PNC Financial Services Group Inc (PNC) 2009 Q2 法說會逐字稿

Good morning.

My name is Felicia, and I will be your conference Operator today.

At this time I would like to welcome everyone to the PNC Financial Services Group second quarter 2009 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 session.

(Operator Instructions) Thank you.

Mr.

Bill Callihan, Director of Investor Relations and Senior Vice President, you may begin your conference.

Good morning and thank you, Operator.

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, James Rohr, and Rick Johnson, Executive Vice President and 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.

Those factors include items described in today's conference call, press release, and related materials, and in our most recent 10-K and 10-Q and various other SEC filings available on our corporate website.

These statements speak only as of July 23, 2009, and PNC undertakes no obligation to update them.

We also provide details of reconciliations to GAAP and non-GAAP financial measures that we may discuss.

These details may be found in today's conference call, press release, and our financial supplement in our presentation slides and appendix, and in various SEC reports and other documents.

These are all available on our corporate website, pnc.com, in the Investor Relations section.

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

Thank you, Bill.

Good morning, and thank you for joining us today.

As you all know, the current economy is a very difficult one.

As a matter of fact, it's the most difficult perhaps that I've experienced in all my years of banking.

But considering the environment, quite frankly, I feel good about PNC's second quarter performance.

We reported net income of $207 million or $0.14 per diluted share.

Excluding the impact of the special FDIC assessment and integration costs, net income would have been more than $375 million, and earnings per diluted share would have been $0.53.

Our performance is what we would expect in this environment.

We've done a good job.

Total revenue grew on a linked quarter basis, and was nearly $4 billion.

Net interest income performed well in the second quarter, and I think that reflects our efforts to transition our balance sheet.

And non-interest income improved significantly from the first quarter, and actually, I like the improved quality of the non-interest income.

We managed our expenses well, and as you would expect of us.

But in today's economy, there are clearly concerns about the asset quality of all banks, and our response has been what you would expect of PNC.

We successfully raised capital at market prices and we increased our capital ratios.

We improved our liquidity ratios.

We increased our loan loss reserves.

We continued to execute our proven business model, creating pre-tax, pre-provision earnings that more than covered our credit costs.

I would say that, with regards to the credit costs, and Rick will get into this in more detail in a minute, even after the impairments that we took at National City, National City still comprised more than 60% of our charge-offs and our increase in NPAs.

And Frankly, I think what we've been doing here with our balance sheet and the reserves positions us to handle the credit challenges of the current economy.

Now when we look at our balance sheet, we're one of the most liquid large banks in the country.

Our Deposit business is going very well.

During the second quarter, we generated an additional average transaction deposits of $6.6 billion.

We re-priced a number of our higher rate maturing securities and deposits with lower rate CDs, and we maintained our customer balances.

And at the same time, we reduced our higher rate, our very high rate brokerage CDs by $5 billion.

As a result, we remain a core funded bank, with loan to deposit ratio of 87%, and the total funding costs fell by 26 basis points during the linked quarter.

The greatest challenge we see is on the asset side.

Loan demand continues to be soft across the country, and it's difficult to find assets that meet our risk adjusted criteria.

As a result, average loans decreased by nearly $5 billion on a linked quarter basis, despite originating more than $29 billion of loans and commitments during the second quarter.

One option would be to replace to increase assets by extending our securities portfolio, but we have not done that at this point.

Like many other banks, we saw a continuing decline in the broader economy during the quarter, which resulted in a corresponding deterioration in our loan portfolio risk ratings.

And as a result, we increased our loan loss reserves again this quarter.

Nevertheless, we're seeing some signs of stabilizing credit.

The growth rate in non-performing assets slowed in the second quarter, and early stage delinquencies began to flatten.

Now in addition, we've made good process in disposing of our foreclosed assets, through the sale of more than 1,600 properties during the second quarter, and that's good news to see that that market is starting to open up.

That said, the size of non-performing assets reflects the challenges we see in the economy, and we believe that unemployment will continue to increase through year end, and since credit costs lag the economy, we expect to see continued deterioration, but at a slower pace.

In response to this credit environment, we've taken aggressive steps.

We have nearly 1,500 people on staff to handle the workout, loss mitigation, and loan modification areas.

And we're reviewing loan files earlier and more frequently, and we think that currently we have the processes and the people in place to perform well during this portion of the credit cycle.

Turning to our customer side, we're very pleased.

In our legacy PNC footprint, every market was at or above their sales goals for the first half of the year, and well above last year.

In our acquired markets, 80% of our regions have exceeded our sales targets through six months, and exceeded last year, and we have positive trends going into the second half.

We're especially pleased with our ability to increase market share in places where we want to grow, and we're deepening these relationships through our fee based products and services across our expanded markets.

In Retail Banking, we continue to invest in our brand and product innovation at a time when some peers haven't.

Our increasing brand strength helped us grow by 14,000 net new consumer and business checking accounts in the second quarter.

For example, we've seen market share gains in greater Washington, greater Maryland, Milwaukee, St.

Louis, and this contributed more than $2 billion in increased average transaction deposits out of the enterprise total of a $6.6 billion increase.

Almost a year ago, we launched our highly successful Virtual Wallet, which was designed for Gen-Y consumers.

We now have nearly 80,000 customers using this product, with above average balances.

We've leveraged our understanding of this market, and combined with our extensive University Banking Program, we launched a new product this quarter for college students and their parents called Virtual Wallet Student.

And we expect further growth in this product as we convert our National City branches and it becomes available across our expanded franchise.

Corporate and Institutional Banking also had another strong quarter in key growth areas.

