PNC Financial Services Group Inc (PNC) 2009 Q4 法說會逐字稿

Good morning.

My name is Tracy, and I will be your conference operator today.

At this time, I would like to welcome everyone to the PNC fourth 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, you may begin your conference.

Thank you, Tracy, and good morning, everyone.

Welcome to today's conference call for the PNC financial services group.

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

The following statements contain forward-looking information.

Actual results and future results could differ, possibly materially, from those 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's, and various other SEC filings available on our corporate website.

These statements speak only as of January 21, 2010, and PNC undertakes no obligation to update them.

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

These details may be found in today's conference call, press release, and our financial statements 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 would like to turn the call over to Jim Rohr.

Thank you, Bill.

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

Given the environment that we had in 2009, I believe this was truly an exceptional year for PNC, thanks for the hard work and the dedication of nearly 56,000 employees.

When I look back, 2009 was probably the most difficult economic year that I've seen in my 37 years of banking, which I think makes PNC's accomplishments all the more impressive.

For the full year and for the quarter, we had solid revenue performance, we managed our expenses effectively, and we continued to grow clients.

And in the second half of the year, we began to see signs that the pace of credit deterioration had eased.

We made substantial progress in transitioning our balance sheet throughout the year, working to institute our moderate risk philosophy throughout our expanded franchise.

And we ended the year with a better balance sheet, that had more transaction deposits, greater reserves, and higher capital ratios.

The acquisition of National City continues to exceed even our own expectations, and the client conversion process is proceeding smoothly.

And while the current regulatory environment remains uncertain, we expect greater reforms and additional regulatory changes.

Given our values and our operating principles, we believe that we're well positioned to navigate through this process.

Turning to 2009's financial performance, we produced strong results in a very difficult economy by successfully executing our business model.

We began 2009 with a strong deposit franchise, and ended the year with an even stronger one.

We remain core funded, with a loan to deposit ratio of 84% as of December 31.

By delivering full year revenue of $17 billion from our diverse revenue sources, I think we performed even better than some expected, and we're continuing to focus on expense management.

As you know, we increased our, our -- what do you call it, our guidance on the integration savings that we'll get from National City.

And we produced pretax, preprovision earnings that exceeded our credit costs by $3.3 billion.

Also, we added to our loan loss reserves throughout the year and in the quarter.

We added marks to our purchased impaired loans, and you know we already had fair value marks on those which were substantial.

Additionally, we added reserves to our mortgage book.

At this point, we feel good about our reserve coverage.

As a result of these efforts, PNC delivered full year earnings of $2.4 billion, or $4.36 per diluted common share.

And while I've said this before, it bears repeating.

Other than the fourth quarter of 2008 when we took the $500 million conforming provision for National City's acquisition, PNC has been profitable in every quarter since the economic downturn began in the middle of 2007.

Now turning to our customers, and perhaps most importantly, we continue to see strong product sales activity in the fourth quarter.

In fact, it was our best quarter of the year.

Our client retention trends are strong in all markets, as reflected in our solid revenue performance.

And we see meaningful product sales opportunities in legacy National City markets, and the results should continue to improve after we complete the customer conversions in the first half of 2010.

Retail banking had a solid year and continued to grow customers, when you exclude the required divestiture of the branches last summer, and we successfully implemented our pricing strategy with the acquired deposit franchise.

And while this results in lower net interest income credit to the segment, it adds significant value to PNC's bottom line.

And because of our conservative balance sheet management, we have further opportunity for increased profitability, should rates turn higher.

Our corporate and institutional banking segment had a very good year and a strong fourth quarter, despite the credit environment.

We continue to see soft loan utilization among middle market and large corporate clients.

However, we're seeing wider loan spreads.

On the fee income side, our solid Capital Markets results included higher M&A fees in the fourth quarter.

And we continued to see a strong performance throughout the year in treasury management and corporate finance fees, and our cross-selling of products and services to National City customers is increasing.

Our asset management group had a successful year, despite the difficult credit market conditions, strong revenue reflected the continued focus on client growth and retention.

Expenses were well managed, and the business pipeline is strong as we begin the new year.

Residential mortgage banking, as you know, had a good year.

Our strategic challenge in 2009 was to build a nationwide mortgage company that met our risk goals.

To that end, we successfully transformed this business.

PNC Mortgage is a top 10 retail mortgage provider, with new management, new operating processes, and a philosophy that reflects our moderate risk approach.

Global investment servicing saw its earnings increase from quarter to quarter in 2009, due to improvements in the equity markets, the benefits from expense reductions that were initiated in previous quarters, and from new customer acquisition.

In fact, all of their key servicing statistics increased throughout the year, resulting in full year earnings of $63 million.

Total fund assets serviced were $2.3 trillion as of December 31, and this business continues to have a strong sales pipeline, and I'm pleased with its relative performance.

The distressed assets portfolio is focused on maximizing the value of our distressed loans.

We continue to make good progress in reducing our foreclosed assets, and overall, we believe the marks that we have taken on these assets are appropriate.

Now let me talk briefly about credit availability.

PNC remains committed to responsible lending.

We recognize the vital importance of credit to our country's economic growth, and we continue to work closely with main street businesses and consumers during these financially difficult times.

