quality assets.

We also saw the resultant significant improvement in our net interest margin.

Capital, which is important in this environment -- we are also well-capitalized.

In spite of the fact that we closed our Sterling acquisition in April, we subsequently strengthened our Tier One capital position in the quarter through non-dilutive issuances and retained earnings and our Tier One is now over 8%.

Also, our trading results improved and at the same time we reduced our trading risk profile as well.

We reduced our commercial mortgage loans held for securitization by more than 20% in the quarter and reduced our proprietary trading position.

The current economy we believe is very difficult.

We actually have two economies.

We have some sectors such as technology, exporting, commodities, healthcare that are doing very well while banking, housing, automotive and related sectors are struggling.

We believe those struggles will continue for some time, and I think quite frankly, because we think we're in a slow growth environment, we can't predict the outcome, we'll remain focused on maintaining a moderate risk profile.

But we have strategies in place to grow PNC, driven by strong and experienced leadership team and we're pleased with what that's done for our second quarter results.

In this environment we recognize that there are opportunities to expand market share and enhance customer relationships, probably uniquely as I look forward, as I look into the past.

We've grown loan to deposits and we have aggressive plans to continue those trends.

Additionally, we're investing in our markets and our products and we believe that that will drive continued customer and revenue growth.

I'll have more color around our growth plans after Rick provides you with additional details about our balance sheet and our financial results.

Thank you, Jim, and good morning everyone.

As Jim indicated, this was a great quarter for PNC, as we reported $505 million of net income, or $1.45 of diluted earnings per share.

These earnings included an after tax gain on mark-to-market of our BlackRock LTIP shares obligation and integration costs primarily related to our Sterling acquisition.

Excluding these items, earnings per diluted share would have been $1.37, a very strong second quarter performance.

Now, here are my key messages.

First, our balance sheet was well-positioned for the Fed rate reductions, resulting in strong net interest income and revenue growth.

Second, while our asset quality continued to migrate and credit costs increased in the second quarter, the pace of this migration remained manageable.

And third, our capital position continued to strengthen from year end and we continued to maintain a strong liquidity position.

So despite a challenging market, PNC delivered strong results due to our business model and the quality of our balance sheet.

Now, let's start with my first key message.

Our liability sensitive balance sheet was well-positioned for the rapid decline in short-term rates resulting in a 70 basis point reduction in our overall cost of funds.

In addition to reducing our overnight borrowing rate by 85 basis points, we were able to make changes to our deposit pricing, reducing the overall deposit rate by 62 basis points, and at the same time, grow our average money market balances by more than $2 billion or an 8% increase on a linked quarter basis.

This resulted in very strong net interest income growth of $123 million or 14% on a linked quarter basis.

Most of this result is reflected in our other segment.

We do not expect to sustain this rate of growth.

However, based on our economic assumptions, we now expect full year net interest income growth will exceed 28% when compared to 2007.

Now, while we don't expect a Fed tightening in the short term, it is a risk we considered in our revenue growth guidance.

My second key message is about our asset quality.

As Jim mentioned earlier, sooner or later you will meet your balance sheet and we like the risk adjusted returns that our differentiated balance sheet has delivered.

As you can see on Slide 4 of our presentation, our total assets are $143 billion, and reflecting our moderate risk profile, only 51% of our assets are loans.

This ranks PNC among the lowest of our peers, which is exactly where you would want to be at this point in the credit cycle.

Before I go into our loan book, let me take a moment to describe the quality of of our other assets.

Our loans held for sale portfolio, which includes our commercial mortgage loans held for sale, represents only 2% of our balance sheet and is comprised of high quality assets.

In fact, we have only one small multi-family loan delinquency in our portfolio.

As the CMBS markets eased modestly, we reduced our inventory by approximately $500 million during the quarter, recognizing a gain of $21 million.

Our goal is to continue to reduce our positions throughout the year.

However, these are high quality assets with excellent yields.

So we will remain patient in our efforts to reduce this portfolio.

Our $31 billion securities book, which represents 22% of our balance sheet, is well-diversified across high quality residential mortgage, commercial mortgage, and asset backed securities.

We have no CDOs, CLOs, or SIVs in the portfolio.

Our focus has been to purchase relatively short dated, higher rated paper.

We have approximately $10 billion of agency backed holdings and our non agency holdings have high levels of subordination and substantially all are AAA rated.