Corporate service fees of $236 million were up more than 8% from last quarter.

Strong results from treasury management and capital markets as we're beginning to successfully cross sell our broad array of products and services to legacy National City customers.

Lower average loans for this segment reflected softer demand, but average deposits increased $3 billion on a linked quarter basis, reflecting increased client liquidity.

Our Asset Management group, which includes Wealth Management, saw its assets under management increase to $98 billion at June 30th, as a result of higher equity market values.

Quarterly profits were down in the quarter due to higher provision for acquired loans in Wealth Management, different than our historical experience.

Sales remained strong in the quarter, led by growth in newly acquired markets, such as Cleveland, Columbus, and Chicago, as well as legacy markets, including greater Washington and Philadelphia.

The pipeline here is solid and I'm pleased with the level of cross selling we're seeing across all of our markets.

Residential Mortgage Banking performed well in the second quarter.

But total income was lower due to the expected declines, primarily in the hedging gains associated with servicing rates.

As you know, they were extraordinarily high in the first quarter.

For the second quarter, total loan originations were $6.4 billion, mortgage rates did rise late in the quarter, which reduced incoming application volume for future loan closings, but still continuing at a good pace.

Now as a step to improve the quality and efficiency of our mortgage operations we announced this quarter that we're consolidating underwriting in some 90 existing operation sites to two locations, Chicago and Pittsburgh.

Global Investment Servicing saw increases in custody and net fund asset service from the first quarter.

The business launched fund distribution support services in Asia, offering a full suite of processing and reporting services for European and US mutual fund firms, with investors based in Asia.

Global Investment Services continues to have a strong sales pipeline, and we're pleased with the relative performance of this business, in spite of the downturn in the markets.

Both our Asset Management Group and Global Investment Services reduced non-interest costs in line with revenues.

I think this will position them well for improved profitability when the equity markets recover.

BlackRock, as you know, reported a good quarter, profit of more than $200 million.

Its assets under management rose linked quarter as a result of improved performance of the equity of fixed income markets.

And as you know, BlackRock announced their pending acquisition of Barclays Global Investors in June, which will make it perhaps the largest, or certainly one of the largest, asset managers in the world.

We truly believe in this transaction.

We believe it is a terrific transformation for Black Rock.

We've supported the transaction, and it should provide us with additional capital upon closing, assuming BlackRock's current stock price.

Let me turn to the Distressed Asset Portfolio.

They had a strong quarter, primarily due to a lower provision for credit losses.

This segment, which manages our distressed loans, is now staffed with more than 130 employees to handle this portfolio's workout.

Let me comment briefly on credit availability.

Obviously, we're committed to meeting the credit needs of qualified customers in these difficult economic times.

In the second quarter, we improved loan modifications totaling more than $0.5 billion, and in addition to our modification programs, we began participating in the Home Affordable Program in May for all GSE mortgages and for non-GSE in July.

And we'll evaluate the second lien program when details are announced.

When we look at the Commercial side, we've enhanced our calling efforts to small business and corporations.

We're offering promotions with special financing rates, such as loans that support green business practices, and loans in the lower and moderate income areas.

These efforts are paying off, as we've originated nearly $1 billion in small business loans in just the last two months.

And for mid-sized companies, we led the nation in the second quarter in loan syndications, putting together almost $1billion in business loans, and together these activities helped us to originate or renew more than $55 billion in loans and commitments year to date.

Turning to the integration of National City, I am very pleased with our efforts.

Our employees are working very hard on the integration, and I really appreciate their ongoing efforts and enthusiasm.

We're well on our way to achieving our cost saving goal.

On an annualized basis, we've already captured almost $500 million in cost savings, a great start towards our two year goal of $1.2 billion.

Preparations are well underway for the initial wave of consumer conversions, which is scheduled for November, with the remaining waves running through mid-2010.

Our goal is for a seamless transition for customers, and I believe we will reach that mark given the investments we're making.

Additionally, we're scheduled to complete the required divestiture of 61 branches in early September.

The acquisition, clearly, of National City, has been accretive to our first half income, and we expect it to be accretive for the full year.

And as we're able to bring costs down and the credit costs begin to diminish, we really are pleased with the opportunity for our shareholders.

Overall, I'm pleased with how PNC's businesses performed in the second quarter, and I remain very optimistic about the benefits of the National City acquisition.

Our business model continues to position us for growth as the economy recovers, and we're working very hard on the asset quality side.

Now, Rick will provide you with more detail about our second quarter.

Thank you, Jim, and good morning, everyone.

Let me add some detail to the business strategies that Jim discussed.

PNC reported second quarter earnings of $207 million, or $0.14 per common diluted share.

This included expenses of $133 million or $0.19 per share, with a special FDIC assessment ,and $125 million or $0.20 per share for integration costs.

Excluding those items, net income and earnings per share clearly would have been substantially higher.

Additionally, second quarter preferred dividends were $0.26 per diluted share compared to $0.11 per diluted share in the first quarter, as we paid a full quarter, or $95 million of dividends, on our TARP preferred shares.

The key take aways for this quarter are first, our earnings were driven by strong and diverse revenue streams and well managed expenses.

Second, we were not immune to the challenging economic environment as reflected in further credit quality deterioration.

However, credit costs remain manageable as our pre-tax pre-provision earnings exceeded our credit costs, and we increased our coverage for credit losses.

Third, we maintained a strong liquidity position and continued to strengthen our key capital ratios.

And fourth, our business model is working, now and it's all about execution.

Let me start with a review of our earnings on slide five.

At PNC, we continue to benefit from having a diversified revenue stream with a strong contribution from our fee-based businesses.

