PNC Financial Services Group Inc (PNC) 2008 Q3 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the PNC Financial Services Group third 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 call over to the Director of Investor Relations, Mr.

Bill Callihan.

Sir, please go ahead.

Thank you, operator, and good morning, everyone.

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

Participating on this call will be 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, included in those described in today's conference call, in today's press release, and related material, and in our 10-K, 10-Q, and various other SEC reports available on our corporate Web site.

These statements speak only of October 16, 2008, and PNC undertakes no obligation to update them.

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

These all available on our corporate Web site, www.pnc.com, in the Investor Relations section.

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

Thank you, Bill.

Good morning, and thank you for joining us today.

The environment we are facing today is clearly as volatile and as extreme as I have seen.

In the space of a few weeks, the financial services industry has been completely transformed.

Several large investment banks are gone, and the pendulum is now swung back to traditional banking as the business model for stability in this industry.

I think that was recently confirmed by the extraordinary government intervention and support of the banks.

In wake of these changes, financial companies are being liquidated, consolidated, merged, and the governments worldwide are taking extraordinary measures to stabilize these economies.

In short, every financial services company is meeting its balance sheet.

And the quality of that balance sheet is determining the future of many companies.

Many consumers have lost confidence and the ramifications are extraordinary.

We support the efforts of the Treasury to stabilize and restore confidence in the financial industry, and PNC is currently evaluating the Treasury initiative and as we get full details we will review it with our board.

Overall, we are seeing renewed respect for the importance of the fundamentals, balance sheet strength, solid capital and liquidity position, and a focus on customers and that is where PNC has been all along.

We continue to take the long view, investing in products and markets where we see opportunities for growth.

Now during a time of great uncertainty, PNC, we believe, has posted solid results, reflecting the performance of our core business activities.

Now let me go through those core items for you.

Our net interest income grew 31% compared to the same period last year as very much in line with the full-year guidance that we provided.

Our Treasury team had our balance sheet well positioned from a credit and an interest rate perspective.

Moving on secondly to credit quality.

This reflects our moderate risk profile and our third-quarter results were well within the parameters we projected last quarter.

For example, our third-quarter total net charge-offs, which were marginally above our second-quarter results, should continue to be among the best in the industry.

And as you've come to expect, our expenses were well managed in the quarter.

As we told you in September, we expect market volatility to affect several non-interest income items in the quarter.

The impact of this volatility affected corporations such as Fannie Mae and Freddie Mac and other valuations in our portfolio.

On valuation side, we had some valuation changes for our commercial mortgage loans held for sale.

These valuation adjustments did not represent credit quality concerns with the underlying assets as the credit quality remains excellent.

BlackRock's share price was up linked quarter increasing the quarterly valuation of our LTIP obligations.

Reflecting volatility on the corporate side, we took some other than temporary impairment charges in the quarter, primarily related to the ownership of Fannie and Freddie's preferred stock, but we also had losses in our trading position.

Rick will discuss these in more detail in just a moment.

Moving to our businesses, PNC added 36,000 net new consumer and business checking relationships through organic growth during the third quarter, a 160% increase over the growth in the second quarter reflecting a flight to quality.

Virtual Wallet, our banking product designed for Gen Y customers helped drive that account growth.

We started marketing this online banking tool in early August and generated 15,000 accounts by the end of September.

These are high-quality accounts with deposit balances that are nearly 20% higher than we expected.

Retail Banking also saw strong growth in consumer loans and transaction deposits compared to the same period a year ago.

When we look at our Corporate and Institutional banking segment, we also saw significant growth in the quarter as more large corporate, middle market and municipal customers are turning to us for a banking relationship that includes credit and fee-based products and services.

While softness in the real estate market remains, we are showing very good returns on our new customer relationships and spreads are better, and we continue to allocate capital based upon risk-adjusted return opportunities.

And our third business, the servicing revenue in global investment services was up compared to the same period last year.

Now despite experiencing outflow of funds due to the dislocation in the global equity markets, we saw net new customer growth in the third quarter as a result of our acquisitions of Albridge Solutions and Coates Analytics and the pipeline for new customers is strong.

Now in this very volatile market, we are pleased with the performance of our balance sheet from an interest rate and a credit quality point of view.

Our expense management remains strong for the quarter and our strategic focus on maintaining a moderate risk profile continued to serve us well.

Now Rick will provide you with additional insights about our financial results, with particular focus on the quality of our balance sheet.

Rick?

Thanks, Jim.

And good morning, everyone.

PNC generated solid results in the third quarter, particularly considering the current economic environment.

Our results were characterized by strong net interest income growth, solid fee income performance, disciplined expense management, and manageable credit cost migration.

However, as we explained in the 8-K we filed in September, our results were also affected by the BlackRock LTIP loss of $51 million, $82 million of valuation adjustments related to market dislocation on commercial mortgage loans, and net security losses driven by our $80 million investment in Fannie Mae and Freddie Mac preferred stock.

