PNC Financial Services Group Inc (PNC) 2010 Q2 法說會逐字稿

Good morning.

My name is Sherette, 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 investor conference call.

(Operator Instructions).

Thank you.

Mr.

Callihan, you may begin your conference.

Thank you, and good morning.

Welcome to today's conference call for the PNC Financial Services Group on what I know is a very busy morning for all of you.

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 events 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, related materials and in our 10-K and 10-Q and other various SEC filings available on our corporate website.

These statements speak only as of July 22, 2010, and PNC undertakes no obligation to update them.

We will also provide details of the reconciliations to GAAP of non-GAAP financial measures 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 also all available of our corporate website, at PNC.com, in the Investor Relations section.

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

Thank you, Bill.

Good morning, and thank you for joining us.

This was an excellent quarter for PNC from both a financial and strategic standpoint.

We have executed our business plan in the first half of this year, and are well-positioned to deliver solid results in the second half.

I will say more about the financial results in a moment, but first I would like to highlight some of our strategic accomplishments.

The first one, we completed the final wave of National City customer and branch conversions last month.

I believe this process was handled as well as any large client conversion that's been done in the banking industry.

In total, we brought six million retail business clients in nine states onto PNC's technology platform.

We completed the process six months ahead of our original schedule.

Client retention was within our expectations, and we have already significantly exceeded our original cost savings target.

Second item, sales across our franchise were 126% of plan through June 30th.

On a linked quarter basis, total sales were up 6%.

In our western markets, sales were 113% of plan through the first half and up 15% linked quarter.

I believe that this reflects our customer focus throughout the conversion process, and what I'm very pleased about is the rate of customer penetration in our corporate bank.

Across the Company, cross selling is at 132% of plan year-to-date, and the western markets is 110% of plan through six months.

While not as robust as the levels in our eastern markets, this reflects both the tremendous progress we are making and the opportunities for growth.

With the conversion behind us, we are now investing in people to help us serve our customers in these markets, and we are implementing the PNC business model across the entire franchise.

Now another strategic highlight this quarter was arranging for the sales of residential mortgage loans and brokered home equity loans in our distressed asset segment.

While the income statement effect of this sale is recorded in the second quarter, the balance sheet effect will take place in the third quarter as those sales close.

It's important to note that the majority of these loans are seriously delinquent, and they represent approximately $2 billion in customer balances.

With the market for these loans opening up, we see this as an opportunity to reduce risk with reasonable valuations, and Rick will discuss this in more detail in a moment.

Finally, the regulatory reform legislation is now in place.

We support many of the changes, such as the creation of a systemic risk regulator and the extension of consumer protection laws to non-bank financial companies.

We believe core elements of the bill should contribute to a stronger, more secure financial system over time.

There are a variety of issues in the legislation that we are currently studying.

There is much more to come in the hundreds of regulations expected over the next few years.

One thing is clear; the reform bill will impact revenue and increase the cost of doing business.

However, we believe that the expected changes will be manageable for PNC and will have a smaller impact on us than the Wall Street banks.

Now another important topic is capital, and we are well-positioned from a capital standpoint.

We closed the sale of Global Investment Servicing on July 1st, which added to our capital.

As of June 30th, our estimated Tier 1 ratio was 10.8%, and pro forma as of July 1, after the sale of GIS, Tier 1 would be 11.4%.

The Tier 1 common ratio was 8.4% at the end of the quarter estimated; and reflecting the sale of GIS, the pro forma as of July 1 is 9% for Tier 1 common.

Since we closed on the National City acquisition, we have nearly doubled our Tier 1 common capital ratio when the impact of the GIS sale is included.

Now overall, this was an exceptional quarter for PNC and we are well-positioned for future growth, despite the challenging economy.

Now let me provide you with some highlights of our financial results.

We produced second quarter earnings of $803 million or $1.47 per diluted common share.

That's a 20% increase in net income on a linked quarter basis.

Excluding integration costs of $0.13 per diluted common share, second quarter earnings per diluted common share would have been $1.60, an increase of 22% on a linked quarter basis, after adjusting the first quarter for integration costs and the early redemption of our TARP preferred shares.

Page 16 of the press release summarizes these adjustments.

For the first half of the year, our net income of $1.5 billion was double that of the same period in 2009.

Starting with revenue, our second quarter net interest income was up linked quarter, reflecting our ongoing success and repricing our deposits and lowering borrowing costs, somewhat offset by lower yields on investment securities.

Non-interest income was up linked quarter, primarily due to higher loan servicing and residential mortgage loan sales revenue, debit card income and net security gains, partially offset by declines in our more market sensitive fee categories.

Regarding credit costs, our second quarter provision was $823 million.

Excluding an additional provision of $109 million related to the arranging for the third quarter sales of some distressed assets that I mentioned, the amount is lower than our first quarter provision of $751 million.