In addition, we performed credit analysis on the underlying assets, including stress tests leveraging BlackRock solutions.

As swap rates increase during the quarter, we did experience further losses on the portfolio due to market liquidity.

However, permanent impairments have been minimal to date.

Our other assets of $27 billion includes equity investments including our investment in BlackRock, miscellaneous assets, goodwill, and other intangible assets.

As you would expect in this environment, we did see some modest impairments on our equity investments in the quarter, the largest of which was an impairment in our $100 million investment in GMAC.

However, across all our equity investments, we experienced only $30 million of impairments in the quarter -- again, a very manageable pace of asset impairment.

In the current environment, we recognize there is a great deal of concern about asset quality and loan portfolio performance.

Our adherence to a moderate risk profile has given us a portfolio that is performing well on a relative basis, even under these difficult market circumstances.

Our $30 billion consumer loan portfolio is high quality, and is producing strong returns.

Home equity is a relationship based book and we originated this nearly $14 billion portfolio with the intent to hold them on our balance sheet.

Nearly all of these loans are on our footprint and our strategy to not involve targeting the subprime market.

In the second quarter, net charge-offs were only 53 basis points, which I expect will be well below our peers, but I do expect this charge-off rate to increase modestly in the periods ahead.

As you can see, the 90 day delinquency rate of 44 basis points including non performing loans continued to be manageable.

Our $9 billion residential mortgage book is comprised mostly of seasoned jumbo loans with strong loan to value levels.

We purchased these loans for our overall balance sheet management purposes.

It offered us great spreads with relatively low risk.

The 90 day delinquency rate on this portfolio is 94 basis points.

Excluding non-performing loans, the delinquency rate was 39 basis points and the net chargeoffs were 1 basis point.

I expect these statistics will be well below our peers.

Other consumer loans included education loans, automobile lending and other consumer loans.

The primary risk here this the auto lending as auction values continue to decline in the used car market, impacting our ultimate recovery on repossessions.

Overall, net charge-offs in this portfolio were 63 basis points in the quarter, while 90 day delinquency rates including non performing loans were only 47 basis points.

This portfolio has had a minor impact on our total credit migration.

As you can see, the overall consumer book is performing well.

Now, moving to our commercial book, we have $43 billion in outstanding.

Of the $34 billion in commercial loans which include leased financing, nearly two-thirds are cash flow loans to middle market companies located mostly in our footprint.

This portfolio is diversified and has performed well to date.

Net chargeoffs in this portfolio were 73 basis points in the second quarter and we have seen only modest increases in NPAs.

Looking at commercial real estate, we have more than $7.4 billion excluding residential real estate development.

This book is diversified with no single project type greater than 18% and net charge-offs are only 78 basis points with relatively no non-performing assets.

Our area of stress is the $2.1 billion in residential real estate development which represents less than 2% of total assets.

These loans, the majority of which are in our footprint, are very granular and the average size of these outstandings is about $1.4 million per loan.

We believe this gives us greater flexibility in working through these credits at lower losses.

These loans are primarily located in Maryland, Virginia, Delaware, and New Jersey.

Charge-offs were 1.38% in the second quarter.

We have about $250 million in non-performing assets in this class which represents 35% of our total non-performing assets.

As expected, the pace of loans moving to non-performing status slowed between the first and the second quarter.

We do expect further growth in non-performing assets in this category.

Now, let's take a look at our overall charge-off and reserving trends.

Slide 5 shows our credit quality metrics on a consolidated basis.

In this difficult market, deterioration was to be expected given that these ratios were at historically low levels.

As you can see from the recent trends, our net charge-offs and reserve ratios have been manageable for us.

While net charge-offs have increased, they are among the lowest in the industry.

Of course, we will continue to monitor the situation as we do expect charge-off rates to increase.

However, we believe we are adequately reserved to cover these increases.

Our allowance to loans has increased to 1.35% this quarter, a significant increase versus the prior quarter.

We expect to continue to increase this coverage as the market and our credit quality migration dictates.

Overall we believe our moderate risk profile and our adequacy of our reserves differentiates our balance sheet from our peers.

As an aside, given the recent press on cross border leasing, I would like to remind you all that we are fully reserved and have substantially settled all our tax and accounting risk related to this activity.

Now, we're going to turn to our third key message our capital and liquidity positions.

We believe capital and liquidity are critical differentiators, and as you can see on slide 6, PNC has a strong liquidity position and a disciplined approach to capital management.