In addition, we recorded a $44 million charge of other than temporary impairment losses in the quarter which should have been recorded in the second quarter.

As a result, PNC reported $248 million net income, or $.71 of diluted earnings per share for the quarter.

While these results are below our quarterly expectations, we still remain comfortable with our full-year guidance.

And that is my first key message for today.

My second message, we continue to maintain strong capital and liquidity positions.

And third, our moderate risk profile has provided us with a differentiated balance sheet resulting in high-quality securities portfolio and manageable risk from our credit books.

Now let's take a look about the second key message, as capital and liquidity are critical differentiators in these tumultuous times.

Our disciplined approach to capital management has resulted in a Tier 1 capital ratio of 8.2%.

We intend to continue to work to build capital flexibility to maintain earnings growth, to provide the support our customers need during this period of uncertainty.

However, we are also evaluating the government program and will consider this as another potential source of further capital strength.

We also take a very proactive approach to liquidity management.

We regularly stress test our liquidity forecast for extreme market events beyond the current environment and for funding contingencies such as our outstanding commitments, our conduit and our [VRDN] programs.

We remain comfortable that our liquidity forecasts are more than adequate under these stress scenarios.

Further to my point, government actions continue to provide additional sources to our liquidity position.

Let's turn to Slide 5 and talk about our differentiated balance sheet.

In the current environment, balance sheet strength is critical to the long-term management of capital and liquidity and PNC's balance sheet is strong and well diversified.

We have grown our noninterest bearing and interest-bearing deposits.

In fact, total deposits grew 8% year-over-year.

In addition to acquisitions, much of this growth was a result of a flight to quality and we were not under as much pricing pressure as many of our peers.

In our Retail segment, we have seen core growth and demand in money market deposits, partially offset by lower CD deposits reflecting our focus on relationship customers.

We also saw loan growth of 14% year-over-year with less access to the capital markets, more companies are looking to banks to meet their needs.

We are seeing higher utilization rates by some of our existing Commercial customers.

Further, we have had opportunities to grow new customers as we have had the products and capital flexibility to respond to opportunities that meet our moderate risk profile.

Now let's take a look at our securities portfolio.

As shown on slide 6, our $31 billion securities available for sale portfolio represented 21% of our balance sheet at September 30.

And this is a high-quality portfolio.

First of all, $12 billion of the securities are agency-backed.

Second, 95% of the non-agency securities are AAA-rated with 98% greater than single A, all with relatively high levels of subordination.

And third, the remainder of the portfolio is granular and well diversified.

While the net unrealized losses of this portfolio have decreased from $2 billion to $3.6 million in the third quarter.

This increase was primarily driven by market liquidity factors and was not representative of credit quality concerns on the underlying assets.

In addition, the expected weighted average life of these fixed income securities was 4.7 years at quarter end which we believe is one of the shortest in the industry.

Clearly, we have the liquidity to be patient as these short-dated assets pulled apart and we recapture the market valuations.

However, as you would expect, we did take some charges during the quarter related to this portfolio, the most significant being a $74 million charge related to our ownership of $80 million of Fannie and Freddie preferred stock reported in net security losses.

Now turning to other balance sheet assets.

Our loans held for sale represents 1% of our balance sheet and declined 36% year-over-year.

As you know, the securitization market was essentially frozen in the third quarter.

Despite the lingering softness, our goal is to continue to reduce our position.

In fact, we reduced our inventory by approximately $90 million during the quarter due to individual loan sales; however, we did incur $82 million of valuation losses this quarter in this category due to market illiquidity.

Overall, this portfolio is comprised of high-quality assets and the largest portion of this portfolio is $1.5 billion of commercial mortgage loans with less than $15 million of delinquencies.

Other assets of $30 billion includes our investment in BlackRock and other equity investments, trading positions, good will and other intangible assets.

We did have some valuation impairments to our equity investments in the quarter, the largest of which was the additional other than temporary impairment of $30 million to our investment in GMAC and $23 million of mark-to-market adjustments in our private equity portfolio.

In addition, we reported $54 million of trading losses during the quarter driven primarily by significant widening of credit spreads in extremely illiquid markets.

As we have been doing all year, we continued and we will continue to reduce our risk in this portfolio.

Now let's look at our credit portfolio and our overall charge-off and reserve trends.

Now slide 7 shows our credit quality metrics on a consolidated basis.

Our loans make up only 52% of our balance sheet at quarter end.

So relative to our peers we have fewer credit assets overall and the performance of these assets on a relative basis has been better than most.

In these challenging markets, deterioration was to be expected.

In the third quarter, with we saw a manageable migration of $142 million in assets to nonperforming status.

As you can see from the recent trends, our net charge-offs of 66 basis points continue to be relatively stable and should be among the lowest in the industry.

And the allowance to loans ratio continue to increase to 1.4% representing another form of capital in this challenging period.