Assuming continued economic growth, we believe that the credit quality has stabilized and some metrics are showing signs of improvement on a linked quarter basis.

Namely, our delinquent loans and our non-performing loans have shown meaningful declines.

Our second quarter expenses were down 5% linked quarter.

Enough said.

Our financial results, frankly, were driven by our business segments, and we are seeing growth opportunities throughout our expanded franchise.

Retail banking remained focused on expanding and deepening customer relationships.

Checking relationships grew by 20,000 during the second quarter of 2010, and our goal is to deepen these relationships.

We saw active online bill payment grow by 5% during the second quarter alone.

Our corporate institutional bank had a very good quarter.

While loan demand remains tepid, we are focused on our goal of adding 1,000 new customers in our corporate bank this year, which would double our new client growth for the combined Company.

Through six months, we are on target -- we are on track to reach that target.

Now with more of our clients on one platform, we saw increases in treasury management revenue in the second quarter.

For the first half of the year, treasury management revenue was up $40 million to $600 million, an increase of 7% over the same period last year.

Earnings for our asset management group were affected, as you might guess, by the second quarter declines in the equity markets.

In the quarter, this segment remained focused on deposit growth and adding customers and expense management, and this will position the business for improved profitability as the market rebounds.

Our residential mortgage business posted good second quarter results.

Application volume increased, largely due to seasonal factors.

I would have to tell you that this business is making great progress as it transitions to a more moderate risk position.

A new mortgage origination system was implemented to better serve clients and manage risk, and our mortgage business is continuing to rebuild its sales force, which should help to drive increases in high quality loan originations.

Regarding our distressed assets, this portfolio of $17 billion is down $4 billion since the same time last year, primarily as result of paydowns, net chargeoffs and dispositions.

However, the sales I mentioned earlier are not reflected in this decline because they haven't closed yet, and we are making progress in managing the risks and returns on our distressed loan portfolio.

Now BlackRock had a very good second quarter.

Their net income increase linked quarter nearly doubled that of over a year ago.

They are making good progress in their merger with Barclays Global Investors, which made them the largest publicly traded investment management firm in the world, with more than $3.1 trillion in assets under management.

At the end of the second quarter, our share of BlackRock's earnings was 23%.

Overall, I believe that we achieved excellent strategic and financial results in the second quarter, but I would like to spend a few minutes talking a little bit in detail about our well-positioned balance sheet.

Turning to slide four, we believe that our balance sheet differentiates us.

It remains highly liquid, and it's well-positioned for the current environment.

On the asset side, we remain patient with our investment securities and continue to focus on short duration agency and government securities.

Total loans were down 2% in the second quarter, which we believe was consistent with industry trends.

Loan utilization remains soft across the country; however, the pace of contraction appears to be slowing as we begin the third quarter.

We recognize the vital importance of credit to our country's economic growth.

We originated and renewed approximately $40 billion in loans and commitments in the second quarter, $72 billion for the first half of the year, which includes more than $2 billion in small business loans.

And additionally, we are committed to working with homeowners to help them avoid foreclosure where appropriate.

We completed approximately $1.5 billion in refinancing out of the Home Affordable Refinance program from the inception of the program through June 30th.

Now we've also set out approximately 86,000 workout packages to troubled borrowers under the Home Affordable Modification program.

Now on the deposits side, transaction deposits were relatively flat linked quarter, but up more than $5 billion year-over-year as we have been embracing -- enhancing our deposit mix with a focus on customer relationships and increased profitability.

We have a strong deposit franchise, and we remain core funded with a loan to deposit ratio of 86% as of June 30.

Our balance sheet as of June 30 remained asset sensitive, with an estimated duration of equity of approximately negative three years.

Our balance sheet provides with us the capacity to support clients as the economy gains momentum, and at the same time our position allows for patience in the event economic conditions are slow to improve in a meaningful way.

We also saw growth in common equity of $1.2 billion linked quarter, and this does not include the positive impact from the July 1st sale of Global Investment Servicing.

Overall, this was a very strong first half, and we accomplished a lot.

And now Rick will provide you with more detail about our second quarter results, beginning with our ability to deliver high quality earnings.

Rick?

Thank you, Jim, and good morning, everyone.

Today, I will focus on, first, our strong financial results and the key drivers of our pre-tax, pre-provision earnings; second, the stabilization of our credit quality and the improvement in some our credit metrics, our related credit costs and the adequacy of our reserve levels; and third, our continued improvements in the quality of our capital structure.

In the second quarter, our well-diversified revenues increased and we reduced expenses.

This allowed us to deliver pre-tax, pre-provision earnings and more than doubled our credit costs.

As you can see on slide six, we delivered $3.9 billion in revenue in the second quarter and $1.9 billion in pre-tax, pre-provision earnings compared to our provision of $823 million.

Now let's begin with the components of revenue.

