PNC Financial Services Group Inc (PNC) 2011 Q2 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the PNC Financial Services Group investor 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).

As a reminder, this call is being recorded.

I will now turn the call over to the Director of Investor Relations, Mr.

Bill Callihan.

Sir, 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, 10-Q, and various other SEC filings, available on our corporate website.

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

We also provide details of reconciliation to GAAP and 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 slides and appendix and in various SEC reports and other documents.

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

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

Thank you, Bill.

Good morning everyone, and thank you for joining us.

In our presentation today, I'll focus on PNC's second-quarter strategic and financial accomplishments and highlights for our businesses.

PNC delivered very strong second quarter performance, driven by exceptional customer growth, and improved credit metrics.

One, we earned $912 million in net income or $1.67 per diluted common share.

Our profits in the first half of 2011 were up 18% from the same period last year, and I believe this is an impressive accomplishment in the current economic and regulatory environment.

One item I would like to mention that is unusual is you'll see that we benefited from a much lower effective tax rate, primarily as a result of a reversal of deferred tax liabilities that contributed about $0.10 to our results.

Other than that, the quarter was relatively straightforward, and we believe that our second-quarter performance really was excellent.

Rick will provide more detail, along with an update on our full-year outlook, which remains positive.

Other items, based on our success in adding clients, improved demand, we saw strong commercial loan growth of $2 billion in the quarter.

Another item is we continued to transition to a higher-quality balance sheet and we remain core-funded.

Our Tier 1 capital ratio is estimated to increase to 10.5%, a new record for the quarter, but we achieved this while still raising the quarterly dividend by 250%, which we paid to our shareholders, as you know, in early May.

This quarter, we grew the number of customers we serve dramatically.

In fact, retail checking relationships and corporate business clients are at record levels for PNC, and we continue to deepen our relationships with them.

Our overall credit metrics showed significant improvement, compared to the previous quarter, and on a year-over-year basis.

And reflecting our overall growth strategy, we successfully completed the acquisition and conversion of 19 branches, 60,000 customer accounts, and approximately $324 million of deposits from BankAtlantic in early June.

Also, we announced plans this quarter to acquire RBC Bank USA.

We see this transaction as an opportunity to extend our recognized product set and distribution capabilities into several faster growing southeastern markets, and this represents, we believe, an outstanding opportunity.

Last but not least, our second quarter return on average assets of 1.4% was a very strong performance, reflecting the strength of the business model.

Overall, we're off to an excellent start in the first half of what we believe will be another very strong year for PNC.

Let me turn to the customers now.

We've been investing in our brand and our product innovation for some time, and the customer growth that we saw this quarter reflects this focus.

Let me begin with retail banking.

We launched our new suite of checking and credit card products in late March, we're seeing strong acceptance by new and existing customers.

Organic new checking relationships grew by 74,000 during the second quarter.

This does not include the 32,000 additional retail relationships we acquired in June from BankAtlantic.

And the net growth of small business checking relationships was 3 times greater than the same quarter last year.

On an annualized basis, our second-quarter checking relationships saw organic growth of nearly 5.4%, far exceeding the average population growth in our retail markets.

Our new checking product offerings also helped to shift our mix of free checking accounts much faster than we expected.

In April and May, 60% of our customers were signing up for relationship accounts, as opposed to free accounts.

That's exactly the customer behavior change we were hoping to see.

Our goal over time is to shift our mix to 70% relationship checking, and 30% free.

Additionally, we want to deepen our client relationships, and we saw active online bill payment customers grow nearly 20% from a year ago.

Another deepening, we saw a 300% increase in the opening of new credit card accounts in the second quarter, compared to the same period last year.

FICO scores of these approved customers averaged nearly 760.

On a spot basis, we're beginning to see growth in the credit card portfolio and in direct auto loans.

When we turn to the corporate and institutional bank, they continue to benefit from greater awareness of our brand.

We saw average loans increase over $2 billion in the second quarter, compared to the linked quarter, due to continued strength in commercial loan production and improved utilization.

We saw new business growth, predominantly in the middle market and corporate finance sectors.

We're well ahead of our customer acquisition goals in the corporate bank.

We are on track to exceed our goal of adding more than 1,000 new primary clients this year.

This would represent a 12% increase in total new primary clients.

Treasury management revenue was down slightly, linked quarter as a strong quarter processing revenues and sales volumes were more than offset by the impact of lower interest rates on deposit credits, but we continue to see excellent sales activity across the footprint.