In fact, we originated and renewed more than $110 billion in loans and commitments in 2009.

For homeowners, our goal is to avoid foreclosure where appropriate, and we've been expanding our use of short sales as one tool to help consumers.

Additionally, we've completed nearly half a billion dollars in refinances through the end of the fourth quarter under the home affordable refinance program.

And we've sent out more than 70,000 work out packages to troubled borrowers under the home affordable modification program.

On the commercial side, we continue to call on small businesses and corporations.

We have stepped up our efforts and are giving a second look to credit requests given the importance of credit to the economic recovery.

As a result, we originated and renewed nearly $4 billion in small business loans in 2009, and we continue to be a leader in loan syndications, arranging nearly $14 billion in business loans for the full year.

Now let me turn briefly to the integration of National City.

I'm very pleased with our efforts.

We successfully completed the first of four waves in November, converting 240 branches and 1.8 million customers, located in western Pennsylvania, eastern Ohio, and Florida.

Our next conversion wave will begin February 19, involving more than 1 million National City consumer and business customers in Kentucky, southeastern Indiana, and southern Ohio.

We expect to complete the customer conversion process at mid year, ahead of the original schedule.

As I have said before, this transaction is proving to be even better than expected, and it was positive to shareholders in the first year.

We made great progress in capturing the expense savings from the National City acquisition in 2009.

For the full year, we achieved more than $800 million in cumulative cost savings versus our original goal of $600 million.

We are now very confident we will achieve our new annualized cost saving target of $1.5 billion by June of 2011.

Achieving these cost savings goals sooner will enhance our ability to invest in our businesses today in order to deliver innovative solutions, and meet changing customer demands and build revenue momentum for the future.

Through the year, we've been using this score card to reflect the progress we are making as we integrate National City and apply PNC's business model to our new franchise.

And the results continue to be very positive.

Of course, these goals are not new.

Rather, these represent where we were prior to the recession and our acquisition of National City, and demonstrate our efforts as we work to transition our balance sheet and position the Company for future growth.

As evidenced by our full year performance, I believe we're making good progress against these targets.

And as we look ahead to 2010, we'll be focused on the following priorities.

First, we recognize that the current economic situation and soft loan demand will put some pressure on revenue.

However, we ended 2009 with strong sales momentum, and we expect to continue in 2010, as we see additional opportunities to utilize our balance sheet flexibility.

Second, we will continue to focus on effectively managing expenses, and achieving our cost saving targets and our credit cost improvement targets.

Third, we will continue to transition our balance sheet in an effort to reduce higher risk asset classes and to maintain our flexibility in the face of changing interest rate scenarios.

And fourth, we'll complete the conversions of National City clients.

And we see opportunities to gain clients across our expanded franchise, and provide them with a full range of products and services.

And finally, during the year we will continue to effectively manage our capital, and as for TARP, our plans are to repay it this year.

When the economy recovers, we believe we'll be well positioned to deliver returns consistent with our historical performance, in excess of 1.3% return on average assets.

Now, Rick will provide you with some more detail about our financial performance.

Thank you, Jim, and good morning, everyone.

Today I will focus on, one, the repositioning of our balance sheet to a lower risk profile, two, our continued ability to deliver pretax, preprovision earnings exceeding our credit costs.

Three, the stabilization of our credit quality, and the adequacy of our reserve levels, and four, the enhancement to our capital position throughout the year.

As you can see on Slide 6, we continue to be pleased with the progress we've made throughout 2009 in transitioning to a higher quality balance sheet.

Our loan portfolio decreased by $18 billion throughout the year, primarily due to lower demand for credit.

The decline was driven primarily by lower utilization levels for commercial lending among middle market and large corporate clients, although this downward trend in utilization rates seems to have eased in the fourth quarter.

Over the course of 2009, we increased our investment securities by $13 billion through the purchase of short duration, agency and government securities, resulting in a higher quality and more liquid investment book.

We continued that effort in the fourth quarter.

Over the course of 2009, the net unrealized pretax loss on our investment securities improved by $3.1 billion to $2.3 billion as of year end, reflecting better market liquidity for our credit sensitive securities.

The risk shifting and shorter duration of this portfolio has and will continue to result in lower yields in the portfolio in 2010.

During 2009, our transaction deposits increased by $15 billion.

Those increases were more than offset by the planned reduction of $12 billion of higher rate brokered CDs and $9 billion in retail CDs, along with a reduction of $13 billion in borrowed funds.

These reductions and lower pricing on the CD balances retained, resulted in a 91-basis point reduction in our cost of funds from a year ago.

Our balance sheet at the end of 2009 continued to be asset sensitive with the duration of equity of negative one year.

This is exactly where we want to be.

It positions us well for either a rising or steepening yield curve.

Overall, the actions we took in 2009 to reduce the risk profile of our balance sheet have worked well.

Now let's talk about how we've been able to deliver quality earnings at the same time.

In 2009, our ability to grow revenue and effectively manage expenses continued to deliver pretax preprovision earnings that more than covered our credit costs.

For the full year, we delivered $17 billion in revenue and $7.3 billion in pretax preprovision earnings, which more than offset $3.9 billion of credit costs, resulting in net income of $2.4 billion, or $4.36 per common share.

