PNC Financial Services Group Inc (PNC) 2010 Q4 法說會逐字稿

Good morning.

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

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

All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer session.

(Operator Instructions).

Thank you.

I would now like to turn our call over to Mr.

Bill Callihan.

Sir, you may begin your conference.

Thank you.

Good morning, everyone, and 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 that we anticipate in our statements and from a 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.

These statements speak only as of January 20, 2011, and PNC undertakes no obligation to update them.

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

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

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

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

Thank you, Bill.

Good morning everyone.

Thank you for joining us.

In our presentation today, I will focus on PNC's strategic accomplishments for 2010 and full-year highlights for our businesses.

Rick will provide more detail on our fourth-quarter and full-year financial results, and I will close with some of our expectations for 2011.

Overall, PNC delivered exceptional performance in 2010 in a very challenging environment.

Financially, we earned $3.4 billion in net income last year, a record for our company.

In the fourth quarter, we earned $820 million, or $1.50 per diluted common share.

When adjusted for integration costs, our earnings were $871 million, or $1.60 per diluted common share.

Operationally, we transitioned to a higher-quality balance sheet with excellent liquidity.

Our credit quality has improved and we strengthened our capital positions.

In fact, our Tier 1 common capital ratio was at a record level as of December 31, 2010.

Importantly, we completed the conversion of National City customers and branches and have already demonstrated success in implementing our sales and service model throughout the expanded franchise.

Our employee engagement scores also, even with the new employees for 2010 were up across the company.

We exceeded our original acquisition related cost savings goal and ended the year with over $1.8 billion in annualized savings.

Both financially and strategically, we executed our business plan effectively through the year and are well positioned to compete successfully in 2011.

Turning to our businesses, they performed well in 2010.

Most importantly, we increased the number of clients we serve and we have the proven ability to grow in both high potential and mature markets, and we have the scale to compete successively in an consolidating industry with leading positions in our major businesses and products.

Retail Banking, for example, reported higher profits in 2010 compared to the previous year, solid results given the regulatory and a low interest rate environment.

We grew checking relationships by 75,000 in 2010, an impressive gain considering the first half of the year was dominated by the customer conversion process.

In the fourth quarter, our net new checking relationships increased by 27,000, a good result compared to the same period in previous years, reflecting our ability to increase customers throughout our expanded franchise.

Now, in addition to adding clients through our branch network, we recognize some customers are best reached where they work or go to school.

Together, our Workplace and University Banking channels produced 38% of our full-year customer acquisition.

After customer conversions were complete, client acquisitions through these channels in the second half of the year grew by 20% compared to the same period in 2009.

University Banking had an excellent year and increased the agreements with schools by more than 75% in 2010.

Our goal on the consumer side is to deepen these relationships, and we saw active online bill payment customers grow by 25% in 2010.

Now, in response to the new Consumer Banking environment, we will be launching a new integrated payment model in the second quarter that connects credit, debit, and rewards, and leverages the strength of our Virtual Wallet offering.

Based on extensive research, PNC's strategy is designed to give customers choices and options based on their needs.

Rather than optimizing fee revenue, our approach is focused on growing market share and share of wallet.

We believe this approach will provide us the greater flexibility as the regulatory situation unfolds, and it recognizes that interest rates will eventually rise and deposits will become more valuable.

Our Corporate Institutional bank had record earnings for the year.

We grew average deposits by 17%, and credit and non-interest expenses were well-managed.

We had record client growth as customers grew at twice the pace of any previous year.

With more of our clients on one platform, we saw increased sales of treasury management and capital markets products throughout the franchise, but especially the customers in PNC's western markets.

In this important fee area, both Treasury Management and Capital Markets delivered record revenue for the year.

Treasury management revenue increased by 8% in 2010 compared to the previous year, and that compares favorably to industry growth which was projected to be in the range of 1% to 2% annually for the year.

Capital Markets revenues, customer related of course, was up 16% for the full year compared to 2009.

One of the benefits of our increased size is that we now have more opportunities to bid on businesses -- bid on business while maintaining our moderate risk profile philosophy.

As a result, we booked some of the largest transactions in the history of the Company in 2010.

We showed a pace of loan utilization pickup in the fourth quarter, especially among middle market clients.

Overall, we are seeing signs of loan growth in many segments.

Another indication that the economy is improving is the activity we see at Harris Williams, which is one of the nation's largest M&A advisory firms for middle-market companies.

They had a very good year last year and have a strong pipeline of business for 2011.

Our asset management business also had a good year.

Full-year earnings were up 34% year-over-year.

We outperformed our sales goals, ended the year with a record number of new clients as well as a record -- as well as record client satisfaction.

These gains were driven by total sales and referrals from other PNC channels with both increasing more than 40% on a linked-quarter basis.

Assets under administration at year end were $212 billion, and operating expenses remained well-controlled, net of our investments to grow the business.

Moving onto Residential Mortgage, they accomplished a great deal this year.

We have realigned the sales and servicing aspects of this business so that it better reflects our moderate risk philosophy and our relationship-based business approach.

Full-year mortgage loan originations were $10.5 billion.

Originations in the fourth quarter were $3.5 billion alone.

They were up 30% linked-quarter driven by higher loan refinance volume.

Servicing fees for 2010 were up 9% compared to the previous year.

Full-year non-interest expense was down 11% year-over-year.

Now, with regards to our distressed asset portfolio, we continue to make good progress.

We ended the year with fourth-quarter average assets of $15 billion, down $5 billion from the same period quarter a year ago and down $1.4 billion linked-quarter.

This portfolio has been reduced by 45% since the acquisition of National City.

Overall, we have done an excellent job in maximizing the economic value of these assets.

Moving on to BlackRock, they will announce full-year earnings next week.

They continue to integrate Barclays Global Investors, an acquisition that made them the world's largest publicly-traded asset manage.

At year end, our economic interest in BlackRock was approximately 20%.

Now, as a result of these excellent efforts by our employees, last month we were honored by -- and touted to be named the 2010 Bank of the Year in the United States.

This recognition was given to us by the Banker, which is published by the financial Times Group in London.

