PNC Financial Services Group Inc (PNC) 2014 Q2 法說會逐字稿

Good morning.

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

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

(Operator Instructions).

As a reminder, this conference is being recorded.

I would now like to turn the call over to Director of Investor Relations, Mr. Bill Callihan.

Sir, please go ahead.

Thank you and good morning, everyone.

Welcome to today's conference call for the PNC Financial Services Group.

Participating on this call is PNC's Chairman, President and Chief Executive Officer, Bill Demchak, and Rob Reilly, Executive Vice President and Chief Financial Officer.

Today's presentation contains forward-looking information.

Our forward-looking statements regarding PNC's performance assume a continuation of the current economic conditions and do not take into account the impact of potential legal and regulatory contingencies.

Actual results and future events could differ possibly materially from those anticipated in our statements and from our historical performance due to a variety of risk and other factors.

Information about such factors as well as GAAP reconciliation and other information on non-GAAP financial measures we discuss is included in today's conference, earnings release, the related presentation materials and in our 10-K, 10-Q and various other SEC filings and investor materials.

These are all available on our corporate website, PNC.com under the investor relations section.

These statements speak only as of July 16, 2014, and PNC undertakes no obligation to update them.

Now I would like to turn the call over to Bill Demchak.

Thanks, Bill, and good morning, everybody.

As you have seen this morning, we reported net income of $1.1 billion or $1.85 per diluted common share for the quarter with a return on average assets of 1.31%.

For the first half of the year, we are largely trending in line with our planning assumptions.

You have seen that we have grown loans by more than $5 billion and we are growing our fee businesses as planned.

Credit quality continues to improve and we are managing expenses well in spite of a modest increase this quarter due in large part to seasonality.

At the same time interest rates remain low and we are seeing the market moving beyond what our risk return appetite will tolerate in some asset categories.

That has been particularly true in certain parts of consumer and small business lending and on the pricing side in the corporate bank.

Still in the Southeast, loan and client growth basically across all lines of business continue to exceed our expectations.

In retail, we are on target to have completed more than 150 universal branch conversions by the end of this year and more than 300 by the end of the first quarter next year.

For mortgage, we focused on growing our percentage of new purchase originations as refinance activity declines for the industry and we are pleased that the new purchases were 50% of our originations in the second quarter.

Having said that, lower volumes and continued elevated cost structures related to foreclosure activity will continue to make this a difficult business in the near term.

Finally, we continue to see strong growth in fees out of our asset management group with total noninterest income in this business up 11% year to date versus the first half of 2013.

So on the whole, we are trending as we expected through the first half.

Still we are in the same boat as all of our competitors recognizing that continuing credit quality improvement and lower provision have basically enabled us to mitigate the impact of low rates but these conditions aren't going to last forever.

The great unknown as we look toward the end of this year and into 2015 is when credit quality will begin to normalize and whether rates will rise in time to offset the higher credit costs that will naturally be the result when this occurs.

Nobody knows when or how this race will play out but we are mindful of it as we focus on delivering a differentiated customer experience and creating long-term shareholder value.

To that end, we continued to strengthen our Basel III capital position in the quarter and in keeping with our previously stated intention to return more capital to shareholders, we increased our quarterly common stock dividend by 9% to $0.48 per share for the second quarter of 2014.

We also repurchased 2.6 million common shares.

And with that, I will turn it over to Rob for a closer look at our second-quarter results.

Great.

Thanks, Bill, and good morning, everyone.

Overall, we had a solid second-quarter that continued many of the trends we saw in the first quarter.

Importantly our second-quarter results were in line with the guidance we provided during our last earnings call and demonstrated consistency of performance that supports our growth strategies.

The sustained low interest rate environment continues to affect our net interest income.

However, we saw strong fee income growth this quarter that more than offset the net interest income declines resulting in revenue growth on a linked quarter basis.

Expenses remained well controlled and credit quality was favorable.

Our capital ratios increased even after returning $479 million in share buybacks and dividends to our shareholders in the second quarter compared to $234 million in the same period a year ago.

Now let me start with our balance sheet on slide four.

As you can see, total assets on our balance sheet increased by $3.6 billion or 1% on a linked quarter basis and included net loan growth of $2.7 billion or 1.4%.

Total commercial lending during the second quarter grew $3.3 billion or 3% with growth in nearly all areas and consumer lending was down by $568 million or 1% linked quarter as declines in home equity, residential mortgage lending and education loans offset increases primarily in credit card and automobile lending.

Compared to the same quarter a year ago, overall loan growth was $11.2 billion or 6%.

Investment securities decreased by $2 billion or 3.5% in the second quarter as net payments and maturities exceeded our reinvestment activity reflecting the current low interest rate environment.

And lastly, our balances with the Federal Reserve increased to $16.5 billion in anticipation of proposed rules on liquidity coverage standards.

On the liability side, total deposits increased by $172 million when compared to March 31 driven mostly by increases on the consumer side.

We saw growth in demand, money market and savings deposits partially offset by lower retail CDs.

Shareholders' equity increased by $884 million in the second quarter primarily due to growth in retained earnings.

This helped to drive our capital ratios higher.

Our pro forma Basel III common equity Tier 1 ratio fully phased in and using the standardized approach was estimated to be 10% as of June 30, a 30 basis point increase from the end of the first quarter.

As you know from a regulatory capital perspective, we are subject to the transitional Basel III rules.

Our transitional B3 common equity Tier 1 ratio was estimated to be 11% as of June 30, an increase of 20 basis points from March 31.

As I mentioned, our balance sheet reflects our efforts to comply with the proposed liquidity coverage ratio and support continued loan growth.