And driving a substantial increase in our capital position.

In the fourth quarter, we delivered more than $5 billion in revenue and $2.7 billion in pretax preprovision earnings, which more than offset a provision slightly more than $1 billion.

Fourth quarter net income was $1.1 billion, or $2.17 per diluted common share.

Excluding the BGI gain and integration costs, fourth quarter net income would have been $521 million, or $0.90 per diluted common share.

Non-interest income for the quarter of $2.7 billion was up over $900 million, primarily due to the BGI gain of $1.1 billion, partially offset by a $100 million decrease in residential mortgage revenues, primarily due to a decline in origination revenue.

During the course of the quarter, we increased our loan origination recourse reserve by $50 million to cover expected agency put backs of prime mortgage originations from our 2007 vintage.

Net interest income of $2.3 billion was up $123 million, resulting in a margin of 4.05%, driven by $140 million of final cash payoffs on impaired commercial loans.

It appears a work out process of these loans over the course of 2009 is starting to pay off.

However, I do not expect this level of recovery to continue in 2010.

Our fourth quarter provision for credit losses was slightly more than $1 billion, which is up $135 million from the third quarter.

The primary driver of this increase was due to additional reserves required for certain impaired consumer loans.

I do not expect this level of provisioning to continue.

So in effect, the net additional non-interest income from recoveries on commercial impaired loans was offset by additional reserves on consumer impaired loans.

As we look ahead to the first quarter of 2010, we expect net interest income, net interest margin, and the provision to be more in line with the amounts we reported in the third quarter of 2009, rather than the current quarter.

Now I thought you might be pleased to know that we have reinstated our purchase accounting disclosures on Page 8 of the financial supplement.

Better yet, we've even added to these disclosures.

Let me give you what I think is important about this information.

First, I believe the combination of the marks and the incremental allowance of $5.4 billion, or 36% on the impaired loans, continued to be adequate and appropriate.

Second, while we've added $500 million of provision on certain impaired loans in 2009, other impaired loans improved in value and we are expected to recover this value of $900 million over time, as we have increased our future accretible yield.

Finally, as we look to the first quarter, we estimated scheduled purchase accounting accretion of about $320 million.

Keep in mind that this could change if recoveries are better than expected, or values continue to improve.

We continue to manage our expenses effectively.

Our fourth quarter non-interest expenses were $2.4 billion, which was roughly flat linked quarter, as additional cost saves of $100 million exceeded a $66 million increase in integration costs.

Our quarterly run rate of acquisition cost savings increased to $300 million per quarter, or $1.2 billion per year.

Clearly, our ability to deliver strong revenue and managed expenses has served us well, and we have been more than able to cover our credit costs and increase capital.

Now, let's take a look at our credit quality trends on Slide 8.

Early stage and late stage delinquencies continued to show signs of stabilization, as both were essentially flat linked quarter.

While non-performing loans increased by $550 million, they did so at a substantially slower pace.

From last quarter, total non-performing loans were up 11% compared with the growth rate of 23% in the prior quarter.

You should also know that $220 million, or a third of the increase, was related to troubled debt restructurings, primarily of performing loans in the home equity and the residential mortgage portfolios.

Should these loans perform for six months according to the modified terms, they will be restored to the performing status.

As we have discussed before, our moderate risk philosophy calls for keeping our loan portfolio very granular.

For example, none of our non-performing assets were greater than $50 million at year end, and the largest is currently trading in the market at $0.90 on the dollar.

Net charge-offs are up this quarter from last by $185 million, due to commercial real estate, which was up by $233 million.

We were not surprised by the increase in net charge-offs, as we aligned our charge-off policy on small dollar commercial and commercial real estate, as a result of the consolidation of the bank charters.

This change in policy or alignment of policies increased our charge-offs in the quarter by $130 million.

Our provision for credit costs this quarter exceeded net charge-offs, contributing to a $262 million increase and the allowance for losses to $5.1 billion, or 3.22% of loans.

Given our 2009 net charge-offs, we have reserved coverage of nearly 1.9 years, which is one of the highest coverage levels in the industry.

Additionally, the mark on on our impaired loans was $4.9 billion at the end of the quarter.

This means we have $10 billion, or more than 6% of our loan outstandings in reserve, which provides substantial support against the risk associated with these assets.

Now, let's turn to Slide 9.

We continue to strengthen our capital ratios throughout 2009.

Our Tier 1 common ratio was consistently increased throughout 2009.

It has grown to an estimated 6% as of December 31, 2009, and the Tier 1 risk-based capital ratio increased to an estimated 11.5% at the end of 2009.

Since year end 2008, we've increased common equity by $4.5 billion to $22 billion, due to retained earnings and an after-tax improvement in our AOCL of $2 billion that I mentioned earlier.

All in all, given the environment, 2009 has been an exceptional year.

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

Thank you, Rick.

As I reflect on 2009, I'm very pleased with how we've performed.

Our proven business model continues to demonstrate its effectiveness.

Clearly, we have established a framework for success.

Our achievements only serve to enhance our ability to grow our banking franchise and to better serve our customers.

Now, turning to our expectations for 2010, first of all, we expect the economy to slowly improve.