As I mentioned earlier, our balance sheet continues to be highly liquid by many measures and we continue to have ample unused borrowing capacity of nearly $27 billion as of June 30th, 2008.

And PNC has clearly improved its capital position during the first half of the year.

We are able to increase our dividend by 5% for the second quarter, closed on our Sterling acquisition in April which cost us approximately 35 basis points on our Tier One ratio, and still strengthened our Tier One capital position through successful non-dilutive issuances and retained earnings.

At 8.1%, we are well within our targeted Tier One capital range of 7.5% to 8.5%.

We continue -- we intend to continue to work to build capital flexibility to the higher end of this range to support our customers during this period of economic uncertainty.

Now let's take a look at earnings.

Our revenue mix is diverse and grew in double-digit territory both year-over-year and on a linked quarter basis.

I already covered our strong net interest income growth so let me focus on fee income.

Our fee based businesses accounted for 52% of total revenue and grew 10% linked quarter and 9% year-over-year.

Now, if you exclude the impact of the LTIP on bring gas station which was a $40 million increase in revenue, linked quarter growth in non interest income would have been 6%.

Let me highlight a few of these.

Fund servicing revenue grew 2.6% linked quarter, or 11% on an annualized basis, driven primarily by our emerging products and acquisitions of Albridge and Coates.

Our asset management revenues were down linked quarter due to the loss of revenue associated with Hilliard Lyons and lower equity market values.

Nevertheless, we had very strong sales in our wealth management business, particularly in new markets and growth from BlackRock.

Together, consumer service fees and service charges on deposits were down from the prior quarter.

Excluding $33 million of revenue related to Hilliard Lyons in the prior quarter, revenues were up 10% on a linked quarter basis, primarily due to increased debit card usage as a result of higher activation levels and the acceptance of our products and services in new markets.

Corporate service revenue increased 13% linked quarter, primarily due to strong results from commercial mortgage servicing and loan syndication fees and treasury management services.

Other non-interest income benefited from actions we took this quarter to mitigate risk.

Our trading revenues this quarter were $53 million, driven by strong performance in our client trading activities and reflecting our lower risk positions in the proprietary book, and the gains in our commercial mortgage origination business were a positive $21 million, reflecting improved markets and narrowing spreads, enabling approximately $500 million of securitizations which substantially offset the equity investment impairments I mentioned earlier.

As these revenues illustrate, I'm pleased with our product penetration with existing clients and those we're winning in our new markets.

Overall our revenue mix is producing very strong results.

As you can see on Slide 9, we created positive operating leverage on a year-to-date basis.

This has been accomplished with a 16% growth in revenue and a 9% growth in expenses.

The 9% growth in expenses is primarily driven by investing in growth opportunities, including our acquisitions.

Our success in growing revenues while continuing to manage expenses is reflected in our continuous improvement process.

We think having this as part of our culture is particularly important, given the current uncertainties about the economy.

Based on our economic assumptions as we look to the full year, we see higher revenue growth than previously expected driven by net interest income growth in excess of 28% which I mentioned earlier.

As a result, total revenue growth is now expected in the mid-teens on a year-over-year basis, and we expect non-interest expense growth in the mid-to-low single digits resulting in significant positive operating leverage.

Now, just to give you an example of how powerful this is, for each percentage point of operating leverage, PNC creates between $60 million to $70 million in annualized preprovision pretax earnings.

This operating leverage is important, given that we are increasing our full year provision guidance to $750 million.

Clearly, economic conditions are changing as we're seeing higher unemployment rates and slower economic growth.

However, we believe that increased operating leverage will be more than adequate to cover the increased credit costs for full year 2008.

We also expect our effective tax rate to remain at approximately 31% for the rest of 2008.

All in all, as we continue to execute on our business model, and aggressively manage and monitor our balance sheet, we believe we are in a position to deliver a solid second half.

With that, I'll turn it back to Jim.

Thank you, Rick.

To drive future growth, we've been investing in our markets and our product innovation.

And we're seeing strong growth in our 13 sales markets, with all of them meeting our exceeding sales goals for the first half of the year.

And by applying our PNC business model to our recent acquisitions, we're seeing very strong growth in our new markets.

In fact, greater Washington and greater Maryland markets are rapidly becoming our largest markets in terms of new sales, with greater Washington now ranked as first and greater Maryland as number four.

Let me give you a few examples.

Sales increases in greater Maryland helped drive organic net new customer growth.