Net interest income of $2.4 billion and our net interest margin of 4.35% for the quarter were up modestly from our first quarter results.

A key driver is the ongoing repricing of our deposit base and higher than expected interest income on impaired loans, the latter which you can see on page seven of the supplement.

Our cost of deposits in the second quarter was 71 basis points, down 10 basis points linked quarter and down 54 basis points year-over-year.

We have approximately $14 billion of relationship based CDs with an average rate of more than 2% that are scheduled to mature during the remainder of the year.

Assuming rates stay low, and I believe they will, we will continue to reprice these deposits and lower our deposit funding costs even further.

Our total yield on interest earning assets declined linked quarter.

While loan yields were up slightly due to higher than expected interest income on impaired loans, this improvement was more than offset by a 27 basis point decline in the yield on our investment securities portfolio.

This downward trend reflects the continuing migration of the portfolio to lower risk asset classes such as US Treasury and US agency mortgage backed securities, along with the impact of the lower rate environment.

The yield on new security purchases has declined significantly as interest rates have declined.

Looking forward, retail deposits should continue to decline, albeit at a -- retail deposit costs should continue to decline, albeit at a slower pace than we have seen in previous quarters.

And I do expect interest income on loans and loan yields to decline, as the contribution from impaired loans will decrease, looking more like the contribution in the first quarter.

In addition, yields on securities will continue to decline as we replace maturities and prepayments with lower risk securities in a low rate environment.

As a result, you would expect to see the net interest income and yield on earning assets to decline, putting pressure on net interest income and the margin in the second half of the year.

Non-interest income of $1.5 billion was up 7% linked quarter.

The sources of our non-interest income remain high quality and well-diversified.

While client flows remained strong, asset management fees were affected by declines in equity market values, resulting in a 6% decline linked quarter.

Consumer services and service charges on deposits were up 6% linked quarter, primarily due to higher transaction volume related fees and seasonality.

We expect that the new Regulation E rules related to overdraft charges will negatively impact our second half revenue by an estimated $145 million.

Corporate service fees saw higher merger and acquisition advisory fees in the second quarter.

However, overall fees were down marginally linked quarter, primarily due to the exceptional special servicing revenue from commercial mortgage loans in the first quarter.

Residential mortgage fees were up 22% linked quarter, mainly due to higher loan servicing revenues and improved origination volumes.

Net gains on security sales and the impact of OTTI contributed $53 million in the second quarter compared to a loss of $26 million in the first quarter.

Security gains for the quarter were primarily driven by sales of US agency residential mortgage backed securities and US Treasury securities.

Looking ahead, we anticipate ongoing improvement in the OTTI as the economy recovers.

Finally, total other non-interest income was down, primarily to lower customer related trading revenues.

Now once again, the diversification of our non-interest income revenue streams delivered good value in the quarter.

As Jim mentioned, expenses declined 5% linked quarter, primarily due to the reversal of certain accrued liabilities, with $73 million related to a franchise tax settlement and $47 million associated with a litigation indemnification.

Now if you go to slide seven, we will take a moment to talk about our cost savings targets.

We captured another $50 million of savings in the quarter, bringing us to $800 million in annualized acquisition-related cost savings in the first six months of the year, and our 18 month total comes to $1.6 billion.

Our new goal for the end of 2010 is $1.8 billion.

If you recall, our original cost savings target of $1.2 billion represented 10% of the expense base of the combined Companies.

When we reach $1.8 billion at the end of this year, we will have reduced the combined expenses by 15%, six months ahead of schedule.

At the same time, we have remained focused on making investments in support of new customers and product development.

Now let's take a look at our credit quality and cost trends on slide eight.

Overall credit quality continued to stabilize, and delinquencies and non-performing loans showed signs of improvement.

All delinquencies were down approximately 25% in the quarter compared to the linked quarter, and for the first time since the recession began in 2007, our non-performing loans declined.

On a linked quarter basis, non-performing loans decreased by almost $0.5 billion dollars or 8%, driven by a substantial reduction in loans transferred to non-performing loans, which you can see on page 11 of the supplement.

Our provision of $823 million in the second quarter is an increase of $72 million compared to the prior quarter and net charge of $840 million increased from the prior quarter by $149 million.

As Jim mentioned, we made a strategic decision during the quarter to sell some of our residential mortgage and brokered home equity loans in our distressed asset segment.

These loans, the majority of which are seriously delinquent, reflect customer balances of approximately $2 billion and represent a carrying value of approximately $1 billion.

As a result of the planned dispositions, we increased our provision and our chargeoffs by $109 million and $75 million, respectively.

We expect these sales to close in the third quarter.

Now even with the impact of this sale decision, our ratio of net chargeoffs to average loans, while higher than last quarter at 2.18%, compares favorably to industry ratios.

Now we are beginning to see some more liquidity in the market, providing opportunities to sell our distressed assets to avoid future deterioration and servicing costs.