This is the first time we've received this prestigious international recognition for our successful business strategy.

We see it as an important acknowledgment of our continuing commitment to becoming a great company.

Now, with the completion -- let's talk about sales for a moment.

With the completion of our customer conversions this year, we began distributing a broad array of products more consistently.

As shown on Slide 6, our Western markets, which are predominantly legacy National City, accounted for about 44% of our sales in Corporate Banking, Wealth Management, Institutional Investments, and Commercial Banking products for the full year.

That's up 42% since 2009.

An acquisition, legacy National City had more clients than legacy PNC, but product penetration at National City clients was much lower.

By successfully retaining those clients and deepening our relationships with them, we believe our Western markets will eventually account for a larger share of product sales than our Eastern markets, which are predominantly legacy PNC.

In fact, we believe the potential for revenue growth, assuming modest expenses, will be more than $500 million once our sales practices are fully implemented in our Western markets.

In 2010, sales across our franchise were up 20% compared to the previous year.

I'm especially pleased to see in the Western markets sales were up 26% for the full year compared to 2009 and increased 58% in the second half after all of the conversions were completed in June.

This shows the completed conversions have a positive impact on sales and a trend that we expect to continue in 2011.

Cross-selling in these markets improved by 5% over-year, which is a good indicator that these converted markets are beginning to reflect PNC's approach to sales.

In the fourth quarter of last year, we saw commercial loans increase on a linked-quarter basis for the first time in two years.

We saw growth in virtually every commercial loan category, and that gives us optimism as we begin 2011 that loan growth will continue.

Now, Rick will provide you with more detail about our full-year and our fourth-quarter results.

Thank you, Jim, and good morning, everyone.

Our fourth-quarter earnings per share of $1.50 resulted in a record Tier 1 common capital ratio from an estimated 9.8%.

We have made great progress in strengthening our capital position during the year.

As we move into 2011, our focus will shift from accumulating capital to leveraging our capital for the benefit of our shareholders.

Today, I plan to focus on three items -- first, our strong earnings, including the steps we have taken to further migrate our balance sheet toward a moderate risk profile; second, the positive impact our growth initiatives are having on our pretax provision earnings; and finally, the key drivers that we believe will lead to further growth and shareholder value.

Now, let me begin with our balance sheet as shown on Slide 8, which remains highly liquid and well capitalized.

Loan balances stabilized this quarter.

In fact, balances are up almost $0.5 billion.

As we look ahead to 2011, we expect that distressed assets will run off at a 25% pace, which is the same rate as last year.

Excluding the distressed runoff, we expect loan growth in 2011.

On the deposit side, transaction deposits increased by approximately $8.5 billion compared to the previous year end, a strong sign of our ability to grow our customer deposit franchise and capture our clients' excess liquidity.

At the same time, we significantly reduced our higher-cost CDs and other time and savings accounts by $12 billion while retaining nearly 75% of our relationship accounts.

These trends resulted in a loan-to-deposit ratio of 82%, a highly liquid balance sheet.

This discipline resulted in full-year deposit costs decreasing by nearly 50 basis points, which was a strong contributor to our net interest margin growth.

Common equity for the full year increased by $7.6 billion, bringing our total to $29.6 billion as of December 31, 2010.

Our capital and liquidity will provide us the capacity to support our clients as the economy gains momentum and give us the flexibility to support further growth in capital management actions.

Now, Slide 9 shows our credit quality metrics which overall continued to improve in the fourth quarter and from a year ago.

It starts with early-stage delinquencies which declined by 5% and late stage delinquencies which were down 10% compared to linked-quarter results.

This clearly reflects improving credit trends.

Our nonperforming loans at the end of the fourth quarter were down $370 million, or 8% on a linked-quarter basis, primarily driven by improvements across our commercial lending portfolio, partially offset by modest increases in consumer and residential real estate due to increases in troubled debt restructurings.

Fourth-quarter provision of $442 million was also down linked-quarter.

Fourth-quarter net charge-offs of $791 million were up $177 million linked-quarter, and net charge-offs reflect our actions to reduce credit risk.

We expect charge-off trends to continue to be volatile as they are typically the last credit metric to improve.

Looking to 2011, we anticipate an overall improvement in credit migration and a continued reduction in our nonperforming loans, assuming modest GDP growth.

As a result, I expect the average quarterly provisioning for 2011 to be below the fourth-quarter 2010 provision, assuming budgeted loan growth projections.

If our expectations hold, this should result in a year-over-year provision decrease of at least $800 million.

Now, let me turn to our trends and net interest income.

The left side of Slide 10 shows the 2010 impact by quarter of core net interest income and purchase accounting accretion on our net interest income.

It also shows our net interest income by quarter, adjusting for our provisioning.

On the right side of the chart, it shows the trend of our net interest margin and our provision-adjusted net interest margin.

As you can see, PNC's fourth-quarter net interest income held steady from the third quarter, driven by better-than-expected cash recoveries on impaired loans and stable core net interest income.

When the impact of purchase accounting accretion is removed, PNC's core net interest income remains stable throughout the year despite the fact that our average interest earning assets have generally declined.

This has been accomplished by reducing our funding costs rather than by taking undue credit or interest-rate risk.

The chart on the right shows our net interest margin trend, which has declined slightly from earlier in the year.

We expected this as the benefit of purchase accounting has declined.

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

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 provision-adjusted margin has improved throughout 2010.

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 credit or interest-rate risk that is inconsistent with our moderate risk philosophy.

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

Looking ahead to 2011, assuming at least modest GDP growth and continued low interest rates, you should expect decreases in purchase accounting accretion by as much as the $700 million, which will be more than offset by decreases in our provisioning.

At the same time, we expect our core net interest income to increase.

While the net interest margin should decline, we expect our provision-adjusted margin to remain relatively stable.

As you can see on Slide 11, we delivered $3.9 billion in revenue in the fourth quarter and $1.6 billion in pretax pre-provision earnings compared to our provision of $442 million.

This allowed us to deliver pretax pre-provision earnings that were 3.5 times greater than our credit cost.