Consumer new DDA account production and consumer loans are up sharply and that is a record for that market.

We're seeing strong gains in merchant services, in consumer loan sales, in wealth management in both the greater Maryland and greater Washington markets, and these are products that weren't resident in the prior companies that we acquired there.

Strong growth in greater Washington helped drive year-to-date PNC investments brokerage fees up 11% year-over-year.

And corporate banking is posting first half results with a -- record first half results with especially good fee-based product sales results in the greater Washington market.

During the second quarter we closed the largest ever treasury management sale to an existing account in the greater Washington area.

Throughout the footprint all of our markets, we're pleased with the growth that we're seeing in our money market deposits and our market gains.

Net new checking relationships grew by 23,000, more than four times higher than the 5,000 customers added in the same quarter last year.

Capital markets had a record quarter, due to strong client growth, particularly in interest rate derivatives and foreign exchange.

Clearly, we are growing customers in all of our markets and our objective is to continue to seize market opportunities, offering customers the full range of PNC's products and services.

Let me turn to product innovation, because we've continued to invest in our products.

We're launching products in the second half of the year that we believe are game changers in terms of acquiring and serving new customers.

We're looking to leverage our already strong position in university banking, and capture the newest generation entering the workforce, Generation Y, with a product that's built just for them.

It's called Virtual Wallet and the image on Slide 10 is from the website for this new product.

As you can see, this product represents a new way of banking for a new generation of customers.

Virtual Wallet is an online banking tool that provides on demand access to manage spending and saving in real time.

We integrated online bill pay, direct deposit, overdraft warnings, and a savings feature in one view, perfect for this tech-savvy generation.

We see great potential here.

In less than 10 years, Gen Y consumers will outnumber any other generation, and their incomes will surpass that of the Baby Boomers.

With 7 million Gen Y customers in our footprint, we see this as a tremendous opportunity to add and retain new customers, and new tech-savvy folks out there can actually go online and sign up for one of these accounts and we invite you to do that.

With ATMs across the country, we can continue to service you wherever you are.

On the corporate side, the next generation of our Healthcare Advantage product leverages our strengths in technology and our leadership in treasury management.

We have a unique capability today with this introduction and it enables -- this product helps enable hospitals and insurance companies to electronically manage more than 30 billion healthcare transactions that take place in the US every year.

Given the market opportunity, we see strong revenue growth potential for this product.

Turning to PFPC, we announced Monday that we changed the name of this business segment to PNC Global Investment Servicing.

This name better reflects frankly how this segment is changing from an information processor to an information provider.

And we're remarkably pleased with the fourth quarter acquisitions of Albridge Solutions and Coates Analytics.

Both acquisitions differentiate us and we're already seeing client growth.

As these examples indicate, we are investing in our businesses with a goal of growing our customer relationships.

These innovative products are designed to meet market needs and we believe these products, along with our execution in our recent acquisitions will enhance our future market positions, leading to strong future revenue growth.

As we look at the current marketplace, we recognize there are many variables in place such as energy cost, unemployment rates, declining housing prices and unprecedented market volatility.

But despite the challenges of this economy, which we think are significant, we posted strong quarterly results and we're focused on growing our business.

Our balance sheet is strong, as Rick reviewed, and our asset performance reflects our moderate risk profile, and we believe we are positioned to perform well in the second half.

In conclusion, our fundamental metrics speak for themselves.

Given the significant events we've seen throughout the financial sector, I'm very pleased to see how the PNC team has performed compared to others.

We have a solid foundation to continue to invest in and grow our franchise, and I'm confident that we have the leadership team and momentum and the initiatives in place to capitalize on the market opportunities to continue to create long-term value for our shareholders.

With that, we'd be pleased to take your questions.

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

(OPERATOR INSTRUCTIONS) We'll pause for just a moment to compile the Q&A roster.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Matt O'Connor with UBS.

Good morning.

Good morning, Matt.

Good morning, Matt.

You had a very nice increase in net interest margin this quarter.

I just wanted to dig a little deeper in terms of some of the drivers.

Was there any benefit from Sterling on the margin side?

Marginally, not a big impact.

Like a few basis points?

The biggest impact, as we stated, was in the borrowing costs coming down and the overnight borrowing costs coming down dramatically and then you had the effect of -- we specifically focused on rolling some CD balances off and getting those rates down and also being very aggressive on our money market pricing, and all of those together led to a significant reduction in funding cost.