For example, the residential mortgage sales included more than 8,000 loans, the majority of which are seriously delinquent.

We believe these actions are prudent, as they will accelerate the reduction of future credit costs and allow us to redeploy our resources to loans with a higher probability of recovery.

Now even with the final conversion to PNC systems, we also increased our reserve coverage on our remaining portfolio of impaired loans by approximately $200 million.

We remain comfortable with our reserve coverage, including our $5.3 billion allowance and our marks of 27% on our impaired book.

Clearly, our ability to deliver well diversified revenues and manage our expenses continues to drive positive operating leverage and provides with us the ability to effectively manage our credit costs while still increasing common capital.

Now as shown on slide nine, our Tier 1 common ratio at end of the second quarter is estimated to be 8.4%, primarily as a result of second quarter earnings and our lower balance sheet.

Since year end, our Tier 1 common ratio has increased by 240 basis points.

The pro forma ratio of 9% reflects the gain from the sale of Global Investment Servicing and the elimination of the related intangible assets on our balance sheet.

The estimated net impact on capital from the sale is $1.4 billion.

We now have a higher quality capital base, with 78% of our Tier 1 risk based capital in common equity up from 50% a year ago.

Our capital position provides with us the flexibility for future growth while investing in innovative products and services.

At PNC, we have a disciplined approach to capital management which we believe serves us well.

And with that, I will hand it back to Jim.

Thank you, Rick.

Slide ten is the scorecard that we have been using to measure our progress, and we have made great progress in the second quarter.

Our focus now is on lowering our credit costs and growing revenue.

We are making good progress on credit, and with the completion of National City's branch conversion, we are in a better position to provide fee-based products throughout a larger franchise.

Over time, we expect to increase the percentage of non-interest income to total revenue.

Our return on average assets in the second quarter was 1.22%, and 1.12% through the first half of the year.

We now have the branch conversions behind us with the passage of financial regulatory reform.

With that, and our first strong first half performance, we have confidence to increase our return to average assets goal to 1.5% or greater, which is closer to our historical levels of performance.

Clearly, we remain confident in our ability to achieve these strategic financial objectives over time as the economy recovers.

Finally, let me update the guidance we provided last quarter on our 2010 full year forecast as compared to the prior year.

This forecast assumes a slow growth economy and continued low interest rates for the remainder of the year.

First, we expect some pressure on net interest income in the second half of the year.

However, we remain confident in our ability to keep revenue performance stable year-over-year; but this expectation, of course, excludes the impact of last year's BlackRock BGI gain.

Second, our overall credit quality has stabilized given the signs of improvement we are seeing.

We are optimistic, frankly, that the loss provision will decline in the second half of the year, primarily because of declining delinquencies and non-performing loans.

And third, we have demonstrated our ability to effectively manage expenses.

As a result, we continue to believe that our pre-tax, pre-provision earnings will substantially exceed credit costs, and we believe we are on target to deliver a strong full-year 2010 and are comfortable with the range of the second half estimates for PNC.

With that, we will be proud to -- we have been proud announce the second quarter, and we'd be happy to take your questions.

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

(Operator Instructions).

And your first question comes from John McDonald.

Good morning, John.

Hi, good morning.

Rick, I was going to ask you a question about the NIM, and I was going to go with the virtual wallet, but I figured I would start with the NIM.

Fair enough.

So the forward guidance for some pressure on NII and NIM is the assumption that the cash recoveries would go closer to the $75 million that you had in the first quarter?

Is that what you said?

Yes, John.

I think you will see that -- the cash recoveries in this quarter, that that line item -- which are somewhat like one-time items -- was $164 million.

I would probably predict that back to $75 million, and I think if you also look at the accretion table, you will see that that went up a little bit in the quarter; I would go back to the third quarter numbers.

So just a shorthand, I would expect the net interest income on impaired loans to drop by about $100 million next quarter from this quarter.

Okay, so that's the total, right?

That was $376 million, and the $164 million this quarter?

Yes, that's correct.

Okay, because the other line in there is, I guess, the deposits -- the accretion from the deposit repricing, you will still get some, but that's going to fade?

It already started to go down from $167 million to $144 million.

Is that the line that's driving that down?

No, John.

It's just the balance of what we are able to reprice is coming down.

So we have got $14 billion remaining to be repriced between now and the end of the year.

A lot of that is back end loaded.

We will get some of that in the third quarter, but see a lot more of that in the fourth.

Okay, so all in, accretion looks like $100 million less, is your best guess?

That's a good guess.

Yes, I think that's a start.

Okay, and moving into credit, what drove the additional provision for the SOP3 impaired loans this quarter?

Well, we had a couple.

One was the sale we mentioned, which was about $110 million, John.