Now, let's focus on noninterest income and expenses.

In the fourth quarter, client-related fees, which excludes the other category on Slide 11, increased 13% linked-quarter.

Corporate service fees more than doubled compared to the third-quarter.

The gain was driven by an increase in the value of commercial mortgage servicing rights and higher merger and acquisition advisory fees.

Asset management fees also contributed to the increase and were up 22% in the fourth quarter compared to the third-quarter primarily from higher asset values due to improvements in the equity markets and equity income from our investment in BlackRock.

As expected, service charges on deposits were down $32 million linked-quarter, mainly due to an additional $55 million impact of Regulation E.

Residential mortgage fees were lower by $59 million linked-quarter largely as a result of lower net hedging gains on mortgage servicing rights.

The other fee category on Slide 11, net security gains decreased by $53 million while the amount of improvement in our OTTI charges was $27 million.

The remaining other noninterest income increased $201 million linked-quarter.

The fourth quarter included a $160 million gained from our sale of BlackRock stock in November, partially offset by approximately $92 million of recourse reserves primarily in the broker home equity and multi-family housing spaces.

As I look at 2011, we see momentum in our fee-based revenues as a result of our expanded franchise.

At the same time, we will see the continued impact of ongoing regulatory Reform.

With regard to 2011, noninterest income excluding the incremental impact of anticipated regulatory changes on fees of approximately $400 million in 2011, we expect noninterest income to be up in the low to mid single digits compared to 2010.

Expenses increased by $182 million linked-quarter and included $109 million in higher residential mortgage expenses largely driven by increased residential foreclosure-related mortgage expenses as well as higher compensation expenses due to business activity, business volumes, and the increase in our stock-price.

We successfully exceeded our acquisition-related costs savings goal of $1.8 billion on an annualized basis in the fourth quarter, well ahead of our original target amount and schedule.

As a result, on a full-year basis, our expenses were down 5% year-over-year.

Based on our budget, we expect expenses in 2011 will be down as well.

The magnitude of the decline will be dependent on the pace of our investment in growth opportunities.

As shown on Slide 12, our Tier 1 common ratio at the end of the fourth quarter is estimated to be 9.8%, which is up 20 basis points linked-quarter due to fourth-quarter earnings partially offset by our higher risk-weighted assets.

Since December 31, 2009, our Tier 1 common ratio has increased by 380 basis points.

In addition, our book value per share during the same period has increased 18% to over $56 as we have produced further value to our shareholders.

Our Tier 1 ratio at the end of the fourth quarter is estimated to be 12.1%, which means approximately 80% of our Tier 1 capital is comprised of Tier 1 common.

This places us up in the top tier among our peer group while still delivering mid to upper teen returns on Tier 1 common equity.

However, if we operated near the average about our peer group's Tier 1 common ratio of 8.2%, our return on Tier 1 common equity would be almost 3 percentage points higher than it is today.

We have the proven ability to generate capital, our liquidity is strong, and the overall economy is showing signs of improvement.

This should provide us with greater flexibility in capital management than we have had in the past.

As we look ahead, we expect to receive greater clarity from our regulators regarding capital.

Based on what we know today, assuming full implementation of Basel III, the impact to PNC could be as much as 320 basis points, which includes the impact of our BlackRock holdings on after-tax basis and the portion of our securities portfolio that is sub investment-grade.

Let's be clear.

Rules are not yet final and there is still a possibility the full impact of Basel III will not materialize.

However, even if it does, let's put this in perspective.

PNC's 2010 earnings accounted for 130 basis points towards our estimated Tier 1 common ratio at year end.

By the time new BASEL rules go into effect, we expect sub investment-grade securities to be 30% lower due to pay downs of loan.

As a result, PNC is well capitalized today and should be when the rules go into effect in 2013.

Pending approval from our regulators, our Board of Directors views increasing the dividend as a key priority along with stock buybacks.

Clearly, there should be opportunities from our active capital management this year that will give us another means to enhance shareholder value.

With that, I'll hand it back to Jim.

Thanks, Rick.

By all accounts, 2010 was a year of exceptional achievements for PNC.

We successfully executed our business model and delivered record results.

We completed our customer conversions ahead of schedule and exceeded our cost savings goal.

Our accomplishments in terms of financial performance, balance sheet, and capital strengthening put PNC in a solid position to deliver greater shareholder value this year.

Most importantly, our businesses grew and are growing clients.

As a result of the tremendous sales momentum in the second half of the year, we are optimistic for '11.

We saw loan balances increased in the fourth quarter for the first time in two years.

We expect continued uncertainty regarding the regulatory environment.

However, it appears the economy is beginning to look more promising.

We are assuming that the current recovery will slowly transition into a self-sustaining expansion over the course of the year.

That leads us to some optimism.

As we begin 2011, we believe that we can build on this momentum, grow our deposits, and provide credit in line with our moderate risk [book] philosophy.

We see opportunities to grow our diverse revenue stream given the innovative products we already have in the market like Virtual Wallet and Healthcare Advantage, and we have proven cross-selling capabilities.

When I look at the PUC Outlook chart, there are a number of items there that are in our control.

Those are growing client that I just discussed.

We also have disciplined expense management.

You know that, and Rick has been quite detailed in the improving credit quality picture that we have.

So when you add to that the fact that we have slightly higher rates and growing loan demand, which we haven't had in years, when we put all that together, we believe that 2011 will be another fine year for PNC.

With that, we would be pleased to take your questions.

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

(Operator Instructions).

Betsy Graseck, Morgan Stanley.

Betsy, your line is open.

Why don't we move to the next one and we'll come back to Betsy?

Brian Foran, Nomura.

Good morning.

I guess a couple of questions on capital.

Conceptually, when we think about some of the risk of risk-weighted asset inflation I guess more from BASEL 2.5, how should we think about the paydowns as well as -- I'm assuming things like your unrealized gain in Visa are not included anywhere in pro forma capital calculations, and do things like that provide the flexibility to maybe move some of the securities off the balance sheet that drives some of the issues?