In total in we delivered almost $4 billion in revenue.

Non-interest income of $1.8 billion was strong and diversified for the quarter, despite the expected decline in gains from hedging our mortgage servicing rights and our Residential Mortgage business.

For the second quarter, non-interest income represented 45% of our total revenue, and increased $239 million or 15%, compared with the first quarter results.

Our relationship-based fee categories, such as Fund Servicing, Asset Management, Consumer and Corporate Services, Residential Mortgage, and deposit service charges, delivered 82% of non-interest income, a solid and consistent performance.

In the other non-interest income category, improvements in the markets drove gains on securities sales, lower losses on private equity valuations, increases in customer-related trading results, gains on loan sales, and hedges of our deferred compensation program.

Several of these items are highlighted on page six of your financial supplement.

The results underscore the benefits of having a diverse revenue stream.

Net interest income of $2.2 billion and net interest margin of 3.6% were down linked quarter, primarily due to the reduction in higher yielding loan balances, partially offset by lower deposit costs.

While the yield curve has gotten steeper, we have not invested in a meaningful way, and our balance sheet remains very asset sensitive.

We continue to be focused on expense control.

As Jim mentioned, we have already captured $500 million of annualized cost savings against our two-year integration goal of $1.2 billion.

For the quarter, our total non-interest expenses of $2.7 billion included $133 million in special FDIC assessments and $125 million of integration costs.

These and other cost details are also highlighted on page six of the supplement.

Even with these additional costs, our pre-tax, pre-provision earnings for the quarter were $1.3 billion, or $242 million more than our cost of credit.

On a year to date basis, our pre-tax, pre-provision earnings of $2.9 billion were $900 million above our credit costs, providing a solid contribution to the increase in our capital ratios.

Now let's take a look at our loan portfolio on slide six.

This portfolio represents only 59% of our total assets.

PNC's loan portfolio is relatively well balanced, with 55% from commercial lending and the remaining 45% from consumer lending.

As you can see the portfolio is well diversified and granular.

It's primarily in our footprint, and the majority is collateralized.

However, as the effects of the recession continue to spread throughout the economy, we are seeing deterioration in the loan portfolio.

But we continue to believe the pace of change is manageable.

Let's review the overall quality metrics on the bottom right-hand portion of the slide.

Non-performing loans to total loans increased to 2.4%, or $1.1 billion in the second quarter, compared to a $1.3 billion increase in the first quarter.

This is a 36% increase, with 60% of the growth coming from National City.

We believe the rate of growth for non-performers may have peaked in the first quarter.

In total, net charge offs were almost $800 million or 1.9% of loans, compared to 1% last quarter.

National City loans resulted in more than $460 million or 60% of these charge offs.

As you will recall, we established a $2.8 billion allowance for credit losses when we acquired National City.

As such, we should anticipate charge offs on this portfolio to continue until we approach this level of reserves.

Our provision to average loans increased 2.6% in the second quarter, resulting in allowance for loan and lease losses to total loans of 2.8%.

And we increased our reserves to $4.6 billion in the second quarter.

When you add that to the $7.5 billion of valuation reserves we have in our impaired loans, we have over $12 billion of reserves, or close to 7% of loans outstanding.

We believe this positions us well to further manage through deterioration in economic conditions.

Let's take a look at the specific areas of deterioration on slide seven.

Let's start with our Commercial Real Estate portfolio.

The size of this portfolio is approximately $25 billion or 14% of our loan portfolio.

Now broken down further, $8 billion of this portfolio is commercial mortgages, predominantly with recourse, and this portfolio is performing well.

The remaining outstandings is real estate projects.

Non-performing loans in the real estate projects book increased this quarter by $400 million, to $1.4 billion.

Non-performing loans in this sector continued to be driven to a large part by residential development.

In terms of geography, the largest contributors continue to be in Florida, New Jersey, and Maryland.

Our total outstandings in residential development was $3.6 billion.

This is comprised of impaired loans of $1.8 billion, which has a fair value mark of 40% against it as impaired loans, and $1.8 billion of unimpaired loans, with $600 million or 33%, declared non-performing and are well reserved.

Two other areas in the Commercial Real Estate portfolio that we're following closely are retail strip shopping centers and lodging.

While these are small in relation to our balance sheet, we're being proactive in managing these risks, as they are particularly susceptible to the effects of lower consumer spending.

Second, we have real estate related loans in our Commercial book of $8.3 billion.

The areas of greatest stress is this portfolio is in the supplier segment, where outstandings are less than $2 billion.

The majority of these loans were acquired, and we are aggressively managing them through increased due diligence and collateral reviews.

Also on our Commercial book is our exposure to the Big Three auto manufacturers, which is less than $100 million.

The majority of our exposure to this industry is to auto suppliers with less than $1 billion in outstandings; however, most of this business is collateralized which tends to result in a lowered loss given default, and 70% of our auto dealer exposure is to foreign manufactures.

Clearly the midwestern region is bearing the brunt of the downturn in the US auto industry, and we have a team studying the ripple effect on the region.

We believe the additional loan modification and loss mitigation staff we have added will help us successfully manage through this challenging period.

The third area of focus, Consumer Residential Real Estate, is approximately $22 billion.

This portfolio contributed about $350 million of our $1.1 billion increase in non-performing loans.

Of that amount, $300 million of the linked quarter increase was related to the National City portfolio.

Although non-performing assets increased primarily due to the subprime portfolio acquired in the National City acquisition, the overall Residential Mortgage portfolio is performing relatively well, due to the quality of our overall Residential Mortgage Portfolio, with net charges offs of less than $80 million in the second quarter.