Additionally, in the consumer book, as we move loans -- and we converted all of the impaired loans this quarter -- we are able to take a look at some additional credit information of credit bureau data research so we could cross match it against whether those customers had auto loan delinquencies or credit card delinquencies, and so we caught up on some of those reserves.

That drove about $100 million of that reserve there.

And we had -- some of the commercial book had $100 million in reserve, and that was primarily real estate appraisals.

So we think having gotten through all that, a lot of that has been caught up now.

Okay.

So I mean, you didn't give a specific provision outlook, but absent the $109 million for loan sales and then $200 million for impaired loans, I mean, "x" those things, your provision run rate on the quarter looks $300 million lower.

Is that fair just to exclude those things?

Well, it's fair to definitely include the sale.

I think the others, we hope we are optimistic that that is exactly the case, an d hopefully what you are suggesting is how it will play out.

Okay.

But I can't make a prediction on that.

You are looking at more at a core -- at the core chargeoffs for the portfolio if you "x" out the sale on the $200 million for the --

Right, right.

It seems like it's down $300 million.

Okay.

Thank you.

Next question, please.

Your next question comes from Matt O'Connor.

Good morning, Matt.

Hi, guys.

If I could just follow-up on John's net interest income question.

If we take out the purchase accounting accretion and the cash received number -- I realize those can be volatile -- but if we think "x" that, just the underlying net interest margin and the underlying net interest income dollars, how should we expect that to perform in the back half of the year?

Yes, I think the challenge is going to -- clearly, the low interest rate environment is going to put some pressure on that.

But the real determination is going to be loan growth.

If we are able to replace loan runoff, then I feel pretty good about that.

If we can't replace loan runoff, then that will be a challenge.

Okay.

And then your best guess at this point in terms of being able to get some loan growth?

It's a pretty challenging environment, and -- Jim?

I would say that what we have seen is the decline has slowed dramatically.

And so we are still seeing some decline, but it's not like it was over the last 18 months.

And we are -- there are pockets of loan demand that we are seeing, especially in the business credit space.

But the utilization rate by middle market and above companies is still at an all-time low, so I think if we are flat for the rest of the year, I think we would be pleased.

Okay.

And then just separately, I know we don't know what the new pricing for interchange will be, but can you remind us what your actual revenues are for the debit card interchange?

Yes, we are about -- for the first six months of this year it's about $215 million, so obviously it would only be a portion of that that we might lose.

Yes.

Okay, and then lastly, this is a little bit of a -- I guess just a nuance, but if I look at the other intangible assets, they came down a fair amount quarter to quarter.

And obviously that's accretive to capital, and I didn't know what was driving that.

I think it went from $3.3 billion to $2.7 billion.

Yes, you had two factors.

One is the MSRs in our residential book came down about $300 million, and we also sold Red Capital, a subsidiary we had there, which also had mortgage servicing rights; so the two of those together is what the decrease is.

Okay.

All right.

Thank you very much.

Sure.

Next question, please?

Your next question comes from Mike Mayo.

Good morning, Mike.

Hi, Mike.

Good morning.

So you increased your ROA target from 1.3 to 1.5.

What was your thinking behind that, and why now?

Well, I think we are more comfortable with the cost save number that we have been able to achieve.

There's no question about that.

Obviously, we are optimistic about the provisioning in the second half of the year as a result of the delinquencies and non-performing loans, and we finally had the financial reform in place, and I think we have a better handle on what that might mean to us.

And so if you take out the integration expense in the second quarter, we were pretty close to 1.3 in the second quarter alone, so the idea of moving to 1.5, I think, is something that we are comfortable that we could achieve.

And when do you think you could get there?

Well, I think part of that is you've got to tell me what the economy is going to do.

If the economy continues to have a slow growth, I think we can achieve that over time -- over a reasonable period of time.

The real question is do we get loan growth back?

And if we get loan growth back, then maybe we don't get the 1.5 in assets, but net income goes up significantly, and so we would actually prefer -- it's a little interesting.

I mean, we would prefer perhaps not to hit the 1.5 and get a lot of loan growth, which would enhance EPS.

So it depends on how the variables work together, as you well know.

Yes, and Mike, the 1.5% was never a specific date.

It was what the business model can achieve through the cycle.

And let's assume there is not much loan growth for a while.

What are some of your options of how to deploy your capital, and when might we see you deploy some of your capital which is higher than a lot of peers?

And what about the next acquisition, since National City so far has gone well?

Well, I think that when you look at the capital position, I mean, all depends on how long, right?

I think how long we have this kind of environment; and if you assume that the loan demand returns in the first quarter of next year, we will be pretty pleased about that, and life turns out to be pretty good.

If rate goes up for whatever reason -- which we are not expecting, I might add -- our being able to invest in the higher yielding assets with our low cost deposits is a real enhancement for the shareholder as well.

