PNC Financial Services Group Inc (PNC) 2010 Q3 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the PNC Financial Service Group investor conference call.

(Operator Instructions) Thank you.

Mr.

Bill Callahan, you may begin.

Thank you 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 events could differ, possibly materially, from those we anticipate 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 10-K and 10-Q and various other SEC filings available on our corporate website.

That's statements speak only as of October 21, 2010, and PNC undertakes no obligation to update them.

We will also provide details of reconcilements to GAAP, of various non-GAAP financial measures we may discuss.

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

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

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

Thanks, Bill.

Good morning everyone.

Thank you for joining us.

As you can see this was an excellent quarter for PNC in a very challenging operating environment.

We produced very strong third quarter earnings.

We closed on the sale of global investment servicing on July 1, 2010.

Our balance sheet remains well positioned, and we're core funded with a loan to deposit ratio of 84%.

We continue to improve the quality of our capital and our tier 1 capital is now at record levels.

And following the completion of National City's branch conversion, we saw strong sales momentum across the franchise.

And most importantly, we grew new customers throughout our operations.

As a result, you can see that we produced third quarter earnings of $1.1 billion, or $2.07 per diluted common share.

Excluding integration costs, and a gain on our sale of global investment servicing, third quarter earnings per diluted common share would have been $1.56.

Page eighteen in the press release details that's adjustments.

Our year to date net income of $2.6 billion was nearly double the same period in 2009.

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

Our sources of revenue continue to be well diversified.

And while net interest income remains under pressure, we've demonstrated opportunities for future non-interest income growth.

As we told you to expect, revenue in the third quarter was lower linked quarter primarily due to the challenging operating environment, i.e.

the implementation of certain regulations, and we had two items in our net interest income that we had signaled that we wouldn't repeat.

Our third quarter expenses were essentially flat compared to the prior period when two second quarter reversals, totaling $120 million, are excluded.

Overall, expenses continue to be well managed, and we are on track to achieve our annualized acquisition cost savings goal of $1.8 billion by year end.

Rick will discuss our overall income statement in more detail.

Our pretax pre-provision earnings were $1.4 billion in the third quarter, which was nearly three times the cost of credit.

And turning to our credit costs, overall credit quality showed signs of improvement and credit costs were significantly lower in the third quarter.

Our provision was $486 million, sharply lower linked quarter, and down 47% compared to the same period last year.

In part, due to the sales of residential mortgage loans and brokered home equity loans which closed in the third quarter.

We are making good progress on returning to a moderate risk profile through deliberate actions to manage our risks and returns.

Other factors that contributed to the decline of the provision were credit exposure reductions and basically overall improving -- improving credit migration.

With the integration of the National City branches behind us, we are now on a common technology and product platform.

This allows us to distribute new products and services into our new markets providing us with tremendous opportunities to grow our businesses.

Sales across our combined franchise were 120% -- 128% of plan through September 30, 2010.

And on a linked quarter basis, total sales were up 15%.

Our third quarter sales results demonstrated this momentum.

In our newly acquired markets, sales were 122% of plan through the first nine months, up 35% linked quarter and 68% year-over-year, and I think clearly this reflects our customer focus throughout the conversion process.

Now, we're also seeing excellent progress in our ability to deepen relationships with customers, and I was especially pleased with the performance in our newly acquired markets as cross-selling activity there through nine months has increased 11% year-over-year.

Now one thing I'm sure of, we are using our balance sheet strength to make credit available to qualified borrowers, as we recognize this is extremely important to the country's economic growth.

We originated and renewed approximately $39 billion in loans and commitments in the third quarter where $112 billion for the first nine months of the year, which includes more than $2.6 billion in small business loans.

We also saw increased demand for PNC products as a result of implementing our business model in converted markets.

On our retail banking side, we saw significant customer growth as checking relationships increased by 53,000 during the third quarter, which is more than two and a half times the growth we saw in the second quarter.

Our goal is to deepen these relationships, and we saw active on-line bill payment customers grow by 8% in the quarter, and we continued to see strong customer and employee engagement levels throughout the retail operations.

We've been expanding our university banking program, and recently signed agreements with Grove City College in Pennsylvania, Bowling Green State University and the University of Cincinnati in Ohio, and DePaul University in Illinois.

We now have relationships with more than 150 colleges and universities enabling PNC to reach a large group of customers with a variety of banking products and services to students, faculty, and staff.

Our corporate and institutional bank had a very good quarter.

While loan demand remains tepid, our new client growth was at two times the face of any, of any previous record year.

With more of our clients on one platform, we're seeing increases this year in treasury management and capital mark revenues.

Treasury management revenue through the first nine months increased by 9% compared with the same period last year.

In healthcare alone, revenues year-to-date are up more than 20% compared to the same period last year.