Second, we anticipate that we'll be able to continue to grow our relationship based deposits, and that will be offset by additional runoff of higher cost time deposits.

And third, given the current economic conditions, we expect soft loan demand and low utilization rates.

Now, given these assumptions, and turning to net interest income, it will likely be modestly lower as a result of additional runoff of higher yielding assets.

This could be mitigated by rising interest rates and customer growth.

Now, when you exclude the hedging gains related to the residential market servicing, primarily in the first quarter, and the BlackRock BGI gain, we expect our customer-related non-interest income to be relatively flat depending upon the economy.

We anticipate meaningful expense reductions driven by integration cost saves, and finally, we expect that we will see credit cost improvements in line with the pace of the economic recovery, remembering what Rick said about looking more like the third quarter.

Putting these things together, we expect 2010 to be a good year, if the economy returns faster than we expect or if interest rates rise, it could be even better.

Thank you for listening, and we'll now take your questions.

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

(Operator Instructions).

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

Good morning.

Good morning.

Thanks for taking the call.

Question, couple questions.

One is on NIM.

And I know you gave very explicit guidance on the outlook for first quarter, that it should look more like third quarter.

But you also went through a little bit, your securities portfolio and how you're positioning for rising rates.

So could you just help us understand how you anticipate NIM trajects if your baseline 1Q, which reflects the loan book in the current securities portfolio positioning, would shift in a rising rate environment.

And what kind of benefits you would anticipate getting from how your securities portfolio is positioned and how you maneuver through that.

Well, the one thing is that, I mean with a negative duration of equity, it depends on how the rates would rise.

With a steep yield curve, which would give us an opportunity to go out the yield curve, maybe simply replace the securities that we have today, or add to those securities.

I mean that would be significantly beneficial if we had a steep yield curve.

If we have a -- if we simply have a rising rate environment and a 1% increase across the board, we would probably have a 1.5% to 2% increase in net interest income over the year.

So it really depends on how the yield curve would change, as well as how the rates would rise.

Yes, I think also, I would add to that, Betsy, our hope would be that lending returns.

And I think if we can do more lending in the new year, then we would have higher expectation as to what we think the margin can go from the first quarter.

As we replace it with securities, we'll be a little bit more challenged to be able to increase the margin from that level.

And if rates were to rise with the short end moving more than the long end and a flattening occurring over time?

That's why we are buying very short-dated government and treasury securities, so that we'll be able to take advantage of that.

Okay.

So that would be a net--

The fact that we're core funded helps us a lot in that environment.

All right.

So that would drive a result that's higher than your 1.5% to 2% outlook?

It depends.

It depends.

It depends on the, depends on the shape of the yield curve and how much.

I mean if it goes up 50 basis points, I'm not sure we're, I'm not sure that's a bet we want to make.

If it goes up 150 basis points, all of a sudden you start thinking differently about your investment opportunities.

Right, okay.

On TARP, could you just give us a little bit of an update on how you're thinking about TARP.

I know in the past you've mentioned that you would be shareholder friendly.

I'm sure you still want to be shareholder friendly, but can you give us some sense as to how you're thinking about, weighing the opportunity to repay and the desire to be shareholder friendly at this stage.

Well, we're simply, as you would expect, we're considering the various alternatives, and we fully expect, we expect to repay it this year, and then we're going to -- we would have, obviously have to have regulator approval in order to do that.

I think, we'll be seeing that take place over the course of the year.

Is it your sense that given the opportunity to accrete capital here over the course of the year that the ask from the regulators for capital increase goes down coincident with that.

Very difficult to speak on behalf of the regulators, as you know.

I'm just trying to get a sense, is it to your advantage-- .

Every day we open the paper, we see a new regulator.

Yeah, right.

I'm just wondering if it's to your advantage to wait until the end of the year as opposed to the beginning, based on the fact that you anticipate accreting some capital during the year.

It's really hard to say.

That's really hard to say.

Okay.

Last, on reserve build, you gave us a lot of color on what your expectations are for provisioning going forward.

Could you just shed some light as to how you're thinking about the reserve build?

Rick, maybe gave guidance-- .

That's a tough one to give at the moment, because what -- if you recall at the beginning of this year, we did set up almost $2.5 billion worth of reserves related to National City.

And so, as those charge-off comes in, at some point we are going to start to see more charge-offs than what we have today.

And we are starting to see the stabilization in all these leading indicators, the NPLs are only up 11% quarter over quarter.

I think if you actually included the impaired loans in that category, those that would be non-performing, we would have been flat from an NPL point of view.

So I think our growth rates are a little bit exaggerated, given the fact that we don't have the impaired loans in the non-performing statistics.

And then the delinquencies have flattened out.

So I think certainly sometime in 2010, we'll see those two lines cross.

But that's going to be really subject to the economy.

And that's the driver-- .

Our consumer charge-offs have been flat for three quarters now.

And with the delinquencies having been flat for that period of time, you would hope that would be a leading indicator as well.

Is it those lines crossing that drives your view on reserve build?

Well certainly, because we feel comfortable that we've set aside, at this point we feel comfortable with the reserves that we have for our loan book, as we know it today.

Okay.

Super.