Okay.

And then obviously on the asset side, the decline in trading book probably helped with the mix shift.

Actually, yes, that did help a little bit.

But again, that was pretty modest as well.

So is this a pretty good level for the NIM going forward?

Well, I think eventually we expect the Fed to make a move.

We don't think it's going to happen this year.

But I think when the Fed does start to increase rates, I think obviously that could put some pressure on the margin.

I think as we roll our securities portfolio off and that reprices, that could put some pressure on the margin.

But at the same time, I think spreads are very good today.

We're going to continue to try to grow our loans and our deposit balances organically and some of that activity can offset whatever pressure those two other factors may put on it.

But I think based on our forecast this year, it's -- I think for the remainder of this year, it would be flat to down, slightly down.

Okay.

And then separately with respect to capital, obviously your tangible common does not include a full value of BlackRock there, and it slipped a little bit this quarter because of the goodwill and I think the OCI.

Is there an absolute level of tangible common that would just be too low or how -- should we just add the unrealized gains from the BlackRock to the 4.4% or how is that viewed from a rating agency?

I don't think there's an absolute number.

I think we're very comfortable with the risk profile, the balance sheet of the company, which I think allows us to feel really good about our risk based capital position and our Tier One ratio being the primary ratio that we drive the company by.

So I think with the current position of the capital as well as the unrealized gain of BlackRock, we're very comfortable with where we are today.

Okay.

Thank you very much.

Next question, please.

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

Good morning, Mike.

Good morning, Mike.

Good morning.

So for your outlook, you expect higher revenue growth.

Is that mostly reflecting the impact of this quarter?

And when you think about that, do you include the CMBS gain, the trading gain, the BlackRock LTIP, and just if I heard you correctly, so you expect to increase in revenues for the last two quarters to exceed the $150 million in additional provision?

And if so, I mean, by like $10 million?

By $100 million?

Should we go out there and increase our estimates?

First of all, we always take the LTIP number out of the -- plus or minus off of the fee income because we get -- that's unrelated to the business.

But when we look at the growth of revenue going forward, I think Rick was very specific in saying we consider net interest income growth year-over-year at 28% or more.

And we're comfortable with that number for the rest of the year.

And when you strip away the various sundry items in the fee income business, the fee income grew 6%, and we see customer flows that will make us feel comfortable about that number or more going forward.

We think revenue growth is going to be strong for the rest of the year.

Are you guiding higher or are you basically saying the increase in provision expense will be safely covered by the additional operating leverage in revenues?

I'm saying that the increase in operating leverage will be higher than the increased cost on the provision.

Yes.

A lot higher or a little higher or -- ?

Gave you all the percentages.

And I guess book value went down linked quarter.

Is that just due to the higher unrealized security losses and the goodwill from Sterling?

Yes, that was primarily the fact that the AOCI, the mark on the AFS portfolio increased about $400 million in the course of the quarter because swap rates went out about 100 basis points, so that's basically what drove that down.

How much did Sterling add in the second quarter to both revenues and expenses so we can kind of look at a core growth rate?

We'll get that for you, but it wasn't -- I wouldn't have -- would not have been a big number in the -- would not have been a big number in the fee income line.

It did not have a lot of fee income businesses and we'll come up with the NII impact but it was not a significant impact on the quarter-to-quarter change.

Last question.

To the extent that you're guiding higher for loan loss expenses, what's your outlook for NPAs?

NPAs will go up.

I think the pace of NPAs will look a lot more like the growth we saw from the first to the second quarter.

What was that again?

About $100 million.

Okay.

All right.

Thank you.

Which is a slower growth rate than we have seen in the fourth to the first.

All right.

Thank you.

Thank you.

Next question, please.

Your next question comes from the line of Collyn Gilbert with Stifel Nicolaus.

Good morning.

Good morning, guys.

Just a question on the residential real estate portfolio.

Can you talk a little bit about the trends that you're seeing there, maybe some of the severity rates and sort of how you're looking to manage that portfolio in terms of loss recognition versus taking some of the projects into REO?

Well, we -- that's a very small portfolio relative to the total balance sheet.

I think we're one of the smallest banks in terms of residential real estate in the industry.

But nonetheless, we do see migration in the residential real estate business.

Mostly in the Mid-Atlantic states where 75% of it is located.

We only have $250 million of total residential real estate outside of that region and so we -- the average non performers, about $1.4 million.