Brian, I think the key for us is that, as I mentioned, that we are very comfortable that we're going to have a lot of capital flexibility.

We do today and even when BASEL II and BASEL III go into play, we're very comfortable we will have a lot of capital flexibility there as well, even if we do have to provide an additional 3.2% on the ratio, which there's a lot of questions still around whether that's going to play out, so I don't see us in a position where we are going to get rid of value and valued securities that we don't need to as long as we have the capital flexibility, and we believe we will.

Maybe let me ask the same idea but a slightly different way.

Of the 320 BIP risk, I kind of think of it as a little bit more than one-third BlackRock, a little bit less than two-thirds the securities book, but will we ever actually see a capital ratio anywhere close to that?

Because I'm assuming, by 2013 when this rule goes into effect, that securities number will be much smaller via natural paydowns.

Then if you chose and you thought it was the right thing to do economically, it could be smaller still from selling some of these securities.

So is that the right way to think about it?

Maybe help us bridge the gap between the maximum impact and the lowest capital ratio we're ever likely to see.

Everyone likes to take the maximum impact, and there's -- one, we don't know how BlackRock is going to fair.

They, frankly, don't fit the leveraged investment.

They set up the minority investment because -- the minority investment rule because they didn't want banks investing in other banks that were highly-levered companies.

BlackRock is not a leveraged company at all, and so there's some question as to how that interpretation has yet to play out.

Secondly, the securities book, as Rick had in his presentation, pays down just naturally by 30% before we even get to 2013.

So, under the current run rate, if you look at where we are at the end of this year and take our earnings and just simply the maturities that we have in 2011, we will be in excess of the BASEL capital requirements in '11 that are required in '13.

So -- and that's without selling any securities or doing anything else.

So I think we're very, very well capitalized and comfortable that we're in a great place going forward.

Brian, your two-thirds/one-third is correct.

Keep in mind the two-thirds on the securities, two things about it -- the paydown to 30% will result in a 60 basis point improvement in the ratio, so that's pretty substantial.

Also, today, the way the rules are written are asking for dollar-for-dollar capital with respect to securities when, in essence, we will get tax credit if those securities are worthless, and that's not in the rules yet.

Similar to the BlackRock investment, that should be there, and I think that's one of the challenges we will want to make, so you don't know whether that's going to be pre- or after-tax.

Then one last quick one -- when I try to figure out all of the moving parts and expenses, is it fair to assume that the underlying run rate as we head into next year is kind of in the middle of what we saw this quarter and what we saw last quarter, so $2.2 billion is a reasonable starting point?

I think it is.

We had two significant items in the quarter.

Clearly, Residential Mortgage, we put up expenses on foreclosures.

We had about $109 million in total.

About $70 million of that was on the foreclosure piece, and so we think we have reserved for that risk as we've started to go back and restart all our foreclosure activities.

We also had an impact on compensation which primarily was driven by the fact that we had a great quarter in business performance and some of the models pay off based upon directly on that revenue, as well as the stock price was up in the quarter and that drove compensation expense up as well.

So, you had a number of items there which may or may not repeat themselves as we move forward.

Next question, please?

John McDonald, Sanford Bernstein.

Rick, just to clarify that, so it seemed, in other Other Expense, $100 million extra and about $70 million was mortgage foreclosure?

Yes, it was $110 million, John, and about $70 million was foreclosure.

That's correct.

The other was just other legal expense?

We changed the servicer and had to update our estimates of what the cost was there.

We had to take a one-time hit there which we won't have a problem with, with other services.

All right, so generally the whole $110 million you'd view as hopefully one time?

I do.

Okay.

Then on the noninterest income, the other Other Income had a rep and warranty or repurchase kind of contra revenue you said of about $90 million?

That's correct, John.

We set up about $65 million in our corporate home equity space.

We are very coupled that we are fully reserved there on that portfolio, as well as we set up about $35 million on our best lender as we decided it was time to start to set up specific reserves on some of our special-mention credits in that space and that too, is somewhat of a one-time item.

That $35 million is where in (technical difficulty)?

In our best lender commercial real estate.

Okay.

The $90 million, do you feel like that's going to be a provision that you will have to take for a few more quarters as you see how this plays out, or is that something you are trying to reserve ahead of time?

No, I'm reserving ahead of time.

Okay.

Then the last thing is, on the ROA target of 150 basis points, how does this quarter and this year's results leave you feeling about the achievability of the 150 ROA target?

The 150 target, of course, depends upon assay growth.

I think we're seeing -- the good news is, when you look at the fee income businesses that we have, whether it's treasury management or capital markets, to some of the items that we have on the consumer space, those items are going very well and the cross-selling is the key to that as you know, John.

We, to the extent that we are able to cross-sell and deepen our relationships with our customers, we can growth fee income.

Now, if loan demand comes back, it will be more difficult to reset because net interest income will grow, or if interest rates are higher given our balance sheet positioning, net interest income will grow, and noninterest income will grow because we will continue to sell those products.

So the ratio may not hit the 150, but you won't mind that because both revenue items will be in a growth mode.

So, I think we're moving down that path.

What we say is things that we control and things we don't control.

If there's no loan growth and if there's -- if interest rates stay where they are today, we will continue to drive fee income higher, and that ratio will grow as it did in the early 2000s.

However, if loan growth comes back and interest rates are higher, they will both grow and the ratio won't.

Okay.

One more quick thing -- the Corporate Services was very strong.

You mentioned the increase in the value of commercial mortgage servicing rights was a benefit there.

Was the rest of that just kind of Harris Williams strength that you see will pull through to next year?

Yes, Harris Williams had a great quarter and that's up over the prior quarter as well.

TM Capital Markets, all of those areas, they just had a good quarter overall in terms of strong clients flows, and I would say particularly Harris Williams.

We see the pipeline is very strong there, so we expect that to continue.

Just to give you a sense there, one of the things that has happened is that both National City and PNC have very, very strong relationships with their commercial customers across their franchises.

However, their ability to become the agent bank for a lot of middle-market companies was restricted by the fact that the size of each individual company couldn't really position themselves and take a large enough bite to become the agent.