The majority of the loans are in our footprint, with weighted average FICO score or 706 and a weighted average loan to value of 75%.

Finally, our Home Equity Portfolio and Other Consumer Lending continued to perform reasonably well.

Home equity non-performing to loans in the second quarter was 29 basis points, and net charge offs were 1.2%.

As of June 30th, our Home Equity Portfolio had weighted average FICO scores of 728, and weighted average loan to value of 75%.

More than 80% of these loans are in our Retail markets.

Now let's turn to our capital position.

Our estimated tier one common and tier one risk based capital ratios ended the quarter at 5.3% and 10.5%, each increasing by 40 to 50 basis points.

Both ratios benefited from our successful at-the-market common equity offering in May, lower risk weighted assets at quarter end, and retained earnings for the quarter, which was somewhat offset by the increase in goodwill associated with additional impairments.

Our capital plan was accepted by our regulators.

Our position of TARP repayment has not changed.

Our plan is to repay TARP as soon as appropriate and end in a shareholder friendly manner.

Slide nine is a score card we use to measure our progress as we integrate National City and apply PNC's business model to our new franchise.

Jim and I have already highlighted many of the metrics on the slide.

We continue to execute the PNC business model and work to deliver on all of these metrics.

We believe our results this quarter reflect continued progress towards these goals.

The key point of this slide is this.

PNC acquired National City by issuing 95 million shares, or about 20% of our current 460 million shares outstanding, and we doubled the size of our Company.

When we improve our return on average assets to historical standards, which were well in excess of 1.3%, the leverage on our performance should be substantial.

We just need to execute our business model.

And with that, I'll hand it back to Jim.

Thank you, Rick.

And that's exactly what we told our Board at our strategic planning meeting.

And when we look at the second quarter, we've made progress.

We generated solid results in the quarter, despite the economic difficulties that all of us are going through.

Going into this business cycle, many of you viewed PNC stock as a defensive play.

Coming out of this cycle, we view ourselves as an offensive play, and we believe PNC will have three distinct advantages, as the economy begins to recover.

First we fully expect to achieve the $1.2 billion in expense savings from the integration.

Second, with the marks that we've taken on the National City Loan Portfolio that Rick described, I believe that our credit costs will decline as the economy begins to recover.

And finally, on the revenue side, we're already seeing success with customer and market share growth, and improving markets should further enhance income from our fee-based businesses.

We will simply continue to execute our business strategy in support of our customers, and when the economy recovers, I believe we should be able to deliver returns consistent with our historical performance.

As we look ahead, we continue to be comfortable with the range of first call estimates for the second half, and clearly we believe that the combination of National City and PNC has tremendous opportunities for growing shareholder value as we continue to build a great company.

With that, we'd be more than happy to entertain your questions.

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

(Operator Instructions) And your first question comes from the line of Paul Miller FBR Capital Markets.

Good morning, Paul.

Thank you very much.

How are you doing?

On your NIM, your net interest margin was down like 20 some basis points over the quarter.

Was that mainly from just the continuing deleveraging, or were you also de-risking the balance sheet at the same time?

It's a little bit of both.

One, you've got absolute rates coming down a bit, so therefore the rates we would put on securities and we put some on, it was a modest amount, would be the lower rate than the loans that ran off.

So there is de-risking taking place there, as we're starting to see some of our customers reducing utilization rates, and so that's why you're seeing the loan balances come down overall.

So there's a little bit of de-risking; a little bit of just simply lower rates.

What we're hearing across the board a lot of the CD pricing and rates continue to fall on the low end of the curve.

Should we see some bounce-back on the NIM going forward, or is that de-risking is still going to really control the NIM?

The de-risking will control it for the short term, but what you will see is when the CDs are repricing today, for example, we marked all the CDs at National City at about an average of a 2% rate.

We're repricing almost all of those CDs at about 1.7% to 1.8%, and probably retaining right now 70% to 80% of those balances.

So I think on that piece of it, you'll start to see improvement.

But I think as we sell down potentially some of the more risky assets, and if our customers continue to pull back on their lines, then you'll probably see further contraction on that.

Thank you very much, gentlemen.

Next question, please.

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

Good morning.

Good morning Matt.

Just a follow-up on the (inaudible) margin question.

Good disclosure on the purchased accounting adjustments on page eight, and I think that shows about a 20 basis point drag of the lower accretion.

I'm just wondering how that plays out going forward, in terms of the magnitude of runoff?

The way I would look at it is 50% of what you're seeing today in the purchase accounting is coming from loans, and 50% is coming from CDs.

The loan piece will come down if we're not able to replace loans at those same spreads and rates.

The deposit piece won't come down, because of the fact that we are able to replace those deposits at the rates at which we mark them.

And therefore, I would probably split the difference on the impact of the accretion, and suggest that over time, and this is a wild prediction, but over time time, we'll probably run about 3.2% margin over time.

Because I think half of what you're seeing there in terms of the purchase accounting may or may not replace itself.

The other half will.

Okay, that's fair.

So just, as you think about the next couple of quarters, again that page eight, it shows $486 million of benefit.

How should we think about that piece?

Well, that will come down a little bit.

I think our full year projection for this is going to be around $1.6 billion, so you should expect to see about $300 million in Q3 and $200 million in Q4.

But the fact is that those numbers change every time we re-mark the book, so I wouldn't lock them in, but that's our current forecast.

Okay.

And then to your point that it's not the entire going from 486 to 300, that's not the entire hit to the NIM, since the deposits are getting reinvested.

That's exactly correct, and if you look up above, you'll see half of the benefit, if not more, is coming from the deposit side.