If we remain in this kind of a doldrums, which we could, I think we have the ability to continue to take out costs; but we're not going to bet on 2% treasuries, because that's just -- that's creating another problem for yourself.

So I think we have the ability to bring down credit costs and bring down operating costs in order to utilize -- in order to generate EPS; and the other part is, if we have excess capital, if loan demand continues to fall, I think at some point we return the capital to the shareholders.

And Michael, like you, we would all like to have more clarity on what the capital rules are going to look like, and we all have to wait until the end of the year presumably to get a better read on that.

So given that, we are in a position where we are growing capital and we want to be on the high end of that compared to our peers whenever determination is made to run capital standards.

And you say end of the year.

I mean, how do we know when that milestone happens?

It sounds like you are waiting to return capital for more clear indication regulators.

Why at the end of the year do you think you will get that?

That's the prediction right now as to when there's going to be clarity around (Inaudible), and that's the best information we have today.

All right, thank you.

Next question, please.

Your next question comes from Gerard Cassidy.

Good morning, guys.

A question on the loans that you guys sold -- that you are going to sell in the third quarter, I think it was the home equity loans -- you mentioned the resi mortgages.

What price did you receive relative to where you were carrying them?

I think you said you were carrying them at about $1 billion on about a face value of $2 billion?

Yes, we ended up getting about ten per -- we took a provision hit for about 10% of the customer balance effectively, because it was 2 billion in customer balances.

So we were carrying them at around $0.60 on the $1.00, we sold them at 50, that kind of thing.

But the key here is what we avoided in terms of future deterioration on some of those costs that would have come in the future, and over 8,000 loans that ultimately go to foreclosure and end up with 8,000 properties coming into OREO.

I think that's -- it was the most serious delinquent book we had, and we wanted to get rid of that.

I think, Gerard, as you know, when you are selling distressed assets, you start with real estate and you break your assets down into the A, B, C, D buckets, and take your C and Ds and sell them as fast as you can because you never get your value back out of them; and you may manage your Bs, and you always hang onto your As because they recover.

The same is true, I think, when we looked at this portfolio.

This is the worst portfolio we had, and we didn't think, frankly, that the market would open up for such assets, but we were delighted that it did; and the operating cost, as Rick said, of trying to foreclose on all these brokered home equities is very expensive.

So I think we were very pleased that someone else was happy to do that.

And what type of buyer purchased the loans?

Private equity.

Yes.

How -- now is it safe to assume all those loans were on non-performing status, or were there some performing ones?

There was a portion that were impaired, there was a portion non-performing, there was a portion that was just late stage delinquency.

It was mixed.

I see.

You were talking about the higher ROA that you are targeting.

I think I saw in your results your efficiency ratio this quarter is 51%.

What type of number do you think that will fall to get to that 150 ROA?

Well, that depends on the loan growth.

If you get loan growth and drive NII up through the loan growth, your efficiency ratio improves dramatically.

So if you get no loan growth, then your -- if you want your efficiency ratio to go up, you can drive your NII down.

So that's a relative statement.

We would love to see loan growth come back, actually.

I think you are well aware, we don't typically target an efficiency ratio.

We just think it's about continuous improvement, keep growing revenues faster than expenses.

Sure.

Circling back with the excess capital that you may be having on your books after we find out what the regulators want for the capital ratios by the end of the year, how important will the acquisitions be part of that strategy of deploying excess capital, especially if we don't get this loan growth that right now seems pretty depressing in terms of the lack thereof for the industry?

Well, acquisitions -- we are very, very pleased with how National City has worked out for us.

And someone asked the question about what you thought about it, and we paid the right price.

We had the opportunity to study the assets, actually, of National City three times, so we understood the risk that we were taking on.

And banks are sold, not bought, so lot of this depends if there is a bank we would find interesting that is for sale, we would have to have the opportunity to look seriously at it and pay the right price, and all of those are key factors.

I think we are fairly confident that we can integrate very well.

So I mean, our confidence factor around that is higher than it's ever been.

But we also learned our lesson; you can't pay too much, too.

So acquisitions are always opportunistic as opposed to your strategic goal.

Yes, th at's true.

One final question on the acquisitions.

Would you consider something transformational outside your market footprint?

Or no, you just want to keep stuff maybe inside the footprint?

You never know what opportunity comes toward you.

But I think you have seen the history where we have been able to take costs out more effectively when it's adjacent to our existing franchise, and so we can spread the brand and integrate efficiently.

And so I think acquisitions are really driven by cost save opportunities to begin with, and that's a key point.

Buying something in Hawaii, while I like to go there, is probably not first up.

No, understandable.

Thank you, Jim.

Thank you, Rick.

Thank you.

Next question, please.

Your next question comes from Paul Miller.

Good morning, Paul.

Hi, Paul

How are you guys doing?

Just going back to loan modification, it is something nobody's really talked about; and you guys have transferred -- you say very clearly that if a loan performs in six months you transfer it back to performing status, which is a very understandable move.