Year-to date-capital markets revenue, this is basically customer business, is up 19% compared to the first nine months of last year.

And we've booked some of the largest transactions in the history of the company during the first three-quarters of this year.

Our asset management business had a strong quarter and outperformed its sales and client acquisition goals due primarily to significant referrals from other business segments.

In fact, referrals in newly acquired markets were up 40% linked quarter.

Assets under administration at the end of the third quarter were more than $200 billion, and operating expenses remained well controlled.

Residential mortgage also had a good quarter.

Mortgage loan originations were $2.7 billion in the third quarter, up 17% from the second quarter driven by seasonal factors and the marketplace, of course.

Year-to-date servicing fees are up 15% compared to the first nine months of last year, and expenses through three quarters are down 29% year-over-year.

Now I would like to talk to you briefly about the recent industrywide focus on foreclosure documentation.

As you know, our market share for residential servicing is less than 2%.

The vast majority of our servicing business is on behalf of other investors, principally Freddie and Fannie.

Nonetheless, PNC understands how important it is that the foreclosure process is correct so both borrowers are protected, and necessary foreclosures are able to proceed.

We are taking a close look at our foreclosure proceedings -- procedures, and while that review is ongoing I can report the following.

Based on the review to date, we believe that PNC has systems designed to ensure that no foreclosure goes forward unless the loan is genuinely in default.

Indeed, on average, our loans in foreclosure are more than one year delinquent.

Like a number of other banks, we've identified issues with respect to some of the documentation.

We are holding off pursuing individual pending foreclosures until we are confident that any documentation issues have been fixed.

But as of now, we are proceeding with new foreclosures under enhanced procedures designed as part of this review to remove, to remove any question about the processing of documentation in foreclosure cases.

Moving on, I'm pleased with the progress we're making with our distressed assets.

This portfolio of $16 billion is down $4 billion since the same time last year, primarily as a result of paydowns, net charge-offs, and dispositions, and that included the loan sales I mentioned earlier.

And last, but not least, BlackRock had a very good third quarter.

They reported net income of $551 million yesterday, which was up $234 million year-over-year.

Compared to a year ago, their operating results reflect the benefits of the Barclays Global Investor acquisition and the improved markets.

They continue to make good progress on their merger with BGI, which made them the largest publicly traded investment management firm in the world with more than $3.4 trillion in assets under management.

For the third quarter, our share of BlackRock's earnings was 23%.

Now, Rick will provide with you more detail about our third quarter results, beginning with our high quality balance sheet.

Rick?

Thank you, Jim, and good morning, everyone.

Today I'm going to focus on three topics.

First, the steps we are taking to return our balance sheet to a moderate risk profile, and this includes continued improvement in our credit quality metrics.

Second, our strong earnings including the impact of credit risk, reduction activities on our net interest income, and our provision.

And finally, the continued growth in our capital ratios and our book value per share.

Let me begin on slide six with our balance sheet, which remains highly liquid, well capitalized and asset sensitive.

Loan balances continue to contract driven by loan payoffs, loan sales, net charge-offs and continued soft credit demand, primarily in the commercial and commercial real estate categories.

On the deposit side, third quarter transaction deposits increased by $2.5 billion linked quarter, a strong sign of our ability to grow our customer deposit franchise.

We also continued to reduce our higher cost CDs and other time accounts, while retaining nearly 80% of the relationship balances.

These trends resulted in a loan-to-deposit ratio of 84%, a highly liquid balance sheet.

We also added nearly $10 billion in high quality, short duration securities to our portfolio with approximately 90% of the growth coming in purchases of agency residential mortgage-backed securities.

A significant portion of the increase reflected the settlement of previous quarter forward purchases, repositioning from swaps into securities, and investments to utilize the excess liquidity we continue to grade.

We also saw growth in common equity of $1.7 billion linked quarter to $29.4 billion, bringing our total increase in common equity for the year to $7.4 billion.

Our capital and liquidity positions provide with us the capacity to support clients as the economy gains momentum.

At the time same time, our positioning and our ability to grow fee income and manage expenses allow for patience in the event economic conditions do not improve in the near term.

Slide seven shows our credit quality metrics which continue to improve in the third quarter.

Our non-performing loans at the end of the third quarter were down $274 million, or 5%, on a linked quarter basis, and they were lower by $835 million, or 15%, compared with the fourth quarter of 2009.

Early stage delinquencies declined by 23% and late-stage delinquencies were essentially flat in the third quarter compared to linked quarter results.

This clearly reflects improving credit trends.

Net charge-offs declined due to the $75 million of charge-offs in the second quarter related to our bulk sale, and the consumer space and improvement in residential real estate, commercial real estate, and equipment lease categories.

In addition, we continue to see an overall improvement in credit migration for performing loans and a reduction in overall credit exposure.