On the Commercial side, our residential real estate development loans continue to be the concentration of our Commercial credit deterioration.

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

This $1.8 billion portfolio represent less than 2% of our total assets, and the average size of these outstandings is about $1.4 million per loan.

We believe this gives us greater flexibility in dealing with these credits during this difficult market.

However, we do expect further growth in nonperforming assets and charge-offs in this category for the foreseeable future.

On the consumer side, our largest position is in home equity loans.

This nearly $15 billion portfolio is comprised of 39% first lien positions and the rest are second-lien positions.

Both portions are performing well at this stage in the cycle.

Nearly all of these loans are in our footprint and our strategy did not involve targeting the sub-prime market.

In the third quarter, net charge-offs on our home equity portfolio were 58 basis points compared to 53 basis points in the second quarter.

I expect this to be significantly below our piers, but I do expect it to increase modestly in the days ahead.

However, the 90-day delinquency rate of 46 basis points remained flat compared to the second quarter.

Overall, our credit trends remain manageable and our loan portfolio continue to perform well in this difficult market.

We believe our moderate risk profile and the adequacy of our reserves differentiated our balance sheet from our peers.

Looking ahead, we continue to see our full-year provision to be around $750 million with the outcome largely dependent on the strength and weakness of the U.S.

economy.

I hope you get the sense that our long-term approach to business and our moderate risk profile is delivering a balance sheet for all economies.

Now I would like to turn to our diverse high-quality revenue streams, another reason we are succeeding in this challenging environment.

One of PNC's differentiating strengths is the diversity of our revenue streams.

For example, we generated 49% of our revenues from noninterest income and over 80% of our year-to-date revenue from noninterest income and deposits.

As a result, and despite the isolated revenue volatility due to the illiquid markets, we have seen our year-to-date total revenue grow 9% compared to the same period last year.

Now turning to the drivers of revenue, our liability sensitive balance sheet was well-positioned for the rapid decline in short-term rates that took place earlier in the year and reduced our overall cost to funds resulting in strong net interest income growth of 31% compared to the same quarter last year.

Net interest income also increased 2% on a linked quarter basis.

Looking at our noninterest income, two revenue streams you would expect to be affected most by current market volatility were fund servicing and asset management.

Now despite these challenges, fund servicing revenue was essentially flat linked quarter and grew 12% compared to the same period last year driven primarily by growth from existing global investment servicing clients and new business from our emerging products.

Our asset management revenues were down linked quarter and year-over-year due to lower asset values in the broader markets.

Nevertheless, we continue to have strong sales in our wealth management business and a tremendous number of referrals through our branch distribution network.

Clearly, asset valuation and outflows will put pressure on these revenues streams, however, our focus remains on deepening client relationships and developing products to create long-term value.

Together consumer service fees and service charges on deposits were up 4% from the linked quarter 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.

Year-over-year revenues were down due to the impact of the Hilliard Lyons sale.

Corporate service revenue increased 7% linked quarter primarily due to higher merger and acquisition advisory fees offset by lower capital market revenues from fixed income derivatives and loan syndications.

Our other noninterest income was affected by losses mentioned earlier.

Approximately $285 million due to the BlackRock LTIP shares adjustment, commercial mortgage loans held for sale, valuation, net security losses, and trading and equity management losses, partially offset by $61 million reversal of a legal contingency reserve that resulted from settlement.

Overall, we are pleased with growth of our fee-based businesses and we see opportunities for further growth through our investments in new products and markets.

On slide 9, you can see we created positive operating leverage on a year-to-date basis through a 9% growth in revenue and a 7% increase in expenses, primarily driven by investing in new products, new markets, including acquisitions.

Based on our economic assumptions as we look to the full year, we expect full-year total revenue growth to exceed 10% on a year-over-year basis.

We still expect noninterest expense growth will remain in the low to mid-single-digits resulting in significant positive operating leverage, more than enough to cover the increased cost of credit.

We also expect our effective tax rate to be approximately 32% for the full year.

Now all in all, we believe our business model, which focuses on the long term, has continued to serve us well.

Our full-year guidance has not changed.

Our capital and liquidity positions are strong.

Our balance sheet is well-positioned.

And credit quality migration continued to be manageable reflecting our moderate risk profile.

We believe this strategic focus positions us to deliver a very solid year.

With that, I will turn it back to Jim.

Thank you, Rick.

We believe this was a good quarter for PNC during an extremely volatile time for the financial services industry, and I am particularly pleased with the results of our core business activities.

We posted strong mid-interest income growth.

Our asset quality remained manageable in a very challenging market.

Our capital and liquidity positions remained strong.

And many of our fee businesses did well, growing clients and revenues.

But clearly, market volatility affected some of our fair value assets.

Overall, we remain focused on the long term and it is working for us.

We are investing in products, retaining and increasing our customer relationships, and developing markets where we see opportunities for growth.