But I'm just wondering, once those loans do transfer over, is that redefault rate, is it growing?

Is it staying the same?

Is it because the economy is where it is it's remaining relatively low?

It's pretty consistent with the industry.

It's about 58%.

58% of those loans that go back into performing?

No, in total of the whole book.

In total of the whole book?

Yes, yes.

But what is it after six months, do you know?

After six months, we haven't seen a lot -- yet, we have not seen anything go back into non-performing.

Okay.

And then the other issue is -- and I think you gave -- or you already answered it in one sense -- was that your securities -- you used to be very comfortable parking some of your capital in the securities portfolio waiting for loan growth to come back.

Now you are getting a double whammy with treasuries at such a low rate, so can we continue to see, if the treasuries stay here, you selling off some of your securities portfolio?

No.

I think the decline you saw in the current period was somewhat temporary, just a shift between securities and swaps and some forward purchases.

So I think that's just a temporary dip, so I wouldn't look at that as a trend that we are going to start to decline our securities book.

Would you continue to park some capital in there since you are one of the -- since you do have a lot of it, if there is no -- ?

I think we have to be very careful about purchasing longer term fix rate securities.

I think it's a double edge sword.

It might be good for six to nine months, but it could be very painful if rates rise, which I would expect they would over time.

Okay, hey thank you very much, gentlemen.

We've spent a lot of time and effort building up this capital.

I'd hate to like have to give it all back in a bond trade.

Yes, I mean, it's just that we are probably not going to see loan growth for the next six months, maybe up to a year given where the economy is going, and just wondering what you guys as a financial industry is going to do as you grow that capital base out and you don't see loan growth and you don't have an opportunity to put it in treasuries, either.

There are opportunities to purchase assets where we can to get a decent yield there, so where we see those opportunities we will pursue them.

And there are areas where loans are doing well.

As I think Jim said, our asset based lending business continues to have a very strong ability to originate loans.

Okay.

Thanks a lot, gentlemen.

Thank you.

Your next question comes from David George.

Hey, guys, real quick on expenses.

There were some reversals of various accruals in the quarter.

So just trying to get a sense of, obviously "x" kind of integration costs, what an expense run rate should be?

Should we just take out those two accruals and integration costs and that's kind of a reasonable number?

I obviously know there is more Nat City expenses coming through, just trying to get a sense as to what the run rate is going to look like going forward.

I think that's right, David, just as you described; and then remember, we're going to take another 200 out between now and the end of the year.

Okay, appreciate it.

Thank you.

Running rate for the year.

Right, right.

Your next question comes from Ken Usdin.

Hello, Ken.

Hey, thanks.

Good morning.

Couple of quick ones.

You mentioned this in part, but on the delinquency improvement quarter to quarter, can you tell us how much of it was due to the pending sale of the $2 billion?

Yes, it was a modest impact; probably about a third of the decrease, what you are seeing in the residential real estate and the over 90 day, and it did not have much impact at all on the 30 to 89 days.

And it had about 135 million impact on the [NPL] decline.

135 on the NPL?

Okay, got it.

So the vast majority was core improvement?

Yes.

That's correct.

That's correct.

Okay.

Great.

The other income line was a lot softer than it's run for the last several quarters.

Is there anything to mention in there?

Were there any one timers or adverse items?

No.

We had a couple of valuation adjustments because of the low rates on some of our MSR assets.

But they were all pretty de minimus.

Trading was down, primarily also due to that factor, because low rates and some of the valuations of our customer balances there came down a little bit.

It was nothing in particular.

Okay.

And then last quick one, do you have an idea of the size of the step up in FDIC expense that you would expect to start seeing next year?

We're not expecting a step up.

With the change in the way the calculation works, our loan to deposit ratio is going to really help us out because it's now off risk weighted assets less capital.

Yes.

And that ratio, we do well.

While the rate will go up, the balances will come down for us.

Yes, okay.

Great.

Thank you.

Next question, please.

Your next question comes from Betsy Graseck.

Good morning, Betsy.

Good morning, Betsy.

Good morning, hi.

I had a question on the loan and the loan portfolio growth.

You indicated in one of your comments, Rick, that you would be looking at purchasing portfolios if there was something interesting and available, and I guess I just wanted to understand how well you are to grow the loan book through that kind of activity as opposed to client-focused loan growth?

Well, it would be simply an asset purchase, Betsy.

We would look at the risk return on a portfolio like that and see what the opportunities are.

And some people are selling assets because of their capital position, but we would have to look at the risk return first.

Yes, I wouldn't always assume the purchase doesn't mean we can't complement our customer activity within our footprint or within some of the sectors we operate in.

And I asked the question in part because of the CRE exposures that you have -- I mean, relatively high quality, small as a percentage of total loans, small for your type of institution.