Capital markets revenue was up from the first quarter, driven in part by very strong results from loan syndications and corporate securities.

We continue to benefit from our ownership of Harris Williams, one of the nation's largest M&A advisory firms for middle market customers.

Moving on to our asset management group, they reported solid second quarter earnings, driven by growth in non-interest income and improved credit performance.

Assets under administration as of June 30th were approximately $219 billion, compared to $199 billion as of the same date last year.

The increase was primarily due to higher equity markets, strong sales performance, and client retention.

PNC remains one of the largest wealth managers in the country.

Referral sales in the first half of the year to the asset management group from retail banking and corporate and institutional banking businesses more than doubled compared to the year ago, and total sales were nearly 60% higher than the same quarter last year.

We continued to invest in staffing to drive revenue growth, and have added approximately 150 new external hires during the first half of the year.

These employees are focusing their efforts primarily in higher potential markets, such as Chicago, Florida, Milwaukee, Washington, DC, with the goal of increasing revenue.

We are piloting Wealth Insight, a new tool designed to help our high net worth customers view their investments.

It leverages technology in much the same way that Virtual Wallet does for our retail customers, and early reviews from the clients who are using it have been very positive.

We have over 10,000 customers in pilot.

And they're very pleased with the product.

Wealth Insight will be totally launched in September, supported by an extensive marketing campaign, and we believe that it will give us a competitive advantage in the marketplace.

Moving to residential mortgage.

They also had a good quarter, despite the industry-wide softness in originations and lower hedging gains on mortgage servicing rates.

Mortgage loan originations were $2.6 billion, higher than a year ago but down from the first quarter.

However, we did see a 23% increase in loan applications, which is a very positive trend.

Turning to our distressed asset portfolio, we continue to make good progress.

We ended the second quarter with average assets of $13.4 billion, down $5.1 billion from the same quarter a year ago, and lower by more than $750 million linked quarter.

This portfolio has been reduced by more than 46% since 2008.

Overall, the team has done an excellent job of maximizing the economic value of these assets.

And BlackRock made their announcement this morning, they had another very good quarter, driven by strong asset management fees.

At the end of the second quarter, we held a 22% economic interest in BlackRock.

Now Rick will provide you with more detail around our second-quarter results.

Rick?

Thank you, Jim, and good morning everyone.

Our second quarter net income of $912 million, or $1.67 per diluted common share, reflects our strong performance in the quarter, and our ability to deliver quality results to our shareholders.

As Jim mentioned, $0.10 of this EPS was related to a tax adjustment which is not part of our core earnings capabilities.

In my remarks, I will focus on the following.

The continued strengthening of our balance sheet, key drivers of our strong earnings, progress on our performance measures, and our positive outlook for the remainder of 2011.

Let me begin with our balance sheet, as shown on slide 7.

The balance sheet was a continuation of first-quarter trends, as commercial loans increased $2 billion, transaction deposits were up by $2.6 billion, and higher-cost CDs and other time and savings accounts were lower by $2.7 billion.

Looking ahead, we have about $11.3 billion in these CDs scheduled to mature in the second half of 2011, at a weighted average rate of about 1.74%.

Clearly, in the current climate, these should be repriced at a much lower rate, which will benefit our funding costs.

What's new in the second quarter is that the investment securities declined by approximately $1.6 billion compared to the previous quarter, primarily due to sales of residential mortgage-backed securities and the low interest rate environment.

We saw excellent opportunities, excellent market opportunities to sell these securities, as we manage the portfolio on a total return basis.

A portion of these sales, especially in the $350 million, were sub investment grade securities, thus reducing our exposure to the Basel 3 capital rules.

Asset quality on slide 8 is a great story for PNC.

As you can see, our credit quality metrics showed market improvement in every category, both on a year-over-year and a linked quarter basis, leading to a lower than expected loan loss provision.

Our criticized commercial loans declined by approximately $1 billion, or 8% linked quarter and are down $4.7 billion or 29% year-over-year.

Delinquencies in the aggregate were lower by 14% on a year-over-year basis.

It's important to note that greater than 80% of the accounts that were 90 days or more past due consist of government guaranteed or insured loans, and we expect full repayment of these loans should they default.

Our non-performing loans at the end of the second quarter were down $438 million, or 9% on a linked quarter basis, primarily driven by declines in commercial and commercial real estate loans.

Second-quarter net charge-offs of $414 million were down $119 million, or 22% on a linked quarter basis, primarily driven by declines in commercial real estate and home equity loans.