As we see trends across the franchise now, it's the ability to become agent and when you become an agent, you know, you capture 80% of all of the ancillary income from middle-market companies -- has dramatically grown because of our ability to take a larger size.

So that's one of the benefits of the merger that I don't think we adequately estimated when we started.

Okay.

So the only specialized (multiple speakers)

It shows up in Treasury Management and Capital Markets.

Okay, so the only special item there was that $24 million, was it, in the Commercial Mortgage write-up?

In the quarter, John, that was about $40 million.

$40 million?

Yes.

Paul Miller, FBR Capital Markets.

Thank you very much.

You guys made some pretty good comments about capital management, but what target would you guys use on that on your retained earnings?

Would you shoot for 50%, 60%, 70% payout ratios?

We have to wait until we hear back from the regulators.

Capital is very important.

We think we have excess capital.

We would love to raise the dividend.

We are hopeful of hearing back in March from the regulators.

We hope that we hear back that we could increase the dividend.

We hope that we're also in a position to do some share buyback as well because of the capital position that we have.

I think capital is evolutionary.

I think it's good to have a lot of capital in an environment like this and hopefully that we will be able to use it for loan growth, but we've shown in the past that we've been more than happy to return a great deal of capital to the shareholders if we don't have an alternate use for it with the appropriate risk-adjusted return.

So I think it's, given the regulatory environment now, it's hard to come up with a targeted number because we still have to work with the regulators.

Moving onto M&A, would you -- are you out there looking?

A lot of guys have you circled buying some of these bigger banks out there and we're seeing some of the pricing get a little bit rich on some of these deals that were announced this week.

What's your outlook on M&A?

Would you rather return capital to shareholders, or would you like to use it for M&A?

Well, you know, everything we've done for the last decade has been about risk-adjusted returns.

For the most part, we've gotten that right.

If you don't get the right risk-adjusted return, then you probably shouldn't make the loan or buy the company.

I think we've been disciplined about that and we've taken advantages of opportunities, but we've been careful.

We've looked at 40+ -- I don't know what the number is anymore, Rick.

It's way over that -- FDIC transactions and bid on none.

I think the opportunities for us to buy large banks is to a great extent limited, not that any of them are for sale, but a lot of that is quite limited.

So first of all, what we want to do is grow this franchise.

I think the numbers and the cross-sell and all the things that are in the presentation, that's really number one, two, and three for us.

We have a tremendous opportunity to do that.

Secondly, if there are fill-in acquisitions, you know, they were typically small and you've seen us in the past buy banks that are in and around our franchise where we can take out the cost in a shareholder-friendly manner and leverage the brand and the technology.

That really works for us and gives us high returns, so I think we want to do those things and -- but as I said in the last question, increasing the dividend and buying back a few of our shares I think has a very high return and is what we want to do for the shareholders in the immediate future.

Okay, thank you very much, gentlemen.

The next question, please.

Ed Najarian, ISI Group.

Good morning, guys.

How are you?

Just a quick clarification question on Rick's comment in terms of accretable yield down $700 million -- or I guess over $700 million year-over-year.

I take it that you're including in that number the cash recoveries on the commercial loans?

Yes, that's correct, Ed.

What I said was actually it could be up to $700 million decline.

I'm sorry, up to $700 million.

Yes, Ed, the wild card -- obviously the scheduled accretion is pretty clear, right?

You just map that out.

The wild card is how much we continue to get on the cash recoveries on the impaired loans.

As you know, we've been outperforming on that almost every quarter.

What we're finding is that the marks on the commercial side are giving us good opportunity to either get paydowns and you're seeing those recoveries in that.

If you look at the consumer side, I'm really pleased with how that's going.

I would say that well over 80% of that portfolio is performing today.

In fact, we're just about to move about $0.25 billion of that book in the home equity space into the retail bank because it's performing so well and it's with existing customers, so feeling pretty good about the marks and how that book has played out for us.

Okay thanks.

Then just to follow-up on -- in terms of that 300 -- or 20 basis point move on Tier 1 common under the strictest definition of Basel III, do you have any sense from your federal regulators about how they are thinking of that yet?

Or are they thinking they should be applying the strictest definition?

Have they given you any insight on that in terms of how they would think about that for return of capital during 2011?

They haven't given us any insight on the final rules, but they certainly would like us to get over that hurdle as we go through the current discussions around capital.

We're fine.

The next question?

Anything else Ed?

Oh I'm sorry.

I think I was cut off there for a second.

No, it was just a quick statement.

All of our forecasts show that we're fine.

Yes, I'm sorry.

I think I must have just been cut off there for a second, so I guess I --

We didn't do it, Ed.

We didn't do it.

The portion of that, the last portion of that.

Anyway, I guess, just to follow-up, would you -- I think we discussed in the past that those are high-yielding securities.

Would you ever consider selling those, or do you really want to hold onto them because of their net interest income benefit?

I'm talking about the noninvestment-grade securities.

Yes, Ed, if we saw an opportunity to get value out of selling them, we would, but I think, for the most part, these are good, high yielding securities and we like the credit risk in the book.

Again, like most other things we look at, it's risk and return, and we like those securities today.

Okay.

Then just finally, any comments on future expense save initiatives sort of throughout the whole franchise now that you're sort of beyond the integration?

I think you had talked previously about potentially circling back and doing sort of maybe another look at expense saves.

Any thoughts on that?

Expense saves are always important to us.

When you look at that outlook chart, continuous improvement is something that we've had.

I don't think there's any question.

We've got a number of organizational changes that we're in the process of implementing right now, and there's a number of things that we will do over the course of the year to take additional expense out of the Company.

So that's -- I think you can trust us to manage our expenses.

That's a very, very important piece.

We have a lot of the ideas from One PNC that are still around that we haven't implemented across the entire franchise, and so -- and there's a lot of new ideas.

I really have to admit that the continuous improvement area has been able to gin up an awful lot of ideas coming from the businesses and the staff functions to become more efficient.

So that's just now part of the culture of the Company.

Okay, Thank you very much.