We'll be able to reprice and retain that difference.

Okay, that's helpful.

And then just separately, you took some other-than-temporary impairment on your Securities portfolio this quarter, nd the unrealized losses did moderate as spreads tightened.

Can you just remind us, one, what triggers the OTTI, and how should we think about the $3.8 billion in unrealized losses in terms of how much might be realized over time?

I would suggest on the 3.8 what we're seeing basically is that the markets are settling down from the historical instability that we saw last fall.

And I think that will continue.

And I think as markets get more comfortable, spreads will come in, and I think that $3.8 billion will continue to come back in over time.

And then we hope to re-capture as much of it as we possibly can; I think probably the majority of it if not all of it.

On the OTTI side, what you're seeing there is we took in another $150 million of losses there.

Keep in mind those are projected losses, so as 70% of it came from continued delinquencies on loans that were already impaired, the other 30% came from new securities which are [peering] impaired.

But again, in total, I think our losses on this entire portfolio, real losses, is less than $5 million.

So if the markets improve and those delinquencies don't pan out, some of that even could come back to as well, because those are all projected.

Okay, that's helpful.

And I think you've got the big gain from the BlackRock Barclays deal coming later this year, to give some flexibility, right?

We should have a gain, depending on where the BlackRock share price is at the end of the year.

In our fourth quarter is the current expectation of between $400 million to $500 million after tax.

Okay, great.

Thank you very much.

Next question, please.

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

Good morning Betsy.

Good morning, thanks.

My question is on the expense saves and the trajectories with regard to the merger.

I think you indicated that you have $500 million now annualized run rate, and the goal was only $600 million for the full year; I shouldn't say only, but it $600 million for the full year, so seems like you're making a lot of progress.

Can you tell us, is this just an acceleration of what you expected, or is this new stuff?

And if it's new stuff, are you going to raise your guidance on expenses?

I would say that right now it's the acceleration of the expected savings.

I think we've talked about how One PNC helped us learn about a lot of different places where we could find [expected] savings, and so when we went in, I think frankly, our team was able to execute at a more rapid pace than we might have anticipated before.

We're very confident in the billion, $200 million, and I think we'll continue to have that run ahead of schedule.

And I think before we would get optimistic about something more than $1 billion [too], I think we would want to get the first conversion done in November.

If that goes well, we may be back to you, but those kinds of things you walk before you run.

Any color on the revenue side?

The revenue side is coming along nicely.

We're just starting.

A number of the products that we have, like Virtual Wallet, really aren't available in the National City markets until we get the conversions done.

But we've actually been able to get a couple of universities start talking to us about doing a lot of things together.

The big conversion of course is in November, but then a lot of the National City stuff like Cleveland gets done in the first quarter of next year, which gives us a lot of opportunity.

We have crossover products, we call them crossover products, treasury management, and health care, and capital markets, which really weren't cross sold at all in the National City environment, which have taken off.

And so when you look at treasury management growing at 8%, here's an industry that doesn't grow at all.

So the 8% is a market share.

The industry grows at maybe 2%.

The market share gain that we had there, a lot of it is just starting to come out of National City, where we can bring our national products set and our technology to their customers before branch conversions, so we can actually put customers on our systems from the corporate side and health care side, without having the branches converting.

Okay.

So on the revenue side, are you running in line with expectations or not at this stage?

I would say, we mentioned that the majority of the National City markets are ahead of the sales plan that we put in place for them, and across the entire acquired markets, we're at 109% of plan.

So, I would say we're doing better than we thought.

Okay, thank you.

Next question, please.

You next question comes from the line of Mike Mayo of CLSA.

Morning Mike.

Good morning.

Can you just elaborate more on the declining loan yields.

Loan yields down 50 basis points.

Which type of loans, which geographies?

That's such a big linked quarter decline.

Just more color on that would be great.

Sure Mike.

Two things are happening.

One is you have people that are just drawing down on utilizations, and as a result, you've got the balances coming down, so that's one.

And those are coming down from a higher rate environment, than when those loans are put on to where today's rate environment is.

So some of that is just simply the drop in rates.

I'm sorry, you say, so they draw down the utilizations, they take out more money and the rates contracted are much lower.

They're borrowing less.

Borrowing less, Mike.

I'm saying they're borrowing less, and that's why the balances are coming down.

So you have a combination of the balances coming down, and they're coming down from a higher rate environment.

Okay.

As well as a lot of our commercial loans reprice on a short term nature, and so those rates are coming down as well.

So it's really driven very much by the absolute level of rates coming down.

Okay, more on the commercial side than anything?

That's correct.

Okay, and then just generally speaking, you mentioned the gap between your pre-provision, pre-tax profits and your loan losses.

And you have a nice cushion there, but I guess if loan losses have gone from 1% to almost 2%.

If they went to 3%, that gap might evaporate.

Can you talk about how long you think you might have that cushion, or what you could do if things don't pan out ,as well as do you think they might?

What other levers do you have if the economy doesn't improve a whole lot?

I think we're forecasting as we said, that we would be able to perform within the range, I think that's the kind of guidance that we gave.

So if we're able to perform within the range in the second half of the year, that means our pre-tax pre-provision income would be greater than our provision.

So, we don't see an erosion of that number going forward.

And just maybe your outlook for the loan losses, 1.9%.

Do you think it's a little bit higher, a lot higher, how should we think about that?

That's a very tough question, Mike, because you've got some factors which are looking better, we think we may have peaked on non-performing asset growth.

We look at the fact that delinquencies have flattened out a bit.

On the other hand, we expect unemployment to continue to go up.

Right, so you have factors going in both directions.