Given the substantial improvement in our credit metrics, our provision for the quarter decreased to $280 million.

Now let's turn to net interest income on slide 9.

The table on the top shows the breakdown by quarter of core net interest income, purchase accounting accretion, and total net interest income.

It also shows our provision and our net interest income adjusted for provisioning for loan losses.

The chart on the bottom of the slide graphs net interest margin, core net interest margin, and the provision adjusted net interest margin.

Net interest income of $2.2 billion and net interest margin of 3.93% in the second quarter were in line with first-quarter results.

Core net interest income was slightly lower on a linked quarter basis, due to lower rates in our securities sales, but most importantly, our provision-adjusted net interest income increased by 7% linked quarter, and has increased by 16% on a year-over-year basis.

As you can see on slide 10, our strategy of growing diverse revenue streams continued to generate positive results.

Our client fee income of $1.1 billion increased by 3% linked quarter, a strong performance in the current regulatory environment, and considering the $62 million impact on our commercial mortgage servicing right portfolio, due to the low rate environment.

Gains on security sales of $82 million were offset by the $62 million impairment on the commercial mortgage servicing rights, and the net other-than-temporary impairment of $39 million.

The other fee category was lower linked quarter, primarily due to decreased equity management results and prior quarter insurance recoveries.

Overall, the diversity of our revenue streams enabled us to achieve a solid performance in an environment that will continue to be affected by regulatory reform headwinds, and implementation challenges.

At the same time, we see opportunities for growth in our fee-based revenues as a result of our larger franchise.

Turning to slide 11, we do have a culture of continuous improvement at PNC, which was reflected in our lower cost linked quarter for personnel, occupancy, and equipment.

Marketing expenses increased in the quarter due to elevated advertising costs associated with new product launches, and other expenses represented the largest increase linked quarter, primarily due to net expenses of $40 million in the second quarter for legal contingencies, and a $38 million reversal of a portion of the Visa indemnification liability in the prior quarter.

We increased legal accruals primarily associated with a couple of pending lawsuits by approximately $170 million in the second quarter, but we also recognized $130 million related to anticipated insurance recoveries.

These accruals should reduce the reasonably possible losses associated with existing losses previously disclosed in our 10-Q.

Our effective tax rate for the second quarter was 20%, primarily due to a $54 million benefit or $0.10 per share from a reversal of deferred tax liabilities associated with adjustments to the tax basis of an asset.

We would expect our effective tax rate to return to 27% for the second half of the year.

As shown on slide 12, our Tier 1 common ratio at the end of the second quarter is estimated to be 10.5%, 20 basis points linked quarter, primarily due to second-quarter earnings.

We continue to strengthen and will position our Tier 1 common ratio in anticipation of the Basel 3 requirements.

Since June 30, 2010, our Tier 1 common ratio has increased by 220 basis points.

In addition, our book value per common share during the same period has increased by nearly 14%, as we produced [fact] value for our shareholders.

As Jim mentioned previously, our return on average assets was 1.4% for the quarter, and our return on Tier 1 capital has remained fairly steady over the last 3 quarters, as the increase in our earnings has been offset by the growth in our Tier 1 common capital.

Slide 13 provides a summary of our current outlook for 2011, compared to our reported results for 2010, and I continue to be optimistic about our full year outlook.

Let me begin with our balance sheet.

We believe we are on track to deliver modest loan growth in 2011, despite the run-off in our distressed portfolio, with most of the increase coming from commercial loans.

We expect to see a further shift in our deposit mix, increasing transaction costs, while further reducing high-cost CDs.

Turning to our income statement, we believe our core net interest income and net interest margin will be flat to the prior year.

This is lower than previous forecasts, due to our opportunistic security sales, given the low rates and improved security valuations.

We expect our purchase accounting accretion to decline by $700 million.

We believe our provision will decline by at least $1 billion.

This is improved from our earlier full-year guidance of a decline of $800 million.

We see opportunities to increase non-interest income revenue this year in the low to mid single digits, after adjusting for the impact of regulations on overdraft and debit card fees.

We expect the impact on debit interchange revenue to be the less than $100 million in 2011.

Finally, apart from the litigation and regulatory contingencies, full-year expenses are expected to be flat.

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

Thank you, Rick.

In summary, this was another strong quarter for PNC.

By leveraging our broad array of innovative products and services, and the strength of our brand, we're increasing the number of customers that we serve.

We're facing an operating environment that's affected by a soft economy, challenging regulations, and low interest rates.