We're very comfortable we can manage those.

It's a lot easier to manage that size of project than it is these larger mega projects that you see in some of the other states.

It was mostly customer business, not the least of which was driven by the Mercantile acquisition.

But the credit quality there is I think -- while deteriorating, it's not as bad as it is in other parts of the country.

When you talk about the migration of NPAs going higher, is there any one sector that has you concerned?

I mean, it sounds like you're saying that the consumer portfolio is holding in fairly well.

As you're looking at anticipating higher non-performing assets, anything other than the general slowdown in the economy is going to drive that?

Residential real estate, there's no question when you look at the residential real estate business over many, many years and many cycles, you have -- you'll have housing prices bottoming out well after foreclosures peak.

Foreclosures haven't peaked as yet and housing prices are continuing to decline.

I think the residential real estate business on a national basis is clearly as bad as it's ever been.

So when we look at the Mid-Atlantic states, we don't have quite the issue that we have in other markets around the country, but I think you're going to continue to see softness in those markets.

Okay.

And then I may be bold in asking this question, but could you just talk about your appetite or outlook.

I don't know if you said this in your initial comments but about future acquisitions or future M&A?

Well, our best acquisition strategy right now is to acquire new customers.

It's working extraordinarily well in each and every one of our markets as I mentioned.

Every one of our markets is above their sales goal for the year, and it's really been gratifying to see how the teams in the various markets have been able to execute, selling and cross selling various PNC products to new and existing customers.

So that's the biggest and best opportunity for us going forward.

With regards to other acquisitions, I think we're pleased with the ones that we have under our belt that we're executing on those.

I think we just would have to be optimistic, opportunistic in terms of any other acquisitions.

We've been pleased and successful with the ones we've had but the market, I think if you look at the residential real estate market and the economy, quite frankly, it's -- we're going to have a slow economy for a time period, so I think we'll just have to be opportunistic on that.

Okay.

Great.

Thanks very much.

Next question, please.

(OPERATOR INSTRUCTIONS) We'll pause for just a moment to compile the Q& A roster.

Your next question comes from the line of Fred [Graham] with Admiral Capital.

Good morning.

Good morning, Fred.

Good morning, thank you for taking the call.

This is a question related to a subsidiary of yours, PFPC.

I know it's a very small piece of your business, but I'm kind of trying to understand the trend, the possible trend or the movement in subaccounting as it relates to mutual fund client based accounting.

I'm wondering if you can discuss the trend and if you're possibly going to take market share in that space and just from an industry perspective, if you think that that's going to change.

We are clearly the market share leader in subaccounting.

The numbers are honing in on 100%.

So we really like that business.

We have the -- it's not 100%.

We have our lawyer here whining.

But we have a very high market share in the subaccounting business.

Our technology has been extraordinarily successful.

As you see the migration from traditional transfer agency to subaccounting, we're very pleased with that, right in the sweet spot.

PFPC, now PNC Global Investment Services, has a very strong position in subaccounting and we like the migration, actually.

On a linked quarter basis, part of the lift in the revenue there is that we did have several new conversions and new clients.

So again, continuing to add to our market share.

Okay.

Great.

I appreciate that.

Thank you.

Thank you.

Next question, please.

Your next question comes from the line of Collyn Gilbert with Stifel Nicolaus.

Good morning.

Hey, guys.

I guess I'm going to manipulate the call here a little bit.

Just a follow-up on -- in terms of how you look at the impairments.

I think this is a question that every bank is getting.

In terms of determining when something is permanently impaired versus temporary and how you're looking at that within your portfolio.

You're referring to the available for sale in particular?

Yes, yes.

Well, we -- obviously, there's a lot of market liquidity out there.

When we think of permanent impairment, we have to actually see that there's a real credit deterioration in the underlying assets involved in that particular portfolio.

One of the things we go through with BlackRock Solutions' assistance is a very detailed and rigorous stress testing on the underlying assets within that portfolio.

And to the extent that we see that there's some deterioration, we don't believe we'll recover, then we will take a permanent impairment.

I would say that on that entire portfolio to date, we have only taken $15 million worth of impairments.

That's how high quality and careful the individuals were in purchasing this portfolio originally, and we feel that that's not a very big impairment on a portfolio of $30 billion.

Not at all.

Okay.

Great.

Thanks.

Next question, please.

Your next question comes from the line of Betsy Graseck with Morgan Stanley.