So, I don't see our reserve levels changing much from the elevated level where we are today, at the provisioning level I should say, from where we are today.

I have no reason to believe it will get substantially better, nor do I have the reason to believe it will get substantially worse.

Okay.

All right.

Thank you.

Next question, please.

Your next question comes from the line of John McDonald of Sanford Bernstein.

Hi, John.

Good morning John.

Good morning.

Just on that last answer, Rick.

So does that mean you expect the charge offs to go up, but the amount of reserve bill might start to go down, because you start to use some of those reserves you brought over from Nat City?

Well I definitely expect that we'll use up the reserves we brought up from National City, that we'll start to see those charge offs go up.

It just remains to be seen at what pace and whether or not, whether they will start to see other areas subside in terms of charge offs, therefore making room so that we can continue to build reserves.

I'd like to say at this stage of the game we plan to continue to build reserves through the end of the year.

But it's very difficult to predict where this is going, with a lot of mixed signals in terms of where the economy is headed.

But what you were saying to Mike just now, your best guess is that the provision in dollars, the combination of the charge offs and the reserve bill, doesn't move a lot from what we saw in the second quarter?

We have a hard time predicting.

We're hopeful that the increase in non-performers, the rate of increase peaked in the first quarter.

The increase on percentage basis and on an absolute basis was less in the second quarter.

You hope that when we look at our past due loans, when you look on page nine of the supplement, you can see that the past due loans past 90 days have been increasing significantly to around 3%, whereas the 30 to 89 day loans are stuck three quarters in a row at 2%.

So you're hoping that perhaps we've seen the deterioration will to some extent subside.

That having been said, charge offs always follow the economy.

I mean the charge offs will remain at a higher level.

You do your reserve build during the deterioration period of the economy, and then the charge offs frequently follow that, and that's why you have the reserves.

So I think that the reserving and the provisioning and the charge off questions are kind of two different questions.

Yes, I was just looking at the reserves.

You have almost a 3% reserve to loans and a less than 2% charge off.

So it seemed like you might be able to start using some of that Nat City reserve.

You brought over 3%-plus for a non-impaired book, that you would start using it.

Well, at some point we will use it for sure.

That's for sure.

But as we look forward, unemployment probably is going to continue to rise throughout the rest of the year.

The consumer book will follow that number.

So I think it's hard to get - - and housing prices haven't stabilized.

We'd like to see a couple [green shoots] that we saw yesterday and today.

I think the economy is going to be tough throughout the rest of the year.

Okay.

And maybe just a little bit of thought on some of the CE items that were strong in this quarter, Rick, trading, $90 million.

Do you have a sense of what might an average trading result for you guys be over time?

That's a tough one.

I think we have historically said that our customer related businesses probably give us maybe $40 million to $50 million a quarter on average.

And that really hasn't change add lot, the volumes have stayed pretty consistent.

We just happened to have a very good quarter this quarter clearly.

And equally hard is the mortgage as well, in terms of what might be a - - ?

That was pretty low this quarter.

That was $50 million, $50 million, $53 million, so that was $203 million in the first quarter.

We didn't expect to repeat that.

I don't think anyone else expected us to repeat it either.

And 50 feels more normal, given what you see - - ?

I think it's fair to say this is a pretty volatile area.

This number moves around quite a bit, and we've actually worked very closely with our Asset and Liability Team, working with the BlackRock team and actually putting in some better modeling around how to actually hedge the servicing right.

And these guys have done a great job so far of managing that risk.

But I wouldn't suggest to the you that this isn't a volatile item to hedge, because it can be volatile.

Okay.

Last thing, just what kind of pace of run down might we expect over the next couple of years on the Distressed Asset Portfolio?

And them commercial commitments, is there any way you could size for us how low lying utilization is right now?

Well I can tell you we'd love to run the Distressed Asset Portfolio down, and we're working on it.

We have a lot of people focused on it in every way.

I think all the banks are.

The pleasing thing was that in the first quarter, we couldn't get any bids on some of these residential properties at all.

And so the idea that we've been able to move over 500 a month for the last three months is encouraging.

The prices aren't any good, but they're encouraging to start moving these assets.

I think the northeast is the place where the prices haven't fallen yet, but they're starting to.

Unfortunately, we don't have a lot in the northeast, so the Florida stuff and the California stuff, we've taken big marks on.

And I think we just have to keep working on how to predict when that happens, it's hard to say.

The utilization rate just continues to fall.

The number that we have here - -

That's about 3% down.

So it's - -

It's hard to pinpoint an actual rate, but the change is about 3%.

The other issue is when you look at some of the financing we do, interesting, we've had added lot of customers in the last 12 months.

But the average borrowing per customer, and the easiest place to look is in business credit where we've really just added an awful lot of good customers, but their requirements are down by 60% simply because the value of their inventories are down, metals or receivables, and so even though we're adding customers, the average loan balance is down even if their activity is the same.

Okay, thanks.

Next question, please.

Your next question comes from the line of David George of Baird.

Good morning David.

Hi guys.

Couple of quick questions.

First on the Other Income line.

I assume that includes trading, was there anything else that was extraordinarily strong during the quarter?

I'm just trying to get a sense of what a run rate there may be, and then I've got one follow up.

Not really.

I think the one thing you need to take a look at when you look at the change from quarter to quarter, by the way, we lay it out for you on page six of the supplement, is this idea that some of our Compensation line went up simply because our stock price went up, versus in the first quarter our stock price went down.

And so you had almost a $70 million delta related from first quarter to second quarter.

That had an impact on the Expense line.