These are factors beyond our control.

At PNC, we remain focused on managing our business by growing customers, managing expenses, reducing credit risk, and our second-quarter results reflect our ability to produce excellent earnings in a challenging environment.

As we gain greater clarity from the regulators, along with higher interest rates and stronger loan demand, we see even greater potential going forward to create long-term value for our shareholders.

And with that we would be pleased to take your questions.

Candy, if you could give our participants the instructions, please?

Thank you.

(Operator Instructions).

Thank you.

Our first question comes from Betsy Graseck of Morgan Stanley.

Your line is open.

Good morning, Betsy.

Good morning.

Rick, I wanted to dig in a little bit on the non-investment grade bonds.

It's been a bit of a topic.

Can you hear me?

We're having a hard time hearing you.

Try it again, please.

Hi.

Can you hear me now?

Yes.

Okay, great.

So just, Rick, I just wanted to dig in a little bit on the non-investment grade bonds.

It's been a bit of a debate about how much that would impact your Basel 3 capital ratios.

I know you mentioned you sold some in the quarter.

Could you just give us the from-to in terms of how much sold, and what's left, and how you think about the impact on your Basel 3 capital ratios.

Basically, what we saw was just a market environment where we just saw tremendous value in the market with low rates and with a lot of the liquidity coming back into the market and, looking at it from a total return, we thought this was a good opportunity to trade out of some of those securities, as well as some of the non-investment grade as you can see.

We actually sold on the sub-investment grade securities about $350 million of value there, which brings our fair value on that portfolio down to around $6.1 billion, and obviously that balance will continue to pay down over the next couple years, year and-a-half, so it will be even less than that when we hit Basel 3 if the rules don't change and obviously we're still optimistic that maybe we'll get a better treatment than dollar-for-dollar capital on the securities, but even if we don't, that's probably about a point to a point and-a-half impact on our capital ratio, the Tier 1 common.

As you know, we're at 10.5%, so we've got a lot of room with respect to that portfolio as it relates to Basel 3.

1 to 1.5 points is as of today or as of what you expect at the end of 2012?

That would be as of 12/31/12.

Great question.

And the degree of roll-off quarter-by-quarter is consistent with what you had pre the sale of these assets?

We had a rolling off about $1 billion a year.

With the sale here, that would be slightly lower, but not dramatically lower.

I think we're going to continue to see prepayments and that will go down.

Obviously you accreted capital during the quarter.

Any update to the stock issuance guidance that you put out at the RBC acquisition announcement?

Well, as you know, in our discussions we said that we expect to fund the acquisition with cash and the proceeds of some debt and a preferred stock offering.

This continues to be the plan as we look at the markets continuously, to determine the appropriate time to access those markets, and we believe, as Rick said, that with the Tier 1 common ratio being where it is, and our forecasts for Tier 1 common, that we're comfortable that we don't think that we have to issue any common, even though we do have the free option with the RBC.

But we'll find that out from the regulators as we go through the process, but it appears as if our capital ratios will be just fine through the period.

Okay.

Thank you.

Next question, please.

Thank you.

Next question, Matt O'Connor of Deutsche Bank, your line is open.

Good morning, Matt.

Hi, guys.

Just a couple of follow-ups on the net interest income outlook.

I guess first on the purchase accounting accretion, no change in the guidance for down $700 million, but the first half has been coming in better than expected.

So should we literally think of that dropping off in the back half of the year, which if you work out the math, it might be down $100 million per quarter in the back half versus the first half or might that come in better than expected versus the down 700?

It's certainly going to come down.

This quarter was particularly high, given the fact that we had some pay-outs in the commercial space.

I think if you look, the purchase accounting actually went up from the first quarter to the second quarter, and that was due to pay-offs there.

That second quarter purchase accounting number is definitely not sustainable.

It will come down from there.

I'm not expecting a high level of recoveries to make that come up.

If you just take the $700 million year-over-year and you'll hit the right number.

Okay.

As we think about the core net interest income, in the back half of the year, you mentioned that you have some of the higher-cost CDs rolling off.

That's obviously helping.

As we think about a little bit longer term beyond this year, you've got the roll-off of the non-investment grade securities.

How do you think about the puts and takes there in terms of, you might not have as much liability, flexibility beyond this year and then you still have some of the drag on the non-investment grade, do you think you can --

I'd say our guidance this quarter on core net interest income is pretty conservative.

I think what I have ignored is any potential increase in rates, which obviously would be to our benefit.