And given the fact that there is some restructurings going on in that space, I'm a little surprised to see that your CRE book hasn't increased a little bit more potentially from this type of activity.

Is it that you just haven't seen anything that hits your hurdle rates, or -- ?

Betsy, I'm sorry, you broke up a little bit.

What was the first part of the question?

Sorry.

The basic -- the reason for asking the question is on the CRE book, your CRE exposures are obviously small relative to peers, and I would think you have room there to grow through this kind of purchase activity.

Yes, we do.

And actually, we are looking at our Midland servicing book, which gives us more information on commercial real estate than almost any other opportunity.

One of the things, there is a lot of commercial real estate that comes due over the next two to three years, and we have the opportunity to look at assets that -- where we have the cash flows of the asset.

We know when the loan is going to mature, or when the prepayment penalty rolls off, and we have the opportunity to go in there and refinance.

I will tell you, though, that most of those properties won't refinance ahead of time because of the rates that are on the prior financing, because the spreads were so much narrower when -- five and six years ago when they were put out in the first place.

But that is an opportunity for us, yes, and we are pursuing that as those maturities come through.

Okay, thanks.

Next question, please.

Your next question comes from Matt Burnell.

Hello, Matt.

Good morning, Matt.

Good morning, Jim.

Good morning, Rick.

Couple of quick questions for you.

On page four you mapped out your loans to assets and the percentage of the balance sheet that's in investment securities.

Where would you expect to see that in a more normal operating environment once we start getting -- whenever year we start to see loan growth again, where would that loan to asset ratio migrate up to?

I don't see it changing from where we traditionally have been.

I think loans have been about 55% of total assets.

Given our risk profile, we'd love to grow it, but I don't see us going into sectors that we are not comfortable with.

So I don't see that changing dramatically.

Okay, and then regards to the sales that you made -- and maybe I missed this in your comments, but when -- the demand for loan sales is clearly increasing.

Do you intend to make more sales going forward?

And you said there were several buyers.

I'm wondering if you can provide a little more color as to what their demands are in terms of if they have made any requests for certain types of loans?

I think -- I mean, there is a broad answer to that question.

I think you have to look at the risk return.

There's a number -- there is a significant portion of our distressed book where we believe that the asset value will be fully recovered at our current book value, and so those we would probably not want to sell in rapid fashion.

There are others like the ones that we just sold where clearly they were the low end of the food chain and we were more than happy to have someone else try and recover those.

So it's really a mixed bag across the board.

So it's hard to say what level we would sell them, because it depends on the return and the risk we are taking.

I think you will see it continue to shrink over time, as it has already.

We would be opportunistic in our sales.

With regards to buyers, we found multiple buyers for that portfolio.

So different people have different appetites.

The market is opening up.

There is a lot of liquidity sitting on the side lines, and people are starting to aggressively bid on assets in a way that they didn't even six month ago.

I think you saw that there were two commercial mortgage backed securities books that are going to go public in the next quarter.

So I think that really is indicative how the market is changing.

Great.

Thanks very much.

Our next question, please.

Your next question comes from Lana Chan.

Good morning.

Good morning.

Hi, good morning.

Just two follow-up questions, one on expenses.

I think, Rick, you had indicated before to me that any further increases, I guess, in cost savings from National City would start being reinvested into revenue opportunities.

Is that how we should be looking at the increased cost savings target right now?

Looking forward to the bottom line?

No, I think we have been looking all along through this entire period of making investments in our products and services, and we feel it's very important that we develop those today as we have an opportunity to grow this business when the market returns.

So I wouldn't look -- I would look some of that would go to the bottom line, some of that will be reinvested.

Okay.

And second follow-up question was on the Reg E impact in the second half of the year.

The $145 million, is that somewhat higher than your previous guidance, and does it not assume any loss mitigation efforts?

What we did was we changed Reg E guidance to give it to you pretax.

Previous guidance we had given to you after tax, and I think we changed that because I think people were getting confused about the impact on revenue.

It's the same number, just happens to be a pre-tax number.

Okay.

But does it include loss mitigation efforts?

No.

No.

So that number could be lower than the $145 million?

What are you seeing in terms of the opt in -- ?

To date, the experience has been pretty much as we expected.

Okay.

Thank you.

Your next question comes from David Hilder.

Hi, David.

Good morning, gentlemen.

Just a clarification.

It looks like the additional chargeoff on the residential distressed sale went through chargeoff in the second quarter; is that correct?

That's correct, David.

$75 million?

Sorry, how much?

$75 million.

Great.

Thanks very much.

Sure.

All right, we have no more questions in the queue.

Jim, do you have any closing comments?

Okay, well, thank you very much for joining us.

I think this quarter was an excellent quarter for PNC, not only financially but also strategically, and we look forward to a solid second half of the year.

Thank you very much.

Take care, everyone.

Thank you for participating in today's conference call.

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