Thank you.

Thanks, Betsy.

Next question, please?

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

Good morning, Mike.

Good morning, Mike.

Good morning.

You said third quarter NII margin provision should be like the third quarter, but you didn't mention charge-offs, and I guess charge-offs going from 650 to 835, that was a big jump, but you said 130 of that was due to the change in policy.

So do you get that back, charge-offs in the first quarter?

I don't think -- well, first of all, we're not going repeat the 130, so that was a one-time event in charge-offs there.

So clearly we're going to get a number closer, but I think you can expect charges to be somewhat volatile, as we said in the past, it's a question of timing.

I think the more important thing is where we are provisioning and where we have our reserve levels set, which we feel very comfortable with.

And on expenses, am I doing this math right?

Looks like you have an 18% annualized decline in non-interest expenses if you back out the integration costs.

So, down almost 5% linked quarter.

Well, certainly should be down, Mike.

I just haven't done that math, and we can do that for you and get back to you.

But there's no question that we are taking costs out.

You can see that in the personnel expense line.

It's down $100 million in the quarter.

You can see that in terms of the FTEs for the Company.

They are down all through the year, and we'll continue to do that through 2010, just, not only reducing personnel costs, but costs across the board.

So we feel real good.

As you know, we increased our goal from $1.2 billion to $1.5 billion and we're very confident we'll hit the $1.5 billion.

Sounds like revenues aren't doing a whole lot for you for the industry.

Are you confident that expenses can decline faster than any decline in revenues?

It's hard to -- I mean that's hard to predict.

But as we said, we think that revenues might modestly decline.

It depends on the economy and the interest rates, but revenues might modestly decline if the utilization rates and the loan demand stays where it is, but we expect the expenses to come down quite nicely over the course of the year, in the quarter and over the course of the year.

And I would keep in mind, Mike, in the revenue line, we have two very large hurdles in 2009.

We had the gain on BGI and we also had $350 million of hedging of the mortgage servicing rights.

So those are two big numbers to overcome as we go into the new year.

So obviously those will be down.

But does your guidance exclude the impact of those two one-time events in saying revenues should be lower?

Yes.

Okay, and then last follow-up, in terms of repaying TARP, would you be open to selling off assets?

I think there was some story that talked about PFPC, but just more generally, would you raise additional capital through asset sales that would allow you to repay TARP more easily?

We have no comments on the rumors.

By the way, you're dating yourself.

We changed the name of PFPC a little while ago.

I'm sorry.

Make me feel better actually when I call it PFPC, but anyway, we have no comment on rumors, of course, and we always look at all of the various opportunities from a shareholder point of view.

All right, thank you.

Next question, please?

Your next question comes from the line of Ken Usdin with Bank of America.

Good morning, everyone.

I was just wondering if you could give us a little bit more color on some of the moving parts within the commercial real estate.

Obviously the third quarter was low for the Tier recharge-offs, but then you saw a bigger bounce this quarter, as well as seeing increases in NPAs in both lines of commercial real estate.

So can we -- can you just walk us through kind of trends you're seeing, hot spot areas of concern, and how you expect that to kind of evolve as we move forward?

Well, let me clarify.

We had the charge-offs went up by about, looks like about $80 million to 245, 50 of that was just the change in policy.

So, remember I mentioned before, we had $130 million in total, $50 million related to commercial real estate, and the other $90 million or so related to the commercial book overall.

I think the key there is going to be, as we start to see some of these loans come ready for refinancing.

I think that's going to be the real trick for the commercial real estate market, and whether or not there's going to be a position to be able to get someone to step in and actually keep that project going and make sure that we're getting them financed at a decent capitalization rate.

So I think this is going to be something we'll be looking at and staring at for some time to come.

Okay, and I mean does that mean -- can you kind of give us a little color underneath the different parts of the book, as far as subcategories that are moving the right or wrong direction, whether it's retail, multi-family, office, et cetera, I mean is it just a general financing issue, or is it any piece of the book starting to see better light or worse?

Yes, it's all three.

Office, retail, multi-family, we're seeing a little bit of deterioration in each one of them.

But none of them are moving at a pace that we don't feel we can't cover through the earnings capacity of the Company and still be able to deliver strong earnings.

And keep in mind that overall, our commercial real estate assets are about 8% of total assets, so it's not a substantial issue for PNC like it may be for some other organizations.

That's a fair point.

One more question, if I could, just on the NIM.

Can you just help us understand what the kind of underlying NIM trends were?

We can back out the mathematically, but just as far as, benefits you could see from here on deposit pricing, just kind of how that core trend is going underneath the accretion?

I know there's some mix shift as you go over time, how one turns into the other, but just as far as how that core PNC part is doing?

We will continue to get benefit from deposit repricing.

We have another $27 billion worth of CDs repricing in 2010.

But what's happening I think is you're starting to hit a floor of how much you can reprice those.

And so the rate of value that we'll get from deposit repricing will start to slow.

It still means that overall cost of funding will go down, but not at the speed we saw in the current year.

And then offsetting some of that, you'll obviously have, some of that benefit is going to be the securities portfolio repricing, which will come down unless rates change.

And the real, real -- I think the real challenge is going to be what happens to lending.