I've obviously had to bake in here the security sales, which as you can imagine would have a big impact on that.

But we actually do have more levers on the liability side as we go into 2012.

We still have another $11 billion of CDs next year, that reprice at an average rate of about 2.5% in the first half of the year; 2.5% up to 2.7%.

That's a good lever right there, as to whether those will go to zero or whether they'll go to, obviously, a much lower rate.

The other item we'll have over time, we'll have to wait to see how the market is, we've got close to $2 billion of trust preferred securities that will be coming to call dates between now and the end of 2012.

And obviously, all those hopefully, we would be able to replace some of them at lower rates and we'll adjust as the market goes.

So I think we have a lot of levers on that front, and what I feel really good about, the strongest thing as I look beyond 2011 is, we are seeing good, strong commercial loan growth and I think that's the bread of butter of what makes our NIM work.

Let me give some numbers here.

In the second half of this year, we have $11 billion of CD maturities, with an average rate of 1.74.

As Rick said, in 2012 we've got another $11 billion, but the rates on that $11 billion is 2.95 in the first half and 2.77 in the second half, so the rates are actually higher than this year.

So it's -- there is opportunity on the liability side next year.

That would be in the first quarter and the second quarter next year.

Thank you.

That's really helpful.

And then just separately, the debit card commentary that you gave of less than $100 million in the fourth quarter, how should we think about the full run rate?

Obviously 4Q is seasonally high and there should be some offsets one would think, so I would think it's not just taking $100 million times 4.

No, that's fair.

And as we said, it was going to be less than $100 million.

I think the gross running rate of the impact of the regulation, it's probably around 250, roughly, okay.

I think what we'll be able to do is, clearly we're constantly trying to respond to that adjustment, looking at our cost base in that area, also looking at a shift from debit to credit card; a number of different strategies that we have in place to make that 250 impact lessen over time.

Okay.

That's helpful.

Thank you.

We're also growing customers in that space, so that's -- so it's hard to -- the 250 would be on a static basis, the effect of Durbin, but we're growing customers in the space so it's hard to be too specific.

All right.

Next question, please.

All right.

Thank you.

Paul Miller, FBR, your line is open.

Good morning, Paul.

Good morning, Paul.

Paul?

Excuse me.

Paul Miller, your line is open.

(Operator Instructions).

Hello, this is Ken Barker for Paul Miller, standing in.

Paul had to step out.

Good morning, Ken.

Paul wanted to follow up on the C&I loans, maybe you can give more color around what regions you're seeing, and specifically what pockets, a little more color around the C&I loan growth.

We're seeing some very good customer growth, as Jim mentioned.

We're expecting to grow clients in the corporate bank, over 1,000 in the course of the year, and as those new customers are coming on-board, they're coming on at an average utilization, so we're seeing some good growth from clients.

Second is, our asset based lending business is doing very, very well in terms of adding new customers.

So both of those areas are contributing to the increase in the corporate bank.

Are you seeing pressure on pricing at all?

We saw some in the first half of the year, but that pressure is not increasing right now.

All right.

Thank you very much.

The structures have remained sensible.

Thank you.

Next question, please.

Thank you.

Next question, Moshe Orenbuch, Credit Suisse, your line is open.

Great.

Thanks.

Hey, good morning.

I've just got 2 questions.

The first is just going back to the net interest income guidance.

Looks like last year, the core net interest income was around $7.6 billion, if you back out the purchase accounting adjustments.

So I guess the question that I have is that your guidance for 2011 is something kind of stable with that, plus the benefits of the deposits that you've got repricing, or is that included in that.

That would be included in the deposits repricing.

Got it, okay.

Secondly, could you talk a little bit about your strategies for the mitigations of Durbin, and any kind of other pricing changes related to that and overdraft fees, and how you're thinking about that in the context of your checking office?

Clearly, the repricing of our products was in response to Dodd-Frank, there's no question, in which we introduced the new suite of products in March of this year to try and transition more customers away from free checking into relationship banking, which is -- which has more fees tied to it, and the good news is, as I mentioned, is that 60% of our customers are moving to relationship banking and away from free checking and we hope to continue to drive that to maybe as high as 70%.

So we -- it's hard to quantify as yet, because it's too early, but we'll recapture some of those fees in the new product set.

There's a number of other things, I think, that will come through the market over time with people incenting people to use credit cards instead of debit cards at the retail and a number of other things I think that will come to pass in the marketplace, in order to recover this terrible hit that the Durbin amendment put through the industry.

Great.