But because we hedged that risk, it had a corresponding impact on the Revenue line from one quarter to the other.

And obviously, our Private Equity business didn't have as severe losses as we saw in the first quarter.

That had settled down a bit, the trading we talked about.

And we had some loan sales as we started to take some of these impaired loans and tried to move them off our balance sheet and recognize some gains on that.

I appreciate that.

On page nine of your slide deck, you discuss what kind of a normal or a target loss rate would be, and the number looks to be 30 to 50 basis points.

How do you come up with that number longer term, because both your loss rates, as well as Nat City, were I think considerably higher than that?

So I guess just walk us through that if you don't mind.

That number, 30 to 50 basis points in terms of charge offs?

Provision to average loan.

You're talking about what we have done historically.

What we do, and we actually are revisiting as we speak, is we did this several years ago, we take a look at what we think our credit costs ought to look like through the cycle, and then we set our old risk profile on all our limits and all of our hold levels, and everything is driven from that view.

Right now we're looking at the same thing, recognizing now it's a new environment, recognizing now that it's the fact is capital levels and expectations of capital levels, more involved with the regulators being involved in that.

So we're revisiting all of that.

But we don't see a substantial change.

The only thing over time is the fact that we've picked up Residential Mortgage, and we've picked up Credit Card, and we've picked up Leasing.

We need to incorporate those into the broader portfolio, and we'll be evaluating that over time, but 30 to 50 is what we've used historically.

And we've performed within that range for a number of years.

Okay.

Thanks, guys.

Next question please.

Your next question comes from the line of Ed Najarian of ISI Group.

Good morning, Ed.

Good morning, guys, how are you?

Most of my questions having asked and answered, so I won't take up too much time.

But I decide see two things additionally that jumped out at me.

One, it looked like you had an abnormally low tax rate in the second quarter; if you could just describe what that was and if we should expecting something like that going forward.

And then secondarily, I saw that you had an extra $600 million of purchase accounting marks taken in the second quarter, and I'm just wondering if you think you're finally through additional purchase accounting marks, or if that's something that we could still see play out in the second half of the year.

Thank you.

Let me take your latter point, Ed.

I believe we are.

We feel we are through purchase accounting marks, but you never say never, so I won't commit to that.

But I think at the last quarter we were 90% of the way through.

I think we've made substantial progress over the course of the quarter.

And so we, on the loan balances, I think we're very much comfortable with where we're standing.

There's other factors out there, and I think you've seen in our disclosures that there are shareholder litigation and other cases, which may take a lot longer to come to fruition.

So we'll have to wait to see how they play out over time, Ed.

But as far as the loan book goes, I think we're done.

Okay.

On the tax rate, we had an effective rate in the first quarter for the full year of about 22%.

I would say a more appropriate rate now is 20%, and that being the increase in the credit costs that we've all talked about.

Clearly our credit costs expectations are a little higher than we anticipated.

So I would say if you're looking at the 14, I would say that's probably low by six percentage points, and that's a small number when you do the math.

It's not that big of an impact on the earnings.

So your best guess on a GAAP basis, on a non-FTE basis for the second half of the year would be around 20%?

Yes, that's correct, Ed.

Okay, all right.

Thank you very much.

Next question, please.

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

Good morning.

I believe you said that you have not yet begun to reinvest in the Securities book, and I guess my question would be at what point do you think you will, and what are you waiting for, because it's not likely that rates are going to get a lot higher at this point?

If you can guarantee that for us, we - -

I think Mr.

Bernanke is guaranteeing it for you.

He certainly guarantees he's going to keep the rates low, and we agree with that, and the yield curve has steepened.

And we've remained extraordinarily liquid.

In fact we just did a little study.

We have more demand deposits per share than anybody else in the industry.

So the flexibility that we ought to have going forward to move into that market, I think, is resident in the balance sheet.

At some point when you're spending this kind of money, the government is spending this kind of money that they don't have, at some point we will have higher loan rates.

So the question is, how far out the yield curve might you want to go at what time?

And so those are things we're always considering.

As you and I have discussed, we're not in the business of betting the balance sheet, so I would expect that we would invest a little more aggressively down the road.

Nancy, I would also say, we did a little bit of that in the first quarter.

And I think you saw that in treasury and agencies, where we invested in some securities when rates went up, rates came down, we thought they may stay down, so we thought we'd take advantage of taking that out.

That was some of the security gains you saw in the first quarter.

Right, so this does not sound like it's a very near term event that you're talking about.

We've always had the view that it's not a one time event, it's a gradual thing over time in terms of how we invest in the balance sheet.

Secondly, I'm just a little confused on the trends in the non-impaired portfolio at Nat City.

We saw yesterday that Wells looked like it got some fairly unpleasant surprises from the non-impaired Wachovia portfolio.

So how is the non-impaired Nat City portfolio tracking according to your expectations?

There's two areas where you saw an increase and there's two good reasons why that occurred.

One is, to the extent that we have revolvers in the portfolio, you cannot impair revolving loans.

And so therefore, we were unable to impair them, and as we get through the portfolios and get the appraisals updated and all of that, and we start to get the information to the level where we want it, that's part of the lift you're seeing in non-performing loans.

The other side is, if you take a look at an increase in the Mortgage Portfolio, that went up $300 million I believe in the quarter at National City, we impaired all mortgages that were more than 60 days past due at the end of the year.

So the first quarter you wouldn't have expected to see much increase in non-performing, given they'd have to get past due again, as a portfolio.

That started to happen in the second quarter, and that's part of the reason for the increase.

So it is behaving pretty much as we expected, and that's why we set aside $2.8 billion of reserves against that portfolio overall.