I think if credit balances pick up, then we'll be able to offset that runoff that we're going to impact through the securities portfolio, and if it doesn't, then I expect through the course of the year, those -- the benefit from the deposit repricing will be offset by the decline in the securities side.

Okay, thanks a lot.

Yep.

Next question, please.

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

Good morning, John.

Good morning, John.

Hi, guys.

Rick, just following up on Ken's question on the NIM, so in your 2010 outlook for the NIM, do you assume that any of this cash recoveries, the 141 you had this quarter, do you kind of assume that that goes away or just fades?

Yes, we're assuming that's zero for next year.

Okay.

And then on the deposit accretion, you assume there's some, but not at the levels that we see in this chart here on Page 8, kind of shrinks a little bit, fades down?

I'm sorry, John.

So the deposit accretion, you mentioned that you still have some CDs maturing, but that number that we see on Page 8 that was 189 this quarter, that will start to come down throughout 2010.

Is that part-- .

No, that's correct, John.

I think if you look at Page 8 of the supplement, that $496 million that we had in the quarter on purchase accounting accretion, just remove $140 million, okay, so that will get you down to about $350 million.

That remaining $350 million will look a lot like $320 million in the first quarter of next year, so obviously the scheduled accretion will continue to go down.

But if we do continue to get payments in excess of where we have loans marked, then we could see an upward tick as a result of that.

But at the moment we're not assuming that kind of income.

Okay.

So you'll still have some accretion benefits in 2010 relative to what might be normal, but it will be less than '09.

And then the longer term is going to be dependent on interest rates and the lending?

That's right, John.

And I think 50% of that's coming from the deposits where we are capturing that value clearly and usually more.

The real question is capturing it on the asset side.

Okay, and do the sale of commercial loans, how did that impact your results this quarter, either in the other fee income or does that have any net interest income implications if you're selling previously marked loans?

It was very small, John, in this quarter.

And which line is it in, Rick?

Is it in the NIR--

It would be in other non-interest income, unless it was an impaired loan, in which case it would be in net interest income.

Okay, so there wasn't much impact from the selling of impaired on NII?

No.

And on the other other income, that was also small relative to total other other income?

That's correct.

Okay, so you said this last quarter, does that other other income that's been running around $300 million a quarter, do you feel pretty good about that run rate?

Well, it's been running $300 million a quarter for the last three quarters, probably even in excess of that, but then again, we've had a good run-up in asset values over the course of the year, so I think probably hitting the 3, I would say 3 to modestly down depending on where asset values go in the year.

Okay.

300 to modestly down, yes.

Okay.

Okay, great.

Thanks, guys.

Okay, John.

Next question, please?

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

Good morning, Matt.

Good morning, guys.

You've got a modest off balance sheet conduit, and if you could just remind us, is there going to be any drag to capital from consolidating the off balance sheet assets in general?

No, you're right, Matt.

We've got about $4.5 billion related to our conduit, and I think we have about another $2.5 billion on credit card securitizations.

So they will come on balance sheet January 1, but we've already reflected most of that in our capital ratios already.

So the overall impact might be 5 basis points.

Okay.

And that would include any additional loan loss reserve for those loans?

There will be a modest increase in loan loss reserves for that, but not something that's going to change our forecast.

Okay, and then just separately, if we look at the OCI at the end of 4Q versus September 30, it was relatively unchanged even though spreads on a number of asset classes narrowed, and I was just wondering what's going on there on a quarter to quarter basis?

Well, it was actually getting better from the end of the third quarter through the end of November, but in the month of December, rates went up, right, so rates rose in December.

That's what pushed it back up to those levels.

Okay.

So there's probably some movement where the lower risk stuff, the losses widened and the higher risk stuff from the CMBS, I assume some of those losses narrowed?

That's correct, yes.

Okay, and just in general, there's a zillion proposals out there in Washington, and I personally think a lot of them get watered down, but there is some talk when the new regulatory guidelines come, about including unrealized securities losses in regulatory capital, and I don't know if you've heard anything on that or worry about that at all.

Well, we've heard that discussion.

We've also heard that the FASB wants to fair value all loans and report them through either the income statement or AOCI depending on whether you're holding them to maturity or whatever, but none of those are finalized, and I think we'll continue to make our views as everyone else in the industry will on those points.

I think, I would hope we wouldn't be going in that direction and that would, by the way, be very inconsistent with what we have in terms of the international accounting standards.

So I would be surprised if we get out of step with the international standards at this stage, but it is on the table as a discussion point.

Okay.

All right.

Thank you very much.

Next question, please?

Your next question comes from the line of Paul Miller with FBR Capital Markets.

Good morning, Paul.

Yes, thank you very much.

Just moving over to the residential side, because I think everybody's pretty much went through the commercial side, but the home equity portfolio, which is a pretty substantial side, and I think some of that has already been marked down pretty substantially within that city marks.

But what type of experience are you seeing out there with all these HAMP programs, are you resubordinating the HELOC loans to modified loan, or do you write that down to market value?

Because it's very confusing out on our side how those HELOC loans are being treated inside these balance sheets.

Hello?

Yes, sorry.

Just don't have a specific answer for you on that.

We'll have to get back to you.