Thank you.

Next question, please.

Thank you.

Next, Brian Foran, Nomura, your line is open.

Hi, Brian.

Good morning.

I guess on the accretable yield, if the run rate's going to step down but the total stock of accretable yield seems to be staying at $2.9 billion every quarter, does that imply we're going to have a fairly kind of consistent, if lower, run rate straight through 2013, or I guess how long should we think about that accretable yield sticking around, even if we're not really considering it core.

I think you have to look at it piece by piece.

I think clearly on the deposit side which has a piece of that, that's going to start to run out in 2012 as we reprice these high priced CDs that we talked about earlier.

On the loan side, yes, seeing some of the consumer yield is going to run out for quite a few years, whereas on the commercial side, I expect that to be probably cleared up in the next year to 2.

The debt's going to run for 15 years, right, so it's going to be around for quite a bit, but I think you will see a drop-off probably the middle of next year as we start to reach the end of the deposit repricing.

And then just trying to put your guidance like to like, the fees whereas you used to say the $400 million impact, so with the lower Durbin should we change that $400 million impact to like $250 million because we have the same Reg D but a minimal Durbin this year?

I think $250 million to $300 million is a good way to look at it, yes.

On the expenses, can you break apart the revision higher between what you view as structurally higher expenses versus what's hopefully temporary legal, mortgage, those kind of costs?

I hope to think that the litigation settlements that we have here, potential settlements are what they are and I think we feel pretty comfortable with how we reserve for those.

But I do believe that what's happening right now is, we are seeing so many great opportunities in the markets that we are adding talent at a very rapid pace because we just see a great opportunity to take market share in this environment.

So if there's any one thing that is causing me to be a little bit more cautious on my expense guidance, it's our ability to add talent.

Got it.

If I could sneak one last one in.

The full year tax rate we should be plugging in, based on the old number in the Q and the new number this quarter, is it like 25% for the year?

That's correct.

The full year would be 25%.

The second half of the year would be 27%.

Thanks.

Next question, please.

Thank you, next, Ed Najarian of ISI Group.

Good morning, guys.

Two quick questions, some of them have been answered.

In terms of you talked about the $11 billion CDs repricing this year, $11 billion next year, you gave us the rates that they're currently -- the cost of those CDs currently.

Could you give us some thoughts on where you would expect them to reprice to, how much you would expect to run off?

I mean, where do you expect that sort of $11 billion to go in terms of staying on or leaving the balance sheet and at about what cost?

The items for the second half of this year, which are an average of about 1.7%, I would expect them to initially reprice down around 100 basis points and then ultimately to go to right around probably 50 to 60 basis points.

I would also expect that we'll probably retain about 80% of the balances, and probably 20% run off, so that goes to zero.

We have plenty of liquidity, so we're only going to retain that which is client-related.

I think as you go into the new year, where the rates are up in the average of 2.70 to 2.90, these are long-term CDs.

I'm not sure how much of those we're actually going to continue to capture, so you may get a much greater benefit as they roll off, given that they were long-term, high rate CDs which National City needed to fund their balance sheet.

Okay.

So that second piece, you would say a low percentage of those are likely to stick around?

A lower percentage than 80, yes, I would think so, yes.

As Rick mentioned, that $11 billion is in the first half of next year.

That's right.

Right.

Okay.

And then second question, I know the expense base was up a little bit because of litigation that you outlined.

You indicated that you're adding people to take market share.

I guess the question would be is there some -- is there any additional underlying efficiency initiative, now that you feel like the two companies are pretty well consolidated, you're moving forward to add people, should we think of the expense, the core expense base sort of growing at some normal rate from here, because you're trying to grow revenue, and you're growing people?

Or is there a secondary underlying efficiency improvement initiative or process that we should be thinking about for the next year or two?

I would say that for the last 4 to 5 years, and probably even before that, we've had a very aggressive continuous improvement program, so we're always looking at opportunities to take costs out.

I think probably what's happening at the moment, at least, is the inflection point between the costs we are taking out and the pace at which we are investing and the growth in our businesses and marketing in order to take share I think are probably coming closer together than maybe they have in the past.

But I think obviously, and Jim, you may want to comment, we'll have to watch where rates are, we'll have to look at this as we go into the new year, and we will have a lot of opportunities to take costs out if we need to do that.

That's a good point, Ed.

You know us well.

You know us from One PNC.

And there's still a number of those ideas that are kicking around and we're in the process of implementing them, still in the National City franchise.