Okay.

So there's basically an aging process going on here, that probably will continue in the near term?

That's right, and that's the point we're making, around $2.8 billion of reserves established, and obviously, we'll have charge offs to fill that bucket up over time.

Okay, thanks.

Next question, please.

Your next question comes from the line of Mike Holton of Boston Company.

Morning Mike.

Yes, hi, good morning, guys.

Just two clarification questions.

Jim, you said you thought that the growth rate in MPAs peaked in the first quarter, is that right?

I said it may have.

May have, okay.

So MPAs grew 61% in the first quarter, and like, 29% in the second quarter, so given the economy is still weak, is it reasonable to assume that MPA growth could be somewhere between that 29% level in Q2, and then the 60% level in Q1?

It's very difficult to say.

I think the percentage piece is easier to pinpoint.

But the good news was that, from an absolute point of view, they didn't increase as much in the second quarter as they did in the first, and I think it's important to note we're not forecasting a big turnaround in the economy in the next 90 to 180 days.

In trying to tie it a little bit back to Nancy's question, one of the things we look at are these delinquencies.

As Rick mentioned, the delinquencies in some of the National City stuff, you can see on page nine, the past 90 day delinquencies went from 1.8 to 2.3 to 2.99.

That's the buildup of the real troubled assets.

The thing that we find encouraging is at the top of the page, where 30 to 89 past dues are holding steady at 2%.

So I think in some cases what we hope to find is that the bad stuff continues to just be bad and we've got to deal with it and earn our way through it, while the rest of the portfolio isn't deteriorating anywhere near the pace that we saw the first half of the year.

One thing I should point out to the audience on page nine is that this delinquency information includes impaired loans and un-impaired loans.

And I think if you look at the notes, you'll see that the impaired portion of that over 90 day delinquency is approximately $2.9 billion as of the end of June.

So the un-impaired book actually is improving a lot better than those, performing a lot better.

Okay, and then just the other clarification is your comments around comfort with second half estimates.

Are you comfortable with the consensus of 57 in Q3 and 53 in Q4, because is seemed like that would be heroic, and would require some extraordinary gains to get there, or is it more the range which has estimates a lot lower?

We use the range.

Okay.

And is the BlackRock in Q4 something that's going to help you too, do you include that?

No, we don't include that, but that should help us in the fourth quarter quite a bit.

Okay, thanks.

Next question please.

Your next question comes from the line of Gerard Cassidy RBC Capital.

Good morning, Gerard.

Good morning.

Couple of questions.

First, do the non-performing assets, the review of the non-performing assets this quarter, does that reflect the Shared National Credit Exam that just was completed, or will that be a third quarter event for you guys?

Where we're the agent, yes, but there may be further impact, where we're not the agent, the lead.

We're just the - -

I'm sorry, could you repeat that, you broke up?

That's all of the notifications we've received at this point, including our entire agency portfolio.

Okay.

The second question is on your slides on page nine, where you're talking about the return on average assets, the target rate going down into the future, that 1.30%, is that taking into account any heavy regulations that might be coming from Washington as they rework the regulatory environment for the banking system or the financial system?

I don't think there's any question we're considering that.

It's very difficult to quantify at this point, but I think we'll have more regulation and some of it quite frankly we agree with.

The systemic risk issues that we as a country have fallen into, as well as the industry, is certainly troublesome, and some of the consumer products that were created truly became problematic for all of us, so I think they have some really good ideas.

How they go about doing it, and whether they form a new agency or not, that remains to be seen.

But we're in agreement with some of it.

And to Jim's point, our historical performance has usually been 1.5%-plus, so we've kind of hedged back on that to the 1.3%, because there is a lot of uncertainty about some of these items.

Sure, and then finally on page 12 of the supplement where you give the new inflows of problem loans and your largest individual non-performing assets, I noticed in comparing it to the first quarter, that a large manufacturing credit appeared to fall off.

Did you guys re-work that out, or did you charge it off?

And also a mining credit came off?

Did you work that one out, or what happened to that one?

Well the big charge off (inaudible) manufacturing side, yes.

And then finally [in the Information Services Company that came on], that seems to be different than what you've seen in the past [or through those things].

Any color on that?

That's a highly levered transaction.

Thank you.

All right.

Next question, please.

And your final question comes from the line of Rick Weiss of Janey Scott.

Good morning, Rick.

Good morning.

Wondering if you could discuss whether the troubles at CIT have presented your middle market lending group with either challenges or opportunities?

In terms of CIT you said?

Yes, whether or not, has that affected the lending opportunities in your area.

I think it will.

Clearly in our business credit area.

We only participate in a certain portion of the activities of CIT.

Our business credit area is clearly involved in the more traditional inventory and receivable areas, so that I think that's important to note.

They do a number of things that we're not in, including in factoring and some software financing.

From a direct point of view it's a very [diminuous] exposure.

But the opportunity that you're mentioning I think could be, as it depends on what happens with CIT obviously, but clearly we have a number of credits that we share with them that we're very, very pleased to be sharing with them.

And to the extent that they decide to reduce their balance sheet, I think there might be customer opportunities for us.

Okay.

Thank you very much.

Thank you.

This concludes our call.

Jim, do you have closing remarks.

The only closing remarks, we believe that given the difficult environment we had solid results for the quarter, and I feel particularly good about the progress that we're making in terms of growing customers' revenue and managing the expenses with the integration of National City.

Again, we believe that we're working as hard as we can, and as we bring these two companies together, there'll be a significant amount of shareholder value to be gained.

Thank you very much.

Thank you.

This concludes today's conference call.

You may now disconnect at this time.