Our fundamental approach is emphasized balance sheet strength, expense management and a moderate risk profile.

This business model focused on the long term has served us well and we believe we have the momentum and the initiatives in place to capitalize on market opportunities and to continue to create value for our shareholders.

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

Operator, could you give our participants instructions, please?

Yes.

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Ed Najarian of Merrill Lynch.

Good morning, Ed.

Good morning, Ed.

Good morning, guys.

How are you all doing today?

Good.

Good.

I guess my question relates to equity and capital raising.

You know, bigger unrealized loss in the bond portfolio now took the tangible ratio down under 4%.

You did sort of allude to the fact that you might access the government preferred equity plan.

Can you give us maybe a little more color on what your thoughts are with respect to capital raising?

First off, if the government plan is preferable to doing some kind of maybe private common raising, and then, approximately, what your thoughts are in terms of how much capital raising you might consider?

First off, we are pleased with where our capital position is today with the Tier 1 ratio being over 8.

We are very comfortable.

We think that the capital position that we have today, given the quality of the balance sheet, is fine.

So we are pleased with that.

I think that the balance sheet quality is the -- is the key issue there.

Clearly, we are in difficult times, and I think raising capital is something that a number of people have done, and they have increased their capital position based upon the quality of their balance sheets.

And so I think that environment might say that raising more capital is probably not a bad idea.

The government program, I think, they have done an awful lot of work in order to provide an opportunity to raise what appears to be relatively inexpensive capital.

There are a number of things -- some of the issues are still coming out, as a matter of fact -- we were talking about it last night -- some -- still drafting some of the particulars of how it would actually work.

And I think those particulars we are trying to gather as quickly as we can.

And, you know, we have got to discuss them with our Board before we would -- before we would make any decision on that.

But we think it is an, obviously, a very attractive plan they have put together and we are considering it very seriously.

And to add too that, Ed, the tangible common equity ratio you mentioned at 3.6%.

And I think I took you through the quality of that securities portfolio because it is that one item that's causing it and it's a very high-quality book.

If you remove that, Ed, we would be well over 5%.

So it sounds like then from a capital raising perspective, that you are comfortable where -- let me say it a different way.

You are comfortable that taking a Tier 1 ratio up with a form of, say, preferred equity that would not positively impact tangible common (inaudible) is perhaps the best way to proceed?

You know, Ed, we are evaluating all those choices at the moment, and I think it would be inappropriate to go into details on that right now.

Okay.

Thank you very much.

We are comfortable, however, as Rick said in his presentation, that with the quality of those securities and the securities board just over a moderate time they do pull the par.

So the credit quality is quite extraordinary there.

Okay.

Next question, please

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

Good morning, Matt.

Many think we will get a wave of bank M & A, in part because of the environment orient as well as the Treasury infusion of capital.

If you can give us an update on where PNC fits in on this?

I am not sure I agree with that.

There is a fair amount of speculation.

I think the one -- the thing that hasn't been addressed and can't really be addressed by the government is the fact that housing prices continue to decline.

The fact that housing prices continue to decline, I think most of the estimates I have seen, they think it will go down another 10% to 15%.

Those are government estimates.

You know, those issues quite frankly will mean there will be more losses in the portfolios.

We also are seeing a rising unemployment.

The government estimates are that unemployment numbers will rise from 6% to 7.5% early next year.

Those kinds of issues will tell you that the consumer credit, whether it be credit cards or others will continue to deteriorate as well as -- as well as housing prices.

So I think in terms of acquisitions, you have got to be as careful as you have ever been in terms of acquiring someone else's balance sheets.

So I am not certain that the -- that the capital opportunity will cause a great deal of M&A activity.

Okay.

I guess specifically in the media, PNC has been linked to speaking with National Citi about a combination.

Any comments you can provide on that?

I don't think we can make any comment on a particular rumor.

We don't comment on rumors.

Okay, maybe just bigger picture based on your earlier comments about the credit environment, I would think you wouldn't be open to taking on a lot of risks, but we have seen some Fed-assisted deals that -- there is obviously opportunity to offload riskier assets.

How do you weigh distracting yourself what you have been able to accomplish organically in recent quarters with some of the opportunities that might provide?

Well, let me first say that the business opportunity of running the business is probably never been as good in my career.

The -- the demand deposit growth.

We are actually being very judicious in terms of looking at risk adjusted returns on capital on the corporate and institutional side.

We have got opportunities there that -- you know that backlog -- I am not saying it is endless, but we have got an awful lot of opportunities there and that is without touching the municipal business which is going to be -- which continues to just have enormous opportunities.

The opportunities to just run the business.

I mentioned about the 36,000 new accounts -- the Virtual Wallet opportunity.

That is our first and foremost opportunity.

Acquisitions -- and I think I was -- I have been quoted that you got to be very careful.

You don't want to catch a falling knife.