Hey, Betsy.

Good morning, Betsy.

Hi, how are you?

That was my question.

Just a follow-on on net interest [margin], if you don't mind.

Could you just speak to where you think you are with regard to deposits and deposit pricing in your area and the degree to which you still have room there on the liability side?

Betsy, I think you're well-aware that we've been less aggressive on the CD side because we don't necessarily see that as a relationship product as much as a rate product.

But on the money market side, we're positioning ourselves at the moment to pay aggressively on both the east side and the west side of our franchise.

We believe in this environment, garnering more money market deposits and growing that balance is going to be a big help to us as we look forward into '09 and '10.

Okay.

So that's where you're going to be spending money is in the money market funds?

Yes.

Absolutely.

That's correct.

Okay.

Thanks.

Our next question, please.

Your next question comes from the line of Nick Elfner with Wellington Management.

Hello, Nick.

Hi, how are you?

Couple questions.

I guess in a general statement, where are you seeing market share gains?

I'm kind of wondering, at the expense of whom?

We've seen some pretty impressive revenue numbers from some of the big banks.

I'm wondering if you're seeing pullbacks in various business lines from the community banks, and perhaps the more capital constrained smaller competitors.

Actually we're seeing it across the board and it's across the footprint.

As I mentioned, each one of our markets is over plan on their sales goal which is surprising, actually.

That doesn't happen all the time.

And we have different banks, obviously in different parts of the franchise that we compete with.

So I would say that we've been successful across the board.

Just to give you an example, I got two e-mails this morning with five new customers and they were from four different banks.

So I was pleased to see that we weren't favoring any one bank.

Great.

That's great.

Maybe just on capital, do you have any remaining hybrid or trust preferred capacity and are you concerned at all, potentially, about the goodwill and in terms of impairment?

I know that the test isn't very onerous, but any comments on that would be great.

Terrific.

We will create more capacity as we go to the end of the year, as we generate earnings and put aside retained earnings, that creates more capacity for hybrid and preferred stock issuances.

So we'll continue to look at that.

At the moment, we don't see any need to issue either, but we will have more capacity as the year progresses.

As far as goodwill, we see no risk whatsoever of goodwill impairments.

And do you have any view on the FAS 140 impact potentially on your capital ratios?

I'm not sure how much potential consolidation risk there is for you.

Yes, I mean, we have clearly the risk that our market street conduit could be consolidated as a result of that, but the impact on our Tier One capital ratio of consolidating that is less than 10 basis points.

So while there is a risk, it's not something that we worry about.

And finally, did you take any marks on any of your CMBS positions this quarter, anything prospectively you could share on that?

Well, we recognized a gain of $21 million because we actually when the commercial mortgage market got down to about -- I think it moved about 60 basis points in from where it was at the end of March, we were able to do two securitizations at that point.

But I will tell you that spreads have widened back out to where they were as of June 30th, back to where they were at March 31.

Thanks very much.

Next question, please.

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

Hello, Ed.

Good morning, guys.

Great quarter.

My question is kind of very specific.

It has to do with mortgage servicing rights.

Am I correct that you wrote down your mortgage servicing rights a little bit in the quarter, and if so, could you describe what the thought process was there?

No, we did not, Ed.

Where would you have gotten that from?

Actually it was e-mailed to me so I would --

No, we did not write them down.

Obviously there's a natural process of mortgage servicing right amortization that we go through all the time.

Did you write them up appreciably or did you sort of keep the valuation fairly constant from where it was last quarter?

Maybe a better question is what did you do with your mortgage servicing rights valuation?

No real change in the overall, but the amortization obviously takes place.

And since we haven't added a lot of new securitizations under the portfolio, you would expect the balances to come down a little bit as we amortize where we are because there's simply not a lot of new servicing assets coming on-board at the moment.

There's not as much volatility there as you know as in the retail business, given that there's very heavy seven year prepayment penalty.

Do you see any kind of noticeable slowdown in prepayment speed that would cause you to potentially write up your MSRs relative to where they had been previously?

No, we don't record them at fair value, so we would never write them up.

But what we did see was there was a slight extension, which means that in this quarter you did have a slight slowdown in the MSR amortization, but not material.

Okay.

Thank you.

All right.

Operator, want to poll our group for any last questions?

Hello?

There are no further questions at this time.

Okay.

Thank you for joining us this morning.

Thank you.

Thank you.

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

You may now disconnect.