Now, assuming at least a modest GDB growth, we believe delinquencies and non-performing metrics will continue to come down in the fourth quarter.

Before I review our overall third quarter earnings in greater detail, let me focus on our trends and net interest income and provision, two areas I know are of great interest to all of you.

Now slide eight shows a roll forward of our net interest income and provisions from the second to the third quarter, along with the trend of our net interest margin, our cost of credit, and our credit risk adjusted net interest margin.

The chart in the upper left-hand corner shows the effects on net interest income of certain purchase accounting adjustments recorded in the second quarter of $93 million, which we do not expect to repeat, and the net interest impact of consumer and commercial distressed loan sales that closed in the third quarter of $56 million.

The chart also shows the residual impact of $71 million on net interest income due to lower purchase accounting accretion as expected and the challenge of lower loan balances and low interest rate environment.

This latter decline of $71 million represents 3% of our third quarter net interest income, and is a better indication of the net interest income decline you can expect from PNC from the third quarter to the fourth quarter of 2010.

The chart in the lower left shows the roll forward of our provision for the second to the third quarter.

Similar to net interest income, the provision was lower partly due to the second quarter addition of $109 million for the loan sales we discussed in the second quarter, and of an additional $100 million for seriously delinquent loans in our distressed asset portfolio, which was also booked in the second quarter.

We also saw the provision decrease by $128 million link quarter due it to the credit migration improvement I described in the prior slide, and due to an overall reduction in credit exposure.

Now the chart in the upper right shows our net interest margin trend, which, as expected, declined this quarter.

However, we are paying particular attention to the credit risk adjusted net interest margin which considers the impact of annualized provision as a percentage of our average income earning assets on net interest income.

We use this ratio to help demonstrate our commitment to a moderate risk philosophy and to show the impact of declining net interest income compared to improvements in credit costs as we focus on lowering our balance sheet risk.

As you can see, the credit risk adjusted margin has remained stable over the past couple quarters.

Our focus remains on securing assets that have appropriate risk adjusted returns.

Similar to our strategy prior to the credit crisis, we do not plan to take undue credit or interest rate risk as a means to enhance our net interest margin.

We will continue to remain disciplined to help ensure we get paid for the risk we take.

Now looking ahead, we expect net interest income and margin to trend down in the fourth quarter, but at a slower pace than we saw from the second to the third quarter.

And assuming there's no downturn in the economy, we expect a relatively stable to improving provision and a relatively stable credit risk adjusted net interest margin in the fourth quarter compared to recent quarters of 2.9% to 3.1%.

Now let's review our overall income statement on slide nine.

We delivered $3.6 billion in revenue in the third quarter, and $1.4 billion in pre-tax pre-provision earnings compared to our provision of $486 million.

This allowed us to deliver pre-tax pre-provision earnings that were nearly three times greater than our credit costs.

And while pre-tax earnings declined as expected by 12% compared to the second quarter, we delivered a 32% increase in pre-tax earnings from a year ago.

Since we already discussed net interest income and provision, now let's focus on non-interest income expenses and taxes.

As Jim mentioned earlier, we saw substantial improvement in sales momentum in the third quarter and our core fees increased linked quarter in most categories, with asset management, consumer services, and residential mortgage fees up 2%, 4%, and 21% respectively.

The residential mortgage improvement was driven by strong origination volumes and net hedging gains on mortgage servicing rights partially offset by additional repurchase reserves of $44 million.

On the other hand, we saw a decrease in corporate service fees which were down $78 million linked quarter, primarily due to a $100 million of valuation adjustments in our commercial mortgage servicing rights driven primarily by lower interest rates.

Otherwise, corporate service fees increased by 8%.

As expected, service charges on deposits were down $45 million linked quarter, primarily due to the impact of regulation E.

Net security gains decreased by $26 million, similar to the amount of improvement in our OTTI charges.

Our OTTI charges were down to $71 million in the third quarter.

And other net interest -- non-interest income was down $24 million linked quarter primarily due to $52 million of repurchase reserves on assets related to our distressed asset portfolio.

We continue to be disciplined in expense management.

Excluding the $120 million of accrued liabilities reversed in the second quarter, expenses were essential flat to the linked quarter.

Regarding acquisition related cost savings, we captured another $25 million in the quarter bringing our current 21-month total to $1.7 billion of annualized cost saves.

We are well on our way to reaching our year-end goal of $1.8 billion.

The effective tax rate was lower for the third quarter at 18.8%.

The lower rate resulted primarily from the favorable tax settlement of approximately $89 million that we previously discussed.

As a result, including the $328 million after-tax gain on the sale of Global Investment Servicing, which closed at the beginning of the quarter, we reported net income of $1.1 billion for the third quarter and $2.6 billion year-to-date, which has been a strong contributor to our capital growth.

As shown on slide ten, our tier 1 common ratio at the end of the third quarter is estimated to be 9.6%.