Sorry.

Okay, and then -- okay.

On mortgage banking, we've seen a lot of companies get hit with these reps and warrants because we've seen Fannie and Freddie and some of these other JCs get really strict out there.

Are you guys seeing any of that on the negative side?

I know you've not really strayed away from the basic mortgage originations, but I just wonder with the reps and warrants, where you guys stand on them.

Well, we, we absolutely have.

And we've started to, as I think I mentioned in my comments, we added $50 million to our recourse reserve related to Fannie and Freddie activity on our prime mortgage originations.

Going back to 2007, so what we acquired from National City.

And I think as you know, we didn't really start to see delinquencies associated with the prime mortgages until around the end of the second quarter, third quarter of this year.

And so that's what's caused that to increase, as well as the agencies have added personnel and staff in order to push back more loans.

So we think at this stage, with this extra $50 million, we're well reserved for it.

And this is all related to the previous National City platform.

Yes, I guess, so I guess you're on the hook from National City's underwriting, because I guess it was a merger?

Yes, we established, at the beginning, I think we set up originally $350 million of recourse reserves at the beginning of this year.

We've used some of that and we still have about $240 million remaining going back, and like I said, primarily related to 2007.

Since we have taken over the origination activities this year, we are in good shape.

We're not getting a lot of putbacks on our current activity.

Okay, thank you very much.

You're welcome.

Next question, please?

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

Good morning, Gerard.

Good morning, guys.

Question has to do with, you give us in the supplement the inflows of new problem credits every quarter.

And I believe when you do the math, you had about $2 billion of new loans that were performing in the prior quarter that went into the not performing status this quarter.

Could you share with us some of the color of those loans, if you have it, were they in the commercial or commercial real estate area?

And secondarily, did they mainly come from PNC legacy business or National City legacy business?

You're looking at from September 30 to December 31, increase in non-performing loans?

That's correct.

Looks like for the full year, you guys transferred in $8.5 billion.

And I think in the prior quarter, nine months, it was $6.5 billion or something like that.

Yes, and what I would say to you is, what you're seeing in terms of the growth from September 30 to December 31, you'll see the increase in the residential mortgage line.

That is primarily the troubled debt restructurings that we've done, so these are performing loans where people are actually paying coupon.

But we anticipate that they are going to have some financial difficulty in making those payments over time, so when we restructure it, we have to put it into non-performing for six months until that turns around.

And you're seeing, that's the run-up primarily in the home equity consumer space, as well as in the residential mortgage space.

And then second--

Other than that, the commercial side is pretty flat quarter to quarter.

Is flat.

And then you just have a little bit of a, still some increase in commercial mortgage and real estate projects.

And is there any color on the origination or origin I should say, of these loans, whether they are PNC legacy loans versus National City?

Is there any sense of a breakout, 50/50, 60/40?

I would say around 60/40, maybe 65% National City.

Mm-hmm.

And then as a second question, Jim, some of your colleagues have commented about this new fee that the Obama administration is looking to assess the banking industry for a number of years.

What's your guys' outlook for the probability of that passing and what's your guys' view on it?

Well, it's very difficult to assess the probability of that passing, and it doesn't make a lot of sense to me that we would have to pick up the tab for the car companies.

But, it's the regulator, the regulatory environment is what it is.

For us actually, it's not as bad as it is from other people because we're core funded.

And so the vast majority of our deposits, or a very significant portion of our deposits are federally guaranteed by our premiums that we pay to the FDIC.

So when they calculate the number, the number for us works out around $90 million, but now I read this morning, we're trying to figure out whether it's tax deductible.

The morning paper said it was.

So I think that's -- not that the morning paper always is the source of all accurate data.

But on a relative basis, it's not as -- the penalty isn't as large for us as it is for some of our peers.

Yes, if it is tax deductible, it's something like $0.13 a share for PNC, which is not a big impact.

Right.

Do you guys think that the unintended consequence, should this pass, that if you're a Goldman Sachs, or one of these companies that had an extremely large level of wholesale funding, that you now know that you've got to go out and chase retail deposits then you can pay up to the wholesale funding costs, plus your tax that you have to pay because you don't have the retail deposits, but we could see an incredible competitive market on retail deposits, should this thing pass?

I think there might be -- well, that's possible.

Or there might be the requirement that some of the other players change their business mix, because this -- you'll have to wait and see what kind of business mix they have.

They may decide that some of their activities simply aren't profitable enough to carry the incremental fee on the wholesale deposits.

I think that's going to be -- it will be an interesting process.

I think it increases the cost of doing the repo business by about 15 basis points.

So I think the people that have, the billion dollar fees are going to have to think about their business mix.

Appreciate the insight.

Thank you.

Next question, please?

Your next question comes from the line of Matt Burnell with Wells Fargo Securities.

Good morning, Matt.

Good morning.

Thanks for taking my questions.

Most of my questions have been asked and answered, but I guess I have a couple of theoretical questions for you.

First of all, just to follow up on the last question that was asked about the TARP fee, given that most banks, including PNC, have been buying treasury, shorter duration treasury and treasury-related assets over the past couple of quarters, does the TARP fee, should it be instituted, have any effect, potential negative effect on the valuations of those securities that you hold in your portfolio?