Gerard Cassidy, RBC.

Good morning, guys.

A couple of questions -- Rick, on the TDRs that you guys include in your non-performing assets, what dollar amount of those should come off the TDR status after the first quarter since they've come through the year end and I'm assuming they would have six months of performance of the new -- at the new level?

You know, Gerard, if you look at Page 8 of our supplement, we show you how much is returning to performing each quarter.

I'm not expecting that trend to change.

It's somewhere between $100 million and $150 million a quarter.

So I think you can expect that to continue.

Okay.

In regards to the outlook for mergers and acquisitions Jim, obviously the National City deal that you guys did and the Wachovia deal that Wells Fargo did were phenomenal deals for your shareholders, but it seems like the M&A market has shifted back to a seller's market.

Do you expect -- should you do smaller deals as you have done in the past as you pointed out?

That's -- you're going to have to pay prices that may be dilutive to your own shareholders temporarily?

We have to look at each one one at a time, Gerard.

I think this could be an interesting environment.

I think there's going to be a lot of selling going on.

I think when you look at the troubled bank list that's gone from 19 to 860 at the FDIC, I think there's going to be a lot of opportunities, and I think there will be more sellers than buyers.

So I think, over time, I think it's a buyer's market and I think you just have to be patient.

I think you have to do the right thing for your shareholders, and I think that's what we're going to do.

Okay.

Rick, in terms of asset sensitivity, where does -- how does the balance sheet look going into 2011, assuming possibly there's going to be a rate increase later this year or maybe early 2012?

Yes, at the end of the year, we were still short about a year and a half.

The only reason why it changed from where we were before is because rates have gone up a little bit and as you know, that kind of extends some of your assets and pulls in some of your deposits, so that was more rate driven than any action on our part.

I think, at least for the moment, we kind of like where that is and we will be watching rates as we go forward.

Great.

Jim, just one final question -- I know you don't give future guidance and stuff, but I have to put you on the spot.

What score are you predicting for the Steelers-Jets game this weekend?

I just made my bet with [Fink] and [Capito] yesterday, and those guys are tough negotiators.

I got the three point -- I had to give the three points to those guys, but if the Jets win, I have to fly to New York and buy both of those guys dinner.

If the Steelers win, I still have to fly to New York because they won't eat dinner in Pittsburgh, so they're going to buy me dinner, a good deal.

Very good.

Thank you.

Mike Mayo, CLSA.

This is the lowest you've ever been in the queue, Mike.

We were worried you might not be here.

You know, sometimes I'm seated by the kitchen.

Sometimes I'm last.

It's okay.

Charge-offs were up 29% linked-quarter going back to the level of almost a couple of quarters ago.

Can you give any guidance on charge-offs?

Did you do any special cleanup?

What's going on there?

Yes, we've been -- there is still obviously commercial real estate that we are moving into that portfolio and charge-offs there are up.

We're also looking at some of other asset categories where we feel we ought to sell them and move out of those categories, so we moved some assets.

I would say about -- I think about $100 million of that is on assets we moved into held-for-sale which we will be selling at a later date.

All right, so that would be --

But it won't be volatile, Mike.

As you know, if we take the actions we should around the book and give them the reserve levels we have, you have to have charge-offs over time.

So we shouldn't expect that level to continue?

It could be lower, it could be higher depending on the credit actions we take in any particular quarter.

Most importantly, we're very comfortable with the provisioning and the reserves that we have to take care of the problem assets.

Moving onto capital, the BASEL III hits, a lot of it is from the sub investment-grade securities.

How much were those sub investment-grade securities in the fourth quarter?

I'm going to say the number is about $7.6 billion, Mike.

The one thing about that rule which I really feel that they're going to have to take notice of, to expect somebody to show dollar-for-dollar capital on something that you can absorb the deferred tax asset on by being able to -- we're not going to lose dollar-for-dollar on those securities.

So that's way over the top on the capital side.

So I think that's something like we did with BlackRock stake where we're going to have some intense discussions around how that should be handled.

And you know -- (multiple speakers)

If you had to give a number right now, what's your Tier 1 common ratio under BASEL III?

After mitigating actions, that number would be what?

We have given you our actual Tier 1 common today is $9.8 million.

If we were to retroactively implement BASEL III today, according to the way the rules are defined right now, which again it's hard to say and we said it's $3.2 million, we would be at $6.6 million.

But then you would take some actions that could mitigate that.

No.

Well, we could, but if you don't take any action and you just add the earnings roll forward that we expect and the maturity -- the maturing of the securities over the course of 2011, we've become in complete compliance of the 2013 requirement sometime during 2011 just with doing nothing, just by earning money and letting the securities roll off.

In Rick's presentation, 30% of those securities just pay off over the next two years before we get into 2013.

That's about 60 basis points right there.

Okay.

Then, still on capital, systemically important financial institutions might need to have more capital than all the other banks.

Do you think you will be in that category?

If you don't think you are in that category, would that potentially keep you from pursuing acquisitions?

I think there's probably seven answers to that question.

One is I don't know yet how they are going to define systemically important financial institutions.

One is just basically by size.

In that case, we might be included.

The other one is the systemic people who take on a lot of systemic risk that have a lot of international connections as well as an enormous amount of counterparty risk.

They clearly have a systemic profile that's different than ours.

With an 82% loan-to-deposit ratio and the capital ratio we have, the risk profile we have versus those is clearly different.

So I don't know where they would be.

Secondly, if they were systemically, I would guess that, if you were systemically risky and additional capital is required, I would think that we would end up in the low end of that scheme if there were additional capital required.

So, --.

Third, secondly, if there were additional capital required, we already have more capital than almost everybody else in the industry on a ratio basis, so that doesn't bother me.

Thirdly, I don't think -- I think the capital ratios we have would allow us the flexibility to be in the acquisition game for I think anybody that we would see might come up on the horizon.

So, we're very, very comfortable with our capital position, Mike.

Thank you.

Ken Usdin, Jefferies.

Good morning, guys.

I have a bunch of clarifications just to make sure we are all hearing the right messages.