The 130 basis point gain linked quarter was due to the sale of Global Investment Servicing along with third quarter earnings and our lower risk weighted assets.

Since year end, our tier 1 common ratio has increased by 360 basis points and our book value per share has increased 17% since December 31, 2009.

And it's up 42% since we closed on the acquisition of National City on December 31, 2008.

While we're still waiting for greater clarity regarding Basel 3, I believe our capital position, along with our future earnings, will provide us with flexibility for growth while investing in our markets, our people, and innovative products and services.

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

Now turning to the fourth quarter, let me provide some guidance.

Regarding revenue, as I discussed, we expect to see continued but reduced pressure on net interest income.

However, as mentioned earlier, I am optimistic about prospects for a stable to lower provision.

As a result, we expect our credit risk adjusted net interest margin to be reasonably stable with recent quarters.

We look for solid performance in fee income assuming fewer impairments, and I believe our expenses will be down primarily due to lower integration costs.

Now with that I will hand it back to Jim.

Thank you, Rick.

Slide eleven is the scorecard we've used to measure our improvement since we closed on the acquisition of National City.

This has been an excellent roadmap that has served us well as we work to bring our two companies together.

We're very proud of the accomplishments and our ability to align our two organizations so quickly.

But as you can see from a couple of the categories, we still have other -- have new opportunities to increase profitability, and we're pursuing them aggressively.

In summary, PNC's business model continued to deliver strong results in the third quarter during a time of significant uncertainty for our industry.

The management team has been through cycles like this before, and we are focused on delivering for our customers and our shareholders.

Our balance sheet is strong, our credit metrics continue to improve.

We're growing customers through our expanded franchise and our expenses are well managed.

And we're focused on returning to a moderate risk profile.

And importantly, our capital is at record levels.

We are a Company that's looking to the future by investing in markets, products, and technology, and we believe we're on target for a good fourth quarter and a strong full year 2010, and well positioned for the future.

With that, we'll be happy to take your questions.

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

Yes, sir.

(Operator Instructions) We'll pause for just a moment to compile the Q-and-A roster.

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

Good morning, John.

Hi, good morning.

Rick, on net interest income outlook, just want to understand.

So the outlook for the fourth quarter is for an NII decline in the ballpark of $71 million on slide eight, something more like that is what you're saying?

Yes, that's correct, John.

You know, we can't pinpoint it at this stage.

Obviously we're still managing the portfolio through the quarter, but clearly we're looking at the purchase accounting numbers to come down quarter-over-quarter by about that amount.

And so the rest of the book, though, between what we're doing with loans, what we're repricing on deposits, and some of the securities investments is holding its own pretty flat, so it's primarily the purchase accounting runoff.

All right.

So something in the $100 million or less rather than the $200 plus million (inaudible)?

I think you're safe between $50 million to $100 million.

I think that's a pretty good range.

Okay.

And what are the dynamics for NII heading into 2011, Rick?

We're not giving that just yet, John.

We'll do that with the fourth quarter results.

Okay.

And then on Basel 3, how do you handicap how the BlackRock will be interpreted in the context of the new rules?

Could you just give us some thoughts there?

Any kind of feeling you're getting about how that's going to be interpreted?

And obviously that's a big -- and is that the biggest swing factor in the capital analysis for you?

Yes, that's exactly right.

John, I think the -- there's a lot of questions left to be answered.

I think the one which is absolutely pretty certain is we'll be able to look at this investment after tax.

I don't think there's much question there.

But we have to wait for the rules to be, to be finalized.

And you know that tax benefit is about $1.9 billion on our overall investments, so that's, that's pretty good savings.

Okay.

And Jim, if you have a -- what's your hopeful time frame for increasing the dividend?

Does it depend on the BlackRock interpretation, or could you, could you do that anyway?

I think, frankly, our capital levels are very strong, John, as you can see.

And our forecasts just show the ratios going up.

So, I mean, we would love to see a lot of loan demand, but if loan demand remains, you know -- if it picks up some, we're still going to grow our capital ratio significantly with our, our earnings forecast.

So we build a lot of capital.

So when we look at it, I think the Basel numbers just came out.

We have G-20 this week.

I think the, the regulators have to make some local interpretations, which we've started discussion with them on.

That's going to take you through the quarter.

I would, I would expect that the regulators will come out with some kind of framework for giving us roadmap to how to increase the dividend.

I think they're going to have to do that for the industry.

I wouldn't guess that they're going do that kind of on a one-off basis, but I can't speak on their behalf.

But I would guess we'll probably see some kind of format that, that we can feed into.

By that, by the time something like that happens, you're probably close to the, probably close to the year end, or the beginning of next year and, you know, so they'll wait for earnings to come out for the -- for everybody for year end.