And actually, what we did is we took one of the key regional presidents from National City, and put him in charge of that area.

And we're continuing to find a number of new opportunities to take costs out and if rates stay as low as we are, we'll take -- we'll try -- we'll step it up a bit.

But we're comfortable with where we're headed right now.

Okay.

Thanks.

That's helpful.

And then just last question.

Between now and say, the end of the first quarter, or sort of looking at the time frame between now and the closing of the RBC deal, should we -- is it pretty much likely that we should expect no stock buybacks because you'll be preserving capital for that deal?

Actually, we still have the share buyback of the $500 million on the table.

We still have it in our capital plan.

We just have to wait until we hear back from the regulators on our application of the RBC situation.

The capital plans that we have and the comfort that we have with our ratios that I mentioned earlier still had that included, but we'll have to wait and see.

Okay.

Okay.

Thank you very much.

Next question, please?

All right.

Thank you.

We have Mike Mayo of CLSA.

Your line is open.

Hi.

Good morning, Mike.

Any update about the Royal Bank of Canada acquisition, the US subsidiary, are you going to be forced to raise capital by regulators or not, and when should we have the answer?

I mentioned earlier that we run all of our capital ratios and we said that we would expect to fund this acquisition with debt and preferred shares, and we don't believe, from the way we look at our capital ratios and our Tier 1 common being as strong as it is, that we'll have to issue any common.

But we can't speak on behalf of the regulators.

We'll have to wait and see.

But the ratios appear to be strong throughout, including the acquisition.

And when do you think you would be able to say definitively?

Because you said the transaction should be accretive next year if you don't have to raise capital, so --

If we don't have to raise common, it will be accretive the day after closing, because we're going to close -- we closed other transactions, where it took us a fair amount of time to take the costs out, we're going to close the transaction, we intend to close the transaction in March and convert it the same weekend.

So we'll get the vast majority of the cost saves out of the acquisition in the first 6 months of the acquisition.

So that should be very positive for shareholders, especially if we don't have to issue any common, which is our intent.

I don't want to put words in your mouth.

You're a lot more confident that you don't have to raise common but you don't have the final answer?

I think that's fair to say.

We run more and more of our capital ratio tests and they look good to us, but we can't speak for the regulators, and we can't predict the timing of the regulators either.

All right.

Thank you.

Thank you.

Next question?

Thank you.

Ken Usdin of Jefferies, your line is open.

Thanks a lot.

Good morning.

Good morning, Ken.

Two questions, first on loans.

So you talked about the strong C&I and loans actually did grow this quarter.

I was just wondering, can you tell us a little bit more about where you're expecting loan growth to come from in the future, and connected to that, how if at all is the pace of runoff changing in the non-core book?

The runoff of the distressed is still pacing at about 25% a year so that's probably $3 billion a year, roughly.

Maybe a little more than that.

Corporate loans, commercial loans, we're seeing good growth in those.

We're seeing good growth this quarter in indirect auto.

We expect that to continue.

We're starting to see very optimistic directionals on credit card, so we're starting to expect that to increase.

The home equity portfolio, pretty much flat for the moment.

Originations and paydowns offsetting one another.

Commercial real estate, lot of originations taking place but we still have a lot of small balanced commercial real estate running off.

That business will probably hit an inflection point by the end of the year.

If you take all that together, we're very confident, given the corporate loan growth, the commercial loan growth, that we are going to be able to grow loans spot to spot from the end of 2011 -- the end of 2010 to the end of 2011.

The multi-family business in the real estate sector is very strong.

And that's a national business for us, as you know, so that's doing well and we originated over $1 billion of small business loans in the quarter and that's $2 billion -- over $2 billion in the first half of the year, and I think when we think about the economy, seeing the small business demand come back -- now, it's not anywhere where it was 5 years ago, but seeing that demand come back, I think bodes well for the economy as well.

Okay.

Great.

And my second question is about update on the mortgage business, what you're seeing in trends in the mortgage business how did originations act and if you have any color on the outlook there.

The mortgage business, as you know, is up substantially from a year ago but down -- the originations were down quarter to quarter, but the best thing was that we saw were applications were up 23%.

Those usually turn into originations and new business, anywhere from 60 to 90 days later.

So we think the mortgage business is heading in the right direction.

Thanks a lot, guys.

Okay.

Next question, please?

Thank you.

Lana Chan, BMO Capital Markets.

Your line is open.

Good morning.

2 questions.

1 on the -- you mentioned that line utilization rates were up this quarter.