To take on someone else's balance sheet that has a great deal of risk on it, you just have to frankly be awfully comfortable that you can manage that risk, and that's not easily done.

Government transactions, those are all -- you have to look at those one at a time, because they are -- we look at the recent past.

They take so many different -- so many different forms and you just have to look at them one at a time.

I think, just in terms of the M&A space, I think we just -- the old-fashioned way to acquire customers is the best way, and if there would be a unique opportunity where we could understand how we could manage the risk we would consider it.

But we will be very careful in that space.

Okay.

Fair enough, thank you.

Good question, thank you.

Next question, please.

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

Good morning, Mike.

Good morning, Mike.

I guess you have $41 billion of commercial loans or $31 billion of that which is not real estate related.

Still everything is generally fine, though the non-accruals went up some.

Can you comment on your exposure to retailers and kind of what's moving up on your watch list or what you are concerned about?

Because as the rest of the economy gets weaker, is it inevitable that we see a lot more problems in the commercial portfolio?

Thanks.

I think -- I think we -- we are pretty concerned about the retail -- the retail market, but the good -- the good news is that the places you have to be most concerned, I think, are the consumer -- the consumer debt and we are very small in that space.

As you know our credit card business is extremely small.

And quite frankly, we -- our number one key item on the consumer side is our home equity portfolio and that is performed as Rick pointed out extremely well.

So the consumer play, the consumer play, I think, is the place that will be most difficult next year, automobile credit as well, especially with a loss of -- of AIG who was a big guarantor of leasing residuals.

I think -- and we are out of the automobile leasing business.

I think that is the place that is most difficult.

Rick, do you have --

Yes.

I was just going to say less than 20% of our commercial real estate exposure is in retail.

It is about 17% of the total.

You are right.

We are watching that very carefully.

We are watching lodging, hotels and those kind of areas.

Those are what we expect to have some stress as we move forward and also office space.

We are keeping a close eye on each one of them.

But right now we are feeling pretty comfortable at what pace they are migrating.

I guess a related question.

Maybe this is either good news or bad news, you tell me, you don't have a whole lot of reported loan growth.

I know there are a lot of ins and outs there.

Some might say -- Wells Fargo might say, hey, you need to get loan growth in an environment like this.

Spreads are a lot better, but if you are extremely cautious on credit you say you don't want loan growth.

Can you just explain why your loans are not growing more or whether you want them to grow less?

Well, our loans grew fairly well on a year-to-year basis.

But I tell you we are really still using the risk adjusted return on capital versus other opportunities.

We have been on a number of relationships taken market share in a number our markets.

If you take a look at our markets, every single market we are in is over plan on sales and we will almost -- I'm not certain this will be true, but we are very close to having every market over plan in every business segment.

I think the things we can say -- we can grow loans a lot faster if we wanted to.

I was looking link quarter.

But on a credit basis, we are being very judicious in a declining economic environment.

I was looking link quarter, just -- loans didn't grow a whole lot and I didn't know if that was intentional or what?

Not at all.

If you are looking link quarter you are seeing the commercial lending is up -- almost $2 billion.

What is really flat overall this is a lot of the consumer activity, as well as the fact that we have taken down some of our residential mortgage exposure.

Last question just to follow-up to the other one.

How would you not want to do a merger in this environment if you got some government protection on problem loans and maybe some other government assistance?

Isn't this the moment you have been waiting for to do another deal?

As I mentioned all government deals are unique in their very case.

We would certainly consider one if we could understand the downside risk.

That would be something we would be interested in.

All right, thank you.

Thank you.

Next question, please?

Your next question comes from the line of Nancy Bush of NAB Research.

Good morning, Nancy.

Good morning, Nancy.

Good morning, guys.

Couple of questions here.

First, on the trading loss, Jim, you guys have kind of struggled with trading over several quarters here and I kind of felt like you felt like you had gotten some of the issues on your trading desk straightened out.

I am just wondering if the trading losses in 3Q were of a different nature than the ones maybe we saw a couple or three quarters ago?

The issues in the trading loss, again, were just the widening of the spreads on quality assets, Nancy.

And we were very disappointed with that.

We have taken that risk down now by 75%.

And in this environment, trading is an extraordinarily different -- difficult opportunity and I think that's why we have taken that risk down by 75% effectively right now.

Okay.

So it wasn't a positioning issue as mush as it was just a marketing issue?

The spreads went out of the high-quality assets were worth less.

And trying to figure that out in today's environment is extraordinarily difficult.

And, Nancy, we have to balance as we do that taking down the risk and taking it down to the right value as opposed to giving away value, but at the same time trying to reduce the volatility that as that impacts our income statement.

Okay.

And then also on the utilization rates.

You had mentioned that the utilization rates have gone up.

Can you give us some color where they have moved over the past year or sequentially or what kind of level of magnitude you are seeing in the utilization rates?

I would say it's just a few percentage points.

It is not dramatically different than it was, but it has moved up.