So I would guess that sometime in the first quarter I think we'll have some clarity as to how to increase the dividend.

And as you know, that's a very important issue for us.

I think we'd love to see the opportunity to increase the dividend.

Okay.

Great.

One more final thing for Rick.

Where are we in realizing merger expense saves?

Are they all in now?

And is this the expense run rate that we're seeing here?

We'll get another $25 million in the fourth quarter, John, then we should be through.

We'll be at $1.8 billion annualized, and I think -- we're very comfortable we'll be able to clear that hurdle in the fourth quarter.

Okay.

Thank you.

Next question, please.

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

Morning Betsy.

Morning Betsy.

Hi, good morning.

Question on risk-adjusted margin.

You've been talking about maintaining that risk-adjusted margin.

I know it went up this quarter.

As we look forward, should we expect that we're going to hold where we are today, or does that come down somewhat?

Betsy, I -- what I see is that honing in around 2.9% to 3.1%.

I think if you go back to PNC back in 2005 or so, we presented this ratio background as well, simply because our margin happened to be lower at that time.

But the cost of credit wasn't there, and I think as people were challenging us to take more credit and interest rate risk we said I think it's better to look at this on a risk adjusted basis.

And, so I think, I think we'll hone in around that 2.9% to 3.1% overall.

So we shouldn't be surprised to see potentially a little bit lower next quarter if your NCOs don't come down in line with -- ?

Yes.

Of course, I mean, I'm pretty certain about the fact that we'll see further decline in interest income, and I'm more optimistic that we'll continue to see further decline in credit costs.

Right.

Okay, great.

Thanks.

Next question, please.

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

Morning.

Good morning, Paul.

Hi.

How are you guys doing?

Securities portfolio took a big jump this quarter, and your loan demand was down relatively speaking.

And -- can you just add some color around that?

And also, some people in the, in the, in your regions are seeing -- they're starting to see loan demand.

And I was wondering if you could just make any comments about are you seeing -- are you starting to see loan demand in your footprint?

Let me comment on the loan demand.

I think we've seen, really it appears to be a bottoming.

And I'm talking about loans outside of our distressed book, which we're, which we're proactively reducing.

But the utilization rate appears to have bottomed.

That's been decreasing for three years.

And it appears as if the balances are, are firming up.

We're not seeing a lot of growth yet, but the interesting thing is we're seeing a lot more activity.

And the M&A space, the capital market space, our customers, our customers are much more active than they were a year ago.

So that's a, that's a good sign as it portends to, to perhaps loan growth, loan growth in the future.

But in the meantime, we did add some securities, and I'll let Rick talk about that.

Yes, I think that it, it's a little bit -- I wouldn't get too caught up in the, the size of the growth in the individual quarter.

If you lack back, we had a substantial -- most of that growth occurred, actually is the same, year-over-year.

What happened was, swap spreads got very -- blew out with the European debt crisis in the second quarter, so we swapped a lot of treasuries into swaps, and now we're just moving that back into treasury securities as well as mortgage -- agency mortgage-backed securities.

So most of our investment is in the agency space.

We also had some forward settlement that -- trades that we did in the second quarter settling in the third quarter, and then we just keep generate so much in terms of the deposit base, so we keep generating a lot of liquidity, and we're just -- this excess liquidity we're investing.

Now we're keeping it all in very short duration securities.

The duration of equity of the balance sheet as whole is still negative three to three-and-a-half years, so want to make sure that we're asset sensitive, so when rates do increase that we can take advantage of that.

I think that's a very good question on the securities, and Rick's point about staying short is clearly important.

You don't want to -- we've said frequently, we don't want to risk the capital of the Company in bond trade.

Yes, just like -- it appears that your, that the securities to total assets hovers around 20% to 25%.

Are you targeting that?

Are you just, are you just really making day to day decisions on where's the best way to put your capital?

It's really not a target, but I think if you went back in the history of the Company, we've always had, we've always had a tremendous ability to generate deposits moreso than, moreso than loans.

And because of the fact that we're, we're smaller in a, in the credit card space than the, than some of the larger banks, and the other part is, is that we, we tend to securitize all of our mortgages as to put a, putting large bulks of them on our balance sheet.

So, and we've always been more liquid than others.

Thank you very much, gentlemen.

Sure.

Thank you.

Next question, please.

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

Hello, Matt.

Matt.

Hello?

Matt?

You okay?

Hello, good morning.

Can you hear me now?

Sure.

Great.

Sorry about that.

Thanks.

Thanks for taking my question.

Relative to some concerns in the, in the markets yesterday, and I know PNC does not have a lot of exposure to the home builders, certainly relative to some of your peers, but have you heard any industry chatter, or are you considering potentially putting loans back to some of the home builders relative to, relative to some of the quality of those loans that, that may be sitting in, in your portfolio?