Could you give us some color around that, what the numbers were?

We saw an increase in utilization, primarily in asset-based lending business where they've got more inventory to borrow against.

So we saw utilization rates increase there.

Did not see as big -- as a matter of fact, didn't see an increase in utilization in the corporate bank.

That was pretty modest.

But it was really the lift in the overall client base, and keeping the utilization constant, that generated corporate lending there.

And the corporate banks running at about 38% to 39%, in that range.

Thank you.

And follow-up question on just charge-offs.

They're declining fairly rapidly.

When you look at the mix of your portfolio, as you're running off some of the distressed credits, what would you say your normalized charge-off rate should be for your loan mix over time?

It should be substantially lower from where it is today.

Over time.

I mean, that's a difficult item to predict in terms of where charge-offs -- they tend to be less predictable in terms of what they're going to look like, but I think I feel very confident that our credit costs overall between now and the end of the year continue to maybe not reach the level we're at in the quarter but certainly we'll be below the 400 average I gave you before.

The provision is such an interesting number.

I mean, it reflects a very quantitative review of what's happened to the credit metrics within the Company, and then we add qualitative reserves on top of that, and that's how we arrived at the 280 for the quarter and I think what pleases us is the review that Rick gave, and I think the charts show that the credit quality dramatically improved in every category, and that's why the provision is as low as it is for the quarter, and if those credit metrics continue at that pace, provision will go -- will stay at a very low rate.

The only factor obviously that could change that is substantial more loan growth than we're seeing today, because obviously that would increase the provision, but we'll be happy to see that.

Okay.

Thank you.

Next question, please.

(Operator Instructions).

Thank you.

One moment?

Any other questions?

Thank you.

Our last question now comes from Gerard Cassidy, RBC Capital Markets.

Your line is open.

Thank you.

Good morning, Gerard.

Good morning, guys.

Rick, going back to your comment about the new business wins that you're having in the corporate side, I think you mentioned 1,000, you think you're going to have about 1,000 new customers.

If the you had to break it down between legacy Nat City, versus legacy PNC, where are most of the new customers coming from?

Gerard, we had a conversation just before this call.

We have to change our -- the person who sets the goals for the markets.

We have a book in front of me now that the sales performance in every single market we're in is over plan.

Total markets are up 30% versus last year.

And total markets are 142% of plan this year.

And so the National City markets are clearly up substantially more than the eastern markets are, percentage-wise, not the least of which is from education, new hires and the conversion.

Some of the conversions in the National City markets didn't complete until June of last year.

But I have to say that when we look across the board, it's really remarkable how well all of the markets are doing.

So, again, there's a higher percentage growth in the west because they were coming off a lower base last year.

But all of the markets are performing very, very well.

Is there any trend with you guys being out in Pittsburgh, and of course now with the National City organization part of your organization, manufacturing jobs for the first time in 2010 grew in the United States since 1997.

Are you guys seeing a resurgence of manufacturing, that could actually surprise people in terms of the strength of the midwestern economy that you're focused on?

The utilization rate that went up 2 percentage points in the first quarter, I think was probably indicative of that coming back, and I think the asset-based lending business, which is obviously tied to values of inventory and receivables, the inventory, commodity costs are higher, commodity values are higher and so the borrowing bases are higher and the borrowings required to support them are higher.

So I think it is -- it does have some reflection of an improvement in the manufacturing sector, for sure.

And finally, on credit quality, I noticed your in-flows of new credit problems improved sequentially from the prior quarter's level.

Can you give us some color?

Are your customers just that much stronger, or is it the economy, combination of both?

Do you expect that trend to continue, meaning lower in-flows as we go into the second half?

I can't predict whether the trend's going to go lower but I would say that one of the reasons why it is lower here is, with the end of the year, we're able to get more audited financials which validate our position around some of those customers, and that helps to improve the number.

That's sort of a seasonal thing that comes through, but we don't see any reason why we shouldn't continue to see improvement in that number.

Finally, any guidance or opinions on when you think we might hear something from the regulators regarding your SIFI buffer, what you think that number might be?

We'll file our application in August, as early as we can, and I think after that it will be up to them, so --

Great.

All right.

Thank you.

Thank you, Gerard.

Any other questions, operator?

Thank you.

There are no further questions at this time.

Okay.

Well, thank you very much and thank you everyone for joining us.

We believe this was a very strong quarter again for PNC, and we appreciate your support.

Thank you very much.

Thank you.

This concludes today's conference call.

You may now disconnect.