You know we have a period of probably 10 years where it didn't move at all.

So we are seeing some companies take the -- take the credit risk down, but most of the people we do business with are fairly comfortable with where we are.

Let me see if we have a number for that.

Hang on one second.

We don't have specific percentages, but I would say corporate finance, of course, would be increasing and real estate finance would be up as well, and corporate banking is pretty much flat.

I don't have specific percentages, but that's where people are actually utilizing the lines we have outstanding more than they have in the past.

Okay.

Just one quick question.

On Virtual Wallet, which seems like a very -- a very interesting product, but seems aimed at the Gen Y generation, whatever that may be.

Whenever I hear about these products that are aimed at the kids, I always want to say to banks, what am I, chopped liver.

And I guess I would ask if there is sort of -- there is going to be a Virtual Wallet Seniors or something like it coming down the pike?

That is a great question.

You are exactly right.

Us Gen Y seniors are very important --(laughter) -- they are a very important product group.

What you will see, Nancy, is all customers continue to evolve their use of banks.

For example, online bill pay is up 35% a year each of the last three years.

By 2011, more than 50% of all payments will be made by cards.

So people behind the scenes -- we talk about -- we talk about housing prices and what have you, but behind the scenes, our customer base is changing dramatically how they use banks.

The Gen Y was initial -- the Virtual Wallet was initially targeted for people between 20 and 30 years old and the acceptance appears to be quite acceptable.

The other thing we have to hook onto that is an investment and a retirement module that we are working on right now.

You know the -- if you look at the product, the calendar is the key that is patented -- a key development in bill pay.

Because as you put your bills in there it shows in your calendar the dates you have to pay bills and you program in there the dates that you receive money as well.

So you get notifications on danger days and you can understand when you can save.

That same thing is true for retirees who are on fixed income or some form of fixed income and have regular payments.

That calendar applies to them as well.

So we are building a retirement module that will put on Virtual Wallet, and as you know the people who use the Internet the most, the age group is under 30.

The second largest user of the Internet are people over 70.

They e-mail their grandchildren.

They do a lot of research.

And they have extra time.

So I think, quite frankly, that piece will be equally as valuable.

And may even have some more money tied to it when we get that rolled out for us other than Gen Y'ers?

Okay.

Thank you, Jim.

Sure, thanks, Nancy.

Next question, please?

Your next question comes from the line of Brian Foran of Goldman Sachs.

Good morning, Brian.

Hi, guys.

How are you?

Fine.

I just want to come back to capital because I think there is a lot of confusion what is the appropriate level of capital for a bank today.

And even more basically, what is even the right ratio to focus on.

Appreciating your comments earlier, is there any minimum tangible common equity ratio that you have to manage to?

I think, first of all, let me address the point about what capital ratio we do manage.

We manage to economic capital.

That's how we manage the institution, but from a regulatory point of view, we focus on the Tier 1 ratio and we moved to that about a year and a half ago for exactly the situation we are in today, which is the fact that it is a better reflection of the risk weighted assets of the entire balance sheet as opposed to just cherry picking one component of the balance sheet and putting a mark on that.

And to the point before that I think Ed raised the question originally.

We talk about the tangible ratio and we talk about the valuation of the securities portfolio.

What we don't put in there is the value of our BlackRock stake which is actually just as much as -- the value we have not recognized is just as much as the value we have marked down on our securities portfolio, as well as the value of our deposit base.

There is a lot of factors that don't go into tangible common equity that we think is very misleading about the overall capital health of the Company.

Then following up on that, is there any breakdown you can give us about how much of the OCI is coming from agency MBS, what presumably we can take off the table?

Yes, a large portion of it is coming from non-agency residential mortgages.

The spreads there have widened dramatically.

Okay.

I guess the last two questions from me.

The commercial mortgages held for sale.

I guess it is kind of hard with the inflow and outflow and pay downs and mark-downs you have taken.

Is there an average carrying value you can give us for the loans at this point?

Right now we are probably $.85 on the dollar.

Okay, and then lastly on the residential construction side, appreciating it is not a very big portfolio, the MTLs and charge-offs are very high this quarter.

Is there any sense you can give us of cumulative loss expectations or some type of lifetime credit metric?

No, I couldn't help you there, but I would tell that you the vast majority of the nonperforming loan increase is coming from residential development.

Okay.

Thank you.

We are recognizing the risk in that area and we are marking them to nonperforming and setting up appropriate reserves for them.

I would also mention that the concentration is in the Mid-Atlantic states with the real softness being in Northern Virginia and the Eastern shore of Maryland.

While those developments are struggling and housing prices are down in those markets, they are not down to the extent that you see them in Florida and California, and Nevada and places like that.

Great, thank you.

All right, next question

Your next question comes from the mine of Matt Schultheis of Boeing.

Good morning, Matt.

Good morning, Matt.

Good morning.