That really wasn't a big activity for ourselves or National City.

So that really isn't -- I mean, it's not an issue that we're dealing with right now.

Not a big concern.

Okay.

Thank very much.

sure.

Next question, please.

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

Hello Mike.

Hello Mike.

Good morning.

I guess my question is all this capital and nowhere to go?

So the first part of the question that was --

Were you in our meeting yesterday?

So what are your -- what's your tier 1 common ratio under Basel 3?

Or are you going under Basel 3?

Well, it's hard to say what it is until we get the BlackRock interpretation.

So I think we, I think we just have to wait and, wait and see.

We're -- it, it -- and you can't say this, it does matter.

But, quite frankly, we've got -- however it works out, we've got a lot of capital.

So we're over any of the, any of the guidelines that are currently, currently shown.

And I think we want to be over them, but the real question is how far, and I think we are well over the guidelines as it appears today.

How about risk weighted assets?

What's the impact on Basel 3?

It's not a, it's not a meaningful issue for us at all.

We're really just talking about BlackRock.

And what's -- even just a rough range?

It's, it's hard to say because there's, there's a number of things.

One is, one is that we're not certain that BlackRock even falls under the definition of financial institution.

As you know, the, the rule about investing in, in minority interest and other financial institutions was really proposed to affect banks investing in other banks and then re-levering the same capital.

And so BlackRock is not a leveraged institution, as you know.

So it, it really kind of doesn't fall in the category of the purpose of the, of the rule.

So we have to wait and see whether it's -- and they've not been included under Basel 1 or Basel 2, so we have to wait and see whether it actually fits at all.

And secondly, as Rick said earlier, we have almost $2 billion reserve for taxes set up, so it clearly seems to me that it's got to be an after-tax view because of the theory is, if the stock runs down, well if the stock runs down we're not going to have to pay all these taxes.

So, it's got to be an after tax, after tax item.

And then there's another issue that says in the rule that, that it's common stock, and only 50% of our holdings in BlackRock are in common, the other in preferred.

So, I mean, we've got a number of things that have to be interpreted around the BlackRock, a number of which could go our way.

But, in any event, however it's interpreted, frankly, we've got a lot of capital, back to your initial point.

Yes, and Mike, the public data points are we have an investment of $6 billion.

We've got deferred taxes which probably brings that close to $4 billion.

And 1% on our ratio is 2.5 -- is $2.5 billion.

That's all public data, so you have to think about -- it could be anywhere from 0 points to maybe 1.5 points.

And when do you think will you hear about BlackRock interpretation?

We'd love to hope we're going to hear between now and the end of the year, but we're not certain about that.

And then, lastly, so, you have excess capital.

What are your priorities for using it?

And what about acquisitions?

Well, we'd love to use it for -- we'd love to use it for our customers, but it doesn't appear that the loan demand is there.

And even if it is, we'd have plenty of flexibility on the balance sheet without having to change any capital ratios.

I think secondly, I think our shareholders deserve -- we would love to see, we'd love to have the ability to raise the dividend.

I think that would be a good thing.

We also think that our shares are trading cheaply compared to what they're worth, and kind of amazes me that we do trade at multiples of book that are below some of our peers.

And, and then obviously acquisitions, banks are sold, not bought, and so for the, for the right type of acquisition, I think would be, we'd be interested in that as well.

So, those I think would be the priorities.

All right.

Thank you.

Next question please.

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

Hi, David.

Hi David.

Good morning.

Question on reg E, if you look at service charges sequentially were down, $209 million to $164 million.

Have we felt the vast majority of the pain there?

Can you kind of frame Reg E for us going forward?

Thanks.

Our, our estimate for the fourth quarter is that it will be down another $55 million.

We gave originally $145 as our prediction on that for the second half of the year.

Okay.

So you had $45 million this quarter, roughly, there was some other factors in there.

If you figure the rest is $100 million, that's $55 million decline into the fourth quarter.

Okay.

Appreciate it, guys.

Thanks.

Next question, please.

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

Hello, Matt.

Hello Matt.

Hi guys.

Two unrelated questions.

First, just on the private label mortgage put-back issue there for the industry.

Can you just remind us on the First Franklin that National City sold to Merrill, the legal liabilities do not lie with you, correct?

The legal liability of First Franklin does not lie with us?

Which types of legal liability?

I meant like -- so, if there are mortgage put-backs related to First Franklin loans that were securitized, does that come back to you?

Or, since you sold that company to Merrill, does it go to Merrill?

That's a, I mean, that's a legal issue.

I don't -- I'm not ready to, to answer that question right now, but it was sold to Merrill, clearly.

And -- do we -- hang on, hang on one second.

It kind of depends on what kind of liability it is.

For the most part, the company was sold to, to Merrill Lynch, and so those activities really belong, belong to them.