So first, Rick, I think you mentioned that even after the up to $700 million decline in accretion-related income, that you expect net interest income to net grow in 2011.

Is that correct?

I expect the core net interest income to grow, in other words the net interest income without the impact of purchase accounting.

So you're not necessarily saying that NII would be up, just that other --

No, I'm definitely not making that prediction.

That's correct.

Okay.

But the provision I believe will be down by $800 million-plus.

Right.

So I got your point on the adjusted margin.

Your point is that should still be up.

Then can you talk about again the net driver of that core improvement?

Is it -- what's the core margin going to be doing underneath, again, as the accretion rolls off?

Well, we're probably starting to see close to the bottom on the deposit side, but we will have some potential further repricing throughout the year.

The real opportunity here is rates have started to go up.

Asset growth is starting to improve.

I think those together is going to help us to keep core just where it is.

I think what you really want to take is core from the fourth quarter and take a look at what's happened with rates recently and our ability to be able to lever into just a little bit.

Okay, so it's going to be mostly earning asset growth that is going to drive the core NII growth then?

Yes.

Okay.

The second confirmation is just on expenses.

Again, you made the comment that you thought that expenses will be down in '11 versus '10.

Part of that is obviously the absence of restructuring costs.

So, can you just confirm again, versus the fourth-quarter run rate, how much of that fourth-quarter run rate would you consider to be one-time in dollar terms and in earnings per share?

Well, I think the numbers I mentioned on residential mortgage, which was primarily the foreclosure number, that one-time event there relates to the recent ceasing of foreclosure, and so I think we have adequately reserved for that component.

I'm not expecting anything in that space to come in the future, and I also will not have an additional charge related to a servicer, which is another $35 million to $40 million.

So I think that $110 million is something that I don't expect to see repeated.

On the comp side, hey, if business performance continues to go, obviously that will go up, but I don't -- this is a very high adjustment in this quarter, so I don't see it being that high in the future.

Then the $90 million [contract] for the repurchase, is that also one-time as well?

I see that as getting our life-to-date reserves to where they need to be today, and I think that will be adequate to cover our exposure in those areas.

So if I add all of that up, that's about $0.30.

Does that sound about right?

That's quite a bit, yes.

Okay, so then when we think about the run rate then, the run rate should not necessarily be off of the $2.2 billion you mentioned earlier in the call, right?

Because if it's a $2.2 billion expense run rate times 4, that's $8.8, billion and last year it was $8.6 billion of total expenses.

Yes, I think we're -- that's correct.

I think -- let me just doublecheck where you are at on those numbers.

One clarification -- the $90 million that Rick mentioned was in other noninterest income, not expenses.

(multiple speakers)

Okay, understood.

So the bigger question then is just in regard to the expense run rate.

You said that -- in response to Brian's question, that the run rate looks more like $2.2 million, but that would imply a higher expense base in 2011 versus 2010.

I think a couple of things.

One is I think the third quarter is probably a better indication of what the running rate is given all of the unusual items of the fourth.

Then secondly, we are not done trying to take cost out of the franchise, and so we will continue to try to lower that running rate as we move forward.

Okay, got it.

My last clarification then is just, on the capital side, there's been a lot of questions about what the pro forma BASEL III would look like.

But where do you guys think that you are going to be able to live?

So some other of your peers have said that 7% is a reasonable level over the longer term.

Do you think you will be able to live on 7% adjusted?

Or do you think you're -- or how much above do you think that you're just going to either need to or be told to live above that level?

I would love to know the answer to that question, because then we could just set a share buyback and go to that number.

That's going to change in different economic environments.

Right now, I think we're very happy to have more capital than less.

But clearly we believe that all the forecasts that we have show us having more capital than we need, so I think we have to wait to hear what -- we have to wait to hear what the regulators say to us in the first round.

Hopefully, we'll hear that in the next couple of months.

My final quick one -- thanks for the time.

Can you just talk about your preferred return of capital to shareholders either in terms of, again, this is long-term and you might not have the answer today, but desired proportion of earnings you would like to return over time and the split between dividend and share buybacks?

Thanks again.

We don't have a target for that, Ken.

One of the reasons is that it depends on what the opportunity is for us to use the capital.

If you take -- if you look back to where we were in 2004, '05, '06, we are investing in acquisitions and because of the pricing and the investing in -- and the low growth that people have which have low economic returns, we basically didn't grow the loan book and everybody else was growing HLT loans and subprime loans, a lot of risk.

We just thought the risk-adjusted return wasn't right, so we were -- our dividend payout ratio at that time was in the 60s% I believe and we were buying back a lot of shares at the same time.

Yet, if we find an opportunity where loan growth and good customer growth is available, we would rather -- you would want us to leverage that capital with good economic return.

So, I think the payout ratio that the Board has been comfortable with in the past has been 30% to 40%.

But right now, everything we see going forward, we've got way more capital than would be required by the normal growth of our customers.

Thank you.

Next question, please.

Matt Burnell, Wells Fargo Securities.

Just one follow-up question -- in terms of the fee revenue estimate that you put out for 2011, does -- I'm presuming that your commentary about the potential for fee reduction of about $400 million related to regulatory issues assumes the Durbin amendment goes through currently as -- or basically as it is currently stated.

Correct?

Correct.

That's exactly right.

That would assume that goes into full effect in July 1.

Okay great.

Then I guess a bigger picture comment --

There've been a lot of questions around that, and the industry is very active in terms of trying to mitigate that.

There's no question that ruling has turned that business into a negative business for the entire industry.

Now, our [COGS] are in line so we are not particularly worried about that, but if you take away the entire line of business, that has benefited the retailer probably more than anything else.

Without even reviewing it in the Congress is really something that's kind of amazing, and so we're working hard to hopefully have a study done and postpone the implementation.

Just on the risk -- you probably won't want to answer this question.

I'm just curious what you think the chances of success of repealing at least part of the Durbin amendment might be.

That's -- I'd rather bet on the Steeler game, but I think there's going to be a lot of activity.

There's going to be -- there are a number of things in the financial services bill that have to be reconciled, and I think the Durbin amendment hopefully will be one of those.