I have two quick questions, once again getting to the capital issue.

You guys issued $500 million of preferred stock, and that counts toward your Tier 1 ratio, as I recall, correct?

That's correct.

Why don't I see that on your balance sheet reflected on page 2 of your supplement?

It is in capital.

Capital surplus.

Okay.

Yes, it's not broken out as a separate item.

Okay.

So your capital surplus.

The par value is very low so that gets rounded.

You don't even see that.

It's the capital surplus that it creates and that goes into that account.

Okay.

And you also had some losses on low income housing.

Can you give us a dollar figure on the low income housing, and -- I assume it is basically a tax adjustment and an adjustment to what you guys thought would you receive in tax benefits over time, but can you provide a dollar figure and exactly what that was?

It is not that material.

It's a -- probably less than $15 million.

But what you are seeing there is the write-off of the investment which is a passive loss going in early and then the tax benefits come at a later date.

Okay.

All right?

Yes, thank you.

Okay, thank you.

Next question, please?

Your next question comes from the line of David Knutson of Legal (inaudible) --

Good morning, David.

Hi, good morning.

I noticed that the deposits increased kind of smartly in the quarter, up, I guess, 8% versus 1%.

You mentioned a couple of the types of deposits.

I was wondering if you can give us any more information regarding -- obviously they had to leave somewhere else.

Was it primarily with smaller community banks or regional banks or thrifts or -- maybe you can help a little bit on that?

I tell you, we ask the same question.

We were wondering whether we were getting it from one bank or two banks, and quite frankly, the deposits have come in across the board from all -- all kinds of competitors.

And I think that was evident -- it was most evident when we looked at our market-by-market sales success where every single market is over plan, and the plans were set aggressively.

Every single one is over plan.

When you look at who we compete with.

We compete with different people in different parts of our franchise.

When you look to the West, you see Fifth Third and National Citi and JPMorgan Chase.

And when you look to the East, you see Bank of America and Wachovia.

And then all across the board, there is small banks everywhere.

So the success has been across the board.

And has it been driven by kind of reallocating to get underneath an insurance limit?

Or has it just been a change in better marketing or what do you attribute it too?

All of the above.

I think people have clearly moved -- have moved money to get under insurance.

I think people have also -- we like to think that our marketing has been particularly good and clearly I think the -- we like to think that the flight to quality has been positive for us as well.

And we are seeing this continue.

I don't think -- I personally don't think that -- that the deposit guarantee will stop all of the changes in deposit flows, because I think once -- confidence is clearly the issue.

We have lost confidence in a lot of our institutions.

If you think of each and every one of our businesses, confidence is a key component, but once you -- once you have changed your mind about having confidence in your bank, I think, quite frankly, the ultimate answer is that you will move your account.

So I think we are continuing to see success in that space.

That's a little bit different than one of your -- I guess Eastern competitors, Sovereign mentioned in their 8-K that deposit redistribution had calmed down particularly in October after some of these measures were introduced.

One last question .

The other thing you have to watch is that we are letting CDs run down.

We are not particularly competitive at all in terms of pricing longer-term CDs and those go into some of the FDIC reports.

We are much more interested in the demand deposit account and the money market accounts.

I think that's -- it has worked out very well for us.

That's a great point, Jim.

Even in that space, the CD space, even though we are pricing down as we reprice the portfolio, we are seeing retention rates very, very high, which again comes back to the point that people are coming in for quality, not just for price.

One last quick question on the NIM, a slight decline in the quarter and I guess from what you said on price, how -- why aren't we seeing, I guess, a greater expansion of NIM, and in conjunction that that question, is there substantial undrawn commitments?

I know you talked about the utilization rates going up a bit, but are there commitments out there that will drag on NIM going forward and do you have a size or magnitude?

I think what we need to see in that space is we need to see LIBOR rates come down a bit.

You can reduce Fed funds all you like and certainly you get a benefit from that, but until LIBOR comes down as well, and as you know, that's trading 300 over, until that comes down you will not see the full benefit of repricing your liabilities.

Great, thank you very much.

Thank you.

Next question, please?

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

Good morning.

Good morning.

Thanks.

Good morning, guys.

Just two questions -- first, I have to give you guys credit.

I think you are one of the best managers of risk in the industry, and given that fact, I would be curious to know where you are taking on risk?

What is your appetite, and where do you kind of see opportunity now given obviously what is going on in the market?

I think we are -- we have -- there are a few place where is we like the risk return.

In our business credit portfolio, we are roughly the third largest secured lender for traditional assets financing, just receivables, inventory.

There is a lot of opportunity in that space.

And the returns are quite exceptional, and I think that opportunity is really great.

I think we are working on that.

We have got -- we have municipalities that are coming us to remarkably every day.

And we are able to get the entire relationship with the municipality.

They don't come with just the borrowings as they have in the past and so both of those places for high-quality municipalities and the risk return on the relationship is pretty extraordinary.