But obviously you can get sued for anything, as you know.

Okay.

And then just in general, your private label exposure, I don't think PNC did any, and I think outside of First Franklin, National City didn't have much.

But, I don't know if you have any numbers there that you can provide for us?

I don't think we have, I don't think we have them handy.

I can get back to you, Matt, on that.

Yes, we'll get back to you on that.

Okay, yes, I think it's pretty small numbers but we're just trying to, to make sure.

And then separately, as we think about just kind of the NIM longer term, I can appreciate there's a lot of moving pieces here.

But obviously if rates stay low, asset yields are still likely to come down further, but how should we think about the funding side of things?

Because you still have a lot of CDs.

You have a low loan to deposit ratio.

There's a chunk of long-term debt.

So how should we think about opportunity over pricing to funding?

And, and how quickly and how aggressively can you bring down some of those?

Well you're right, we do have another $7 billion of CDs that are going to mature in the fourth quarter.

Average rate's about 2.2%, so right now we're able to reprice those down 1% and lower, so that, that's -- and that's why when I said before, the, the drop into the fourth quarter is primarily due to the purchase accounting running off as opposed to our core book, which is remaining pretty flat as the benefit on deposit pricing as well as some of the security yields is funding some of what we lose on the loan side as rates remain low.

If rates remain low, at this rate for long period of time, I mean, there's all kinds of economic, economic issues.

But we'll be repricing liabilities for a long period to come.

All right, thank you.

Next question, please.

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

Morning Ed.

Morning guys.

How are you?

Good.

Great.

How are you?

Good.

Two quick questions.

First, I guess, 3.5% reserve to loan ratio pretty high among large regional banks.

Where do you see that sort of coming down to, or what range would you see that coming down to over the long term?

I think that will be guidance we'll give in the fourth quarter, that is.

We have a better indication what next year is going to look like.

I think for the time being, though, we've had two quarters of improvement in the credit statistics.

I think as we get more and more confidence in that decline, as we work through that, clearly that will come lower.

And obviously it will come down as non-performing loans come down.

We'll, we'll continue to release, or utilize reserves as we decrease our non-performing loan category.

So it's reasonable to think about at least several quarters, sort of stop there from an outlook, but several quarters at least of additional reserve recapture?

The building, you know, the building of reserves, obviously, is to take -- is, is for future charge-offs.

So you always see the provision peak before charge-offs peak, because you're providing for future charge-offs, even if you put on a -- put it every day when you put on a passed loan, you put on some reserves for potential future default.

So the provisions will peak and charge-offs will peak later.

So I think, I think you're right about continued improvement.

Okay, thanks.

And then second question, Rick, in terms of the purchase accounting accretion, you talked about it coming down more in the fourth quarter.

Subsequent to that, should we expect it to become more stable for awhile?

Or is there sort of a continued downward trend that we should anticipate?

Well, on the loan side, clearly over the next two to three years you are going to see continued downward trend on both performing and impaired.

So there's no question about that.

The deposit side, probably will run its course next year.

And the secured -- the debt side is going to be the next fifteen years.

Which as you can see is pretty de minimus amounts.

So -- what we're expecting next quarter, Ed is that, that scheduled number, which you had this quarter, 212, maybe that drops to 200.

I think it was 212.

And we're not -- we're expecting the cash recoveries to be much lower than what we had in the current quarter.

We had $111 million, maybe coming down to around $50 million.

Okay.

So I think, overall, purchase accounting next quarter will be about -- in, around $250 million.

Okay, so most of the decline is on that cash recovery side?

Yes, that's correct.

Okay.

Great.

Thank you.

Sure.

Next question please.

Your next question comes from the line of Moshe Orenbuch with Credit Suisse.

Morning.

Morning.

Morning.

Two quick questions.

The first is I noticed that on your averaged balance sheet actually, consumer loans did grow a little bit.

Point to point they were still down.

What, what categories within consumer are looking better than others?

We've seen a little growth in student lending.

Is that -- I'm assuming that's private student lending?

That's correct.

Correct.

That's correct.

Got it.

Secondly, I guess I just wanted to understand your thought process in, in mapping the net interest margin against the provision as opposed to charge-offs.

When you think about it -- and usually when you think about a risk adjusted margin, it's charge-offs because the provision's got this kind of a little bit of a backward looking catch-up to the, particularly at this, at this point.

And there's going to be a point at which your reserve drawdowns stop, and you're not going to have a -- I would think -- not going to have a corresponding jump in net interest income.

So maybe could you talk about that a little bit as to how you have kind of thought about that process?

The provisioning process actually I would suggest is actually a little bit more forward-looking in terms of anticipating what losses we're going to occur in the future that have incurred to date.

Whereas the charge-offs is actually more lagged, when we actually work our way through it, and it's more volatile.