Okay.

Then just one bigger picture question -- one of your competitors noted that they are taking some of their deposit inflow and, given the current loan environment, are moving those dollars into purchasing securities in -- ahead of BASEL III requirements for the liquidity coverage ratio.

Is that something you have been giving some thought to?

If so, how are you thinking about the liquidity coverage ratio affect on PNC?

You know, our loan-to-deposit ratio at 82%, we're in great shape as it relates to BASEL III, so we're not trying to prepare ourselves.

Obviously, we're trying to roll our debt out longer and have I think over a year and a half to two years of capacity on that front right now, and we're just a very liquid institution.

Thanks very much.

Heather Wolf, UBS.

Good morning.

Just a quick question on credit -- it looks like the commercial real estate and resi real estate were really driving the increases in the charge-offs this quarter.

I'm wondering.

Was there some kind of a valuation review or appraisal review, or are these new loans, new frequency or new defaults coming in?

No, just normal credit management actions to try to clean up what is in the portfolio that we previously reserved for and charging off what we think we're not going to recover.

We sold 339 properties in the quarter and we're pleased about that.

When you look at our OREO properties, our OREO expense went down, so we were pleased with those margins.

It's an awful bit like a fourth-quarter cleanup to me.

Is that the right way to think about it?

We've been cleaning it up all year long.

This is just an exercise.

We believe that we will continue to see that kind of charge-offs level in the commercial real estate space probably through midyear.

Then at that point, I think we're starting to feel optimistic that we will start to grow the commercial real estate exposure.

So we've got a little bit more to do here in terms of cleaning up.

But the reserving has been done.

Yes.

Got it.

Okay, thanks so much.

David Hilder, Susquehanna.

Good morning, gentlemen.

Just I guess a follow-up on the charge-off question.

So, Rick, is it fair to say that $100 million was moved into held-for-sale in the quarter?

Was there any other actions that resulted in charge-offs that would have in effect accelerated charge-offs from a future period?

No, not really, David, just normal credit activity.

Okay.

Thanks very much.

Lana Chan, BMO Capital Markets.

Good morning.

I just had one follow-up question.

I think, in regards to the revenue opportunities, as you cross-sell more into the National City franchise, the potential for $500 million of revenue growth that you guys cited, any timeframe in terms of how we should think about that coming in?

Well, we hope -- we're trying to get it in as fast as we possibly can.

I think it's kind of something that should evolve over the next two to three years, but a fair amount of it should come in, in 2011.

If you look at the trends that we showed about the growth in revenue and the cross-sell and the referral networks, I think we're highly optimistic that we're going to continue to grow customers and grow share wallet.

By the way, the sales ratios in the East are not exactly where we want them to be either, and so we want those to continue growing, which they are, and just -- but the opportunity -- the bigger delta is in the West.

So you saw the percentage increases we showed in sales, especially after the conversions were completed in the second quarter where, actually, if you're converting a market, there are a lot of people that are involved in that conversion process.

Once that was finished, you saw people go back to the customer space.

I think the growth in sales in the second half, as we have on the chart, is pretty impressive.

Great.

Thank you.

Just to follow-up, you said that the pace of line utilizations picked up in the fourth quarter.

Could you give any more color on that in terms of specific numbers or what you're seeing there more in terms of the trend?

Well, the spot numbers are in the appendix in the release.

The interesting thing I think is that we saw increases in virtually every commercial category, and I think that's going to continue going forward.

If you think of the manufacturing folks where that's been so soft for a long period of time, now you have a lot of activity has picked up in the manufacturing side.

Steel prices, for example, are up almost 100% in the last three months, and so for asset-based lending in some of our middle-market companies, their inventory levels now just became twice as expensive as they were three months ago.

So as they work through the old inventory costs and are replacing that, I think you're going to see borrowing requirements in the manufacturing space pick up as well, assuming the economy continues.

And so I think that's when you'll see utilization rates change to some extent, but every category was up spot-to-spot -- almost every category was up spot-to-spot in the quarter.

Okay, thank you.

Chris Gamaitoni, Compass Point.

Thanks for taking my call.

Quickly, the only NPLs that seemed to increase quarter-to-quarter were in residential real estate and residential mortgage and home equity.

Is there any trend there regionally?

It's small for you guys, but just wondering what the dynamics are.

Yes, that is the trouble debt restructurings.

As we continue to do modifications, as you know, before we give a principal or interest, we have to put it in nonperforming.

If it performs for six months then we take it off the list.

Right now, I would say that probably 50% of the residential mortgage comes off the list in six months and about I want to say about 70% of the home equity comes off the list of six months, so that's the way it's been performing.

Could you remind me of the general terms of those restructurings?

Well, there could be any number of (inaudible) but we make them a troubled debt restructure when either we get forgiveness of principal or we give a below-market interest rate.

All right.

Then just back onto the sub investment-grade RMBS, that $7.6 billion that you referenced when Mike asked, was that on [principal] balance or fair value?

Good question.

Fair value.

It was fair value?

Yes.

DO you know the unpaid principal balance on that?

We will have to get back to you.

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

I was just trying to go through the math of the relative capital holding accretion of responsible earnings.

Do you expect a credit recapture there, or (multiple speakers) fair value?

Well, a lot of the information you're looking for is obviously in our Qs and our Ks.

So, we will be updating that with the filing of the K this time around, but we will try to get back to you on specifics before then.

Thank you very much.

Brian Foran, Nomura.

Can you just remind us, on Visa, is the limiting factor the March 25th IPO three-year anniversary, or is the limiting factor now the lawsuit?

The lawsuit.

For those of us who don't follow it closely, is there a timeline for that, or is it just kind of TBD when it gets settled?

TBD.

Yes, we really don't have an estimate on it.

Thank you.

There are no further questions at this time.

Do you have any closing remarks?

No, just to thank you very much for joining us.

2010 closes out as an exceptional year I think for PNC.

We are looking forward to 2011 as being another fine year.

Thank you for joining us.

This concludes today's conference call.

You may now disconnect.