The middle market space I think is a place where we have been dominant.

We've been the number one middle market player in the Northeast and the number one middle market syndicator over the years, so that is a place where we have focused and we continue to get opportunities to bring the entire relationship into the Company.

In cases where we tried for years to get certain customers to join us.

So I think -- I think across the board we have excellent opportunities and we are actually being very diligent in terms of making sure that we aren't taking undue credit risk because we don't have to in order to get a good return today.

Right.

Okay.

Actually my second question really kind of ties into that.

The fee income component of your business has obviously been a huge driver of the revenue model in the past, but given the considerable changes we are seeing in the financial marketplace, do you see that strategy modifying at all in the next couple of years?

Those three segments to me seem to be more of kind of on the spread business than the core banking business.

Do you see the overall pie changing a little bit as sort of opportunities change?

That is a very good question.

One of the keys to our businesses is that we have a number fee businesses and we also cross-sell our customers with fee businesses.

And so that strategy isn't going to change.

Just the fact that we have -- we have opportunities to move into relationships that have higher spread relationships, I think, could actually increase our net interest income as a percent of our total revenue, but that won't stop us from continuing to cross-selling products to customers to make sure that we're growing fee income aggressive because we like the diversity -- the diversification of revenue streams.

I think that allows us not to have to double down on certain types of credit risk when margins are lower than they might be today.

Okay, that is helpful.

Thanks very much.

Operator, I think we have time for just one more question here.

Okay, your next question comes from the line of Gerard Cassidy of RBC Capital Markets.

Good morning, Gerard.

Good morning, Gerard.

Good morning, gentlemen.

My question is on credit.

Jim, you touched upon what some of the forecasters are calling for on the economy and more economic data came out this morning that would suggest that the economy is in a recession, and clearly recessions bring on credit problems.

I notice in your top 10 nonperforming assets from the second quarter that nine out of the 10 were construction related this quarter.

It is now six out of 10.

Are you guys starting to see a migration of credit deterioration into the broader commercial book or just the broader book of business from what was primarily a residential construction problem maybe six to 12 months ago?

Actually, that is a great question.

I tell you, we ask it every day around here.

I ask every day about the commercial -- the CMBS portfolio and that is unbelievably clean.

I have been very pleased with that.

The residential real estate as you pointed out is what it is.

The corporate banking stuff, we are de minimus in the automotive and automotive supply side, so we kind of got out of that business for the most part a number years ago.

So we are not very big in that.

The one place that it did show up with the nonperformers this quarter is that we are a large business credit lender, and so you would expect that in a recessionary environment you would have more nonperforming loans coming from secured borrowers, if you will.

It is just kind of part of the business.

But nonetheless, we have a much, much, much lower loss given default ratio there and so the losses in business credit are not anywhere indicative -- are not anywhere related to great part from the nonperforming assets.

We have seen a little deterioration in that portfolio, but other than the real estate, the residential portfolio, I would say the business credit is the only one that has shown any deterioration quite frankly.

And then just one final question on acquisitions.

You guys over the years have done a number of acquisitions, of course.

Is there any -- I know you are not going to specifically name names.

I don't mean to ask that, but is there geographically preference that you are starting to move into that Northern Virginia, D.C.

market with the rigs and mercantile acquisitions.

Is your preference to move further into Virginia and south into the Carolinas or would you go Midwest or Mid-Atlantic up toward Boston?

Any color in there?

Every acquisition is unique in its own right and banks are sold, not bought.

You would have to look at how it would fit you in many ways.

I wouldn't have normally told that you that York, Pennsylvania was a place that we were interested, although Sterling fit particularly well and we were able to take all the costs out and it fit kind loaf like a cog in the picture.

I would have to tell that you Washington, D.C.

has been an unbelievable success and the greater Washington including the Mercantile acquisition is 160% of plan this year in sales, and sales were up 100% last year.

So the idea that we moved into that market place and said that it has the highest net income per household and highest education per household and the estimates say Washington, D.C.

is now greater than Philadelphia, that's worked out extraordinary well for us.

So when you look at an acquisition you have got to look at what the cost opportunity is, what the revenue opportunity, what the risk is, and you have to look at all of those things before you can make a decision.

But in this environment, you just have to be very careful, because as you mentioned, Gerard, you know the economy is headed south and you don't want to catch that falling knife.

I think with that, Jim, do you have any closing remarks before we wrap up?

Thank you very much for joining us and supporting us.

I think this was a very solid quarter for PNC.

The items we had given you guidance on with the net interest income, expenses and credit quality, I think, came right in as we had expected.

Market volatility in the quarter was extraordinary and I think that is true for everyone.

We were -- as we said in -- in the call in the second quarter and to many of you personally, we are not immune to those things.

But quite frankly, I think, a number of the things that we took this quarter, I think will be managed better in the fourth quarter.

Thank you very much.

Thank you.

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

You may now disconnect.