So I don't think it's a -- usually doesn't give you a very good indication quarter to quarter.

So we just think the provision is just a better balancing factor to what you can expect over time.

When you look back in the 2004, 2005, and 2006 area that we were just -- we were using this as a tool to forecast future profitability.

We were -- we were receiving -- people were complaining that we weren't growing our loans fast enough and other people had higher margins, and quite frankly, we said they were taking risks that we didn't think you got paid for.

Obviously, they put on substantial subprime loans that people have big portfolios in the LBO space with leverage that came back to haunt them, and frankly, well, we didn't -- we didn't do those kinds of loans and actually didn't drive our gross margin up the way they did, and I think what happened was our, our risk adjusted margin really proved to be a good indicator of future and consistent profitability.

Okay, thanks.

Next question, please.

Your next question comes from the line of David Konrad with KBW.

Hi David.

Morning David.

Good morning.

Just want to follow up on the (inaudible) warranty risk.

I just wondering if could you guys could add a little color on where your total reserves stands now?

And then just, over the past couple quarters, what the reserve and losses have been for (inaudible) warranty?

Happy to, David.

In total, we've got about $290 million in reserves.

And it's concentrated primarily in the mortgage company at about $150 million to $160 million.

We feel pretty good about that reserve given the fact that, one, the amount of claims that are being made is coming down, and has been coming down.

This is all related to 2008 and prior.

And -- as well as the fact that I think we're just getting better as an organization in terms of defending the claims and what the actual risk is.

So, so that appears to be -- we, we -- this quarter actually handled some additional claims on mortgage insurance as well as the GSEs taking a harder look at OREO, and we feel we've got that recently well reserved.

So we're pretty comfortable there.

We also have the distressed asset book where we've got $100 million of reserves.

And that's a combination of things, but probably the most significant being brokered home equity sales at National City.

We're getting a little bit of push-back on that and we just it appropriate to set up reserves on that.

There may be some further smaller reserves we have to add to that over time as that becomes clear, but whatever it is it will be a manageable number.

And how have the, the losses been trending over the last couple quarters?

Coming down.

I -- particularly in the mortgage company, losses have been coming down pretty regularly with the exception of new events, like the mortgage insurers bailing out or the GSEs going back and looking at OREOs.

But other than that, the basic claims have been coming down pretty rapidly over the last few quarters.

Okay.

Thank you.

Next question, please.

Yes.

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

Hello Heather.

Good morning.

Hi, good morning.

Morning.

Couple questions.

First of all, on the purchase accounting accretion, can you talk a little bit about the decline this quarter, the $376 million down to the $214 million?

Is that just a result of all the loan sales that you guys have been doing?

Or was there some kind of a change in the assumptions behind the future cash flows?

Heather, we had made an adjustment on impaired loans in the second quarter of approximately $78 million, which didn't repeat in the third quarter.

So right off the top that's one of the items.

We also made an adjustment in our purchase accounting for debt for about $29 million.

So you can see the Delta on that second to third quarter.

So that's roughly -- over $100 million of adjustments which were made in the second we didn't expect to repeat.

And then, then the other decrease was that we did have some loan sales, but it was primarily in the commercial space where we sold a number of loans, and we're able to drive net interest income -- came down.

We had a lot of those sales in the third quarter, and what it did was it caused that scheduled NII to come down but we picked that up in the recovery area.

Got it, got it.

Okay, and then just a second question on, on deposit strategies.

I guess if rates stay where they are for an extended period of time, the spread that you're earning on some of your money market, and even your lower cost CDs is going to compress.

Will the strategy be to sort of keep the relationships and suffer NIM compression?

Or will you be looking to maybe shrink your deposit balances a little bit by running off even further CDs than you've talked about already?

We typically would, would have the responsibility to keep, keeping the deposits, but I think you'll see if the rates stay low.

I think you'll see the entire industry taking the, taking their rates down as they have in CD pricing and elsewhere, because there really isn't -- I mean it's not a good time to go out the yield curve, and it's -- or a good -- and I don't, I'm not sure could you go out to credit curb if you wanted to, so -- because loan demand is so low.

I mean, you can always do something stupid like that, but I think, I think you would see the rate, rates come down across the industry.

Yes, the only place we're seeing any pressure on rates is in companies that are in need of significant liquidity funding at the moment, who may be doing more lending than the market is ready to bear at the moment.

So we're seeing a little bit of pressure there, but that, that's about.

Okay, great.

Thank you.

Our next question, please.

There are no further questions at this time.

Geat, thank you.

Jim, if you have some closing remarks.

Thank you very much for joining us.

We think it was an excellent quarter.

We not only had a great earnings quarter, but we also accomplished a lot as a Company in terms of credit conversion, building capital, and we look forward to talking to you again soon.

Thank you.

Thank you.

This concludes today's conference call.

You may now disconnect.