I don't think so.

Not that I'm aware of, no.

Okay, and then the second question relates to acquisitions, and I know you're talking about trying to repay TARP, and you're more focused on National City these days, trying to get that put to bed, but how should we think about your appetite for acquisitions, either from the FDIC or perhaps further down the road, excluding the FDIC?

At what point would you feel comfortable looking at material acquisitions in 2010, if at all?

Acquisition opportunities come along at different times.

It's not something you can have a policy for or set an expectation for.

I mean, the National City acquisition is a perfect example of unique opportunity came along.

We believe that we purchased it right.

The fit turned out to be more than perfect, and the execution is, as I mentioned a number of times, ahead of schedule.

So I think the opportunity for us right now is to get this right.

I mean to the extent that we get this all converted, get these cost savings taking place over the next 18 months, that we enhance the cross-sell opportunity that we have, that we have in all of these new markets, as well as continue to execute it in the historical markets.

I think from a shareholder point of view, that's the number one, two, three thing we can do, is to make sure we take full advantage of really opportune acquisitions.

That's what's on our plate right now, is to simply execute.

With regards to the FDIC, we've passed -- we have elected not to bid on about two dozen opportunities that have been shown to us, and who knows if there's a perfect opportunity or not coming along.

But, again, we're -- the focus on executing around the National City acquisition is our prime priority.

So it's fair to say that you have not seen an FDIC assisted deal that you felt was compelling enough for you to bid on.

That's correct.

Great.

Thanks very much.

Next question, please?

Your next question comes from the line of Matthew Schultheis with Boenning and Scattergood.

Good morning.

Good morning, gentlemen.

Couple quick questions and things I know you've covered that I missed.

What was the reserve -- excuse me, the recourse reserve amount for the quarter, again?

It was $50 million recorded in the fourth quarter.

Our total recourse reserve is about $230 million, $240 million.

And is that $50 million reflected in the mortgage segment?

It, is and you can see that in the origination revenue being down for the quarter.

Okay.

And what were the trading games for the quarter?

We, we basically no longer have a proprietary trading desk and we do have customer-related trading activities, and I think that number, I would have said is probably somewhere around $30 million to $40 million.

But I'm going to have somebody double-check that at the moment.

Okay.

That's fine.

Just wanted to get a ballpark there.

And you don't have any -- okay, okay.

And of the linked quarter cost savings that we saw, how much of that was tied to the branch divestiture and how much of that was tied to just getting more efficient with ongoing businesses?

The actual impact of the divestiture -- it was pretty small.

Yes.

Pretty small.

A lot of this is just, if you take a look at the personnel line, it's the reduction of positions.

It's the reduction in our real estate costs, reduction in the cost of acquiring services.

It's just across the board.

But the area where you see it the best is right there on the personnel line.

Okay, all right.

That's it for me.

Thanks.

Thanks.

We're approaching eleven o'clock.

We've got time for one more question.

Your last question comes from the line of Heather Wolf with UBS.

Good morning, Heather.

Good morning, Heather.

Just a couple of follow-ups on the margin.

First of all, Rick, when you were talking about the future margin hinging on kind of lending activity, is that lending activity in its entirety, in other words, net of the runoff of the impaired portfolio?

Or are you thinking about it more from a gross perspective, new originations?

I'm thinking from a gross perspective in terms of new originations, because new originations will add better spreads onto the portfolio.

And I think that that will help us to offset some of the runoff that you're seeing in both runoff and paydowns and so on in the distressed book, primarily.

Okay, and then one quick follow-up.

When you quote us your asset sensitivity, can you talk a little bit about what kind of deposit duration is embedded in that, or how much pass through you expect when the fed does start tightening?

We don't, we don't usually share that information.

There's a lot of estimates associated with that, and we haven't in the past shared that duration of our deposit base.

Well, qualitatively, would you expect the passthrough to be roughly equivalent to what we've seen in previous tightening cycles?

You say the passthrough.

I'm trying to follow your question.

I'm sorry.

So the percentage of the rate increases that you actually pass through to your deposit customer.

I see, I see.

I think that's going to be the question, right, because I think as short-term rates go up, how much can, how much can you lag if you like the increase in rates, and I think that will depend on competition in the marketplace.

There's a lot of factors that are going to have an impact on that, because obviously if we're lending at that point, growing the balance sheet, then we'll obviously want to continue to fund as much of that as we can through the deposit growth.

Part of the corporate banking book is floating rate, so it's all LIBOR-plus.

So to the extent -- and that's a very big book for us.

I would say only about a half of the home equity loans are floating rates.

So it's a mix of products, and so it depends on which products, of course, are growing as well.

So -- but we would be able to pass through a significant portion of it, I'm sure.

But it doesn't affect us quite that much because we're so core funded.

We only lend out 84% of our books.

So to the extent that we have significant loan growth, we can grow loans right off of the base of our deposit base without having to experience the wholesale funding.

Got it, thank you very much.

Very good.

I think that concludes the question and answer.

Jim, do you have any closing thoughts?

Thank you very much for your interest.

We think it was a very good quarter and a very good year and we're looking forward to 2010.

Thank you very much.

This concludes our call.