For example, our interest earnings deposits with banks which are primarily with the Federal Reserve, increased by $2 billion from March 31 and by more than $13 billion compared to the same time a year ago.

We increased total borrowings by $2.3 billion or 5% linked quarter.

A substantial portion of this supported our enhanced liquidity position as well as loan growth.

As you know, the LCR rules are still in proposed form; however, we believe we are well positioned in relation to the proposed targets.

Finally, our tangible book value reached $58.22 per common share as of June 30, a 3.4% increase linked quarter and a 15% increase compared to the same time a year ago reflecting our commitment to delivering shareholder value.

Under our existing common stock repurchase authorization, we repurchased approximately 2.6 million common shares for approximately $225 million during the second quarter against our capital plan of $1.5 billion.

We remain committed to shareholder capital return and expect to continue our buyback program with the flexibility to increase repurchases over our second-quarter levels through the first quarter of 2015.

Turning to our income statement on slide five, net income was $1.1 billion or $1.85 per diluted common share and our return on average assets was 1.31%.

Our second-quarter performance for net interest income and expenses were as expected while exceeding expectations on fee income and provision.

As a result, total revenue increased by $33 million or 1% linked quarter.

Let me highlight a few items in our income statement.

Net interest income declined by $66 million or 3% compared to the first quarter.

Of that, $31 million was due to the impact of an accounting change to reclassify certain commercial facility fees from net interest income to corporate service fees.

Importantly this change is revenue neutral.

The remaining NII decline of $35 million was primarily attributable to lower purchase accounting accretion and lower loan yields and security balances.

Non-interest income increased by $99 million or 6% linked quarter primarily due to fee income growth in corporate which includes a reclassification as well as increases in consumer fees and residential mortgage revenue.

Non-interest expense increased by $64 million or 3% in the second quarter following seasonally lower costs in the first quarter.

Overall expenses continue to be well managed.

Finally, provision in the second quarter declined to $72 million due to continued overall positive credit trends.

Now let's discuss the key drivers of this performance in more detail.

Turning to net interest income on slide six, total net interest income decreased by $66 million or 3% for the reasons I just highlighted.

As you can see, purchase accounting accretion declined on a linked quarter basis consistent with our expectations.

Regarding our core NII, excluding the $31 million impact of the accounting change, the net impact was a decline of $19 million which is primarily related to lower security balances, spread compression and liquidity related actions.

Net interest margin declined 14 basis points linked quarter.

Of that amount, approximately 5 basis points was due to the commercial fee reclassification.

Of the remaining 9 basis point decline in NIM, 3 basis points was attributable to purchase accounting accretion, an additional 3 basis points was due to liquidity related actions, and the remaining 3 basis points was primarily due to spread compression.

In terms of our interest-rate sensitivity, our balance sheet remains asset sensitive as we have maintained a duration of equity of approximately negative 2.5 years.

Although we recognize this may constrain our NII growth, we will continue to remain disciplined with a focus on achieving appropriate long-term risk-adjusted returns.

Turning to non-interest income, we saw strong fee income growth this quarter reflecting progress we continue to make against our strategic priorities.

Total noninterest income increased by $99 million or 6% linked quarter.

Now in fairness, $31 million was related to the commercial fee reclassification.

However, the remaining growth reflected momentum across our diversified businesses.

As Bill mentioned, our asset management group had another good quarter with growth driven by increases in the equity markets and sales production.

As you know, the asset management fee category reflects the combination of fees generated by our asset management business along with the earnings attributable to our interest in BlackRock.

Compared to the same quarter last year, overall asset management fees were up $22 million or 6% due to increases in equity markets and sales production.

Consumer services fees and deposit service charges were higher in both the linked quarter and year-over-year comparisons.

Compared to the first quarter, these fees increased by $42 million or 10% as we saw strong growth in credit and debit card, merchant services and brokerage fees due to broadly higher customer activity.

Compared to the second quarter of last year, fees were up $18 million or 4% primarily due to growth in customer activity.

Corporate Services fees were up $42 million or 14% linked quarter.

As I mentioned, $31 million of that was attributable to the reclassification.

However excluding that, fees increased $11 million or 4% linked quarter primarily due to higher treasury management fees.

Compared to the second quarter of last year and again setting aside the re-class, corporate services fees were down by $14 million or 4% primarily driven by lower net CMSR valuations.

Residential mortgage banking noninterest income increased $21 million or 13% primarily driven by higher loan sales revenue.

A couple of items to point out here in regard to our mortgage revenue.

First, we recorded a production income increase of approximately $11 million reflecting higher quarter-over-quarter originations.

Second, we had elevated loan sales and fair value mark increases on portfolio levels totaling $61 million in the second quarter compared to $24 million in the first quarter or a $37 million linked quarter increase.

And third, partially offsetting these items was a net $21 million reduction of repurchase reserve benefits compared to the linked quarter.

Origination volume increased to $2.6 billion in the second quarter, up from $1.9 billion in the first quarter but down from $4.7 billion in the same quarter a year ago.

Importantly, purchase originations production of $1.3 billion in the second quarter essentially equaled the same quarter a year ago reflecting our strategic focus in this area and purchase originations represented 50% of our total originations.

The gain on sale margin was 538 basis points in the second quarter.

Our margins benefited from the gains associated with the loan sales and fair value marks that I just mentioned.

We continue to expect our margin to trend closer to 300 basis points through the remainder of 2014.

Other noninterest income increased $19 million or 8% primarily due to higher revenue related to asset sales and higher credit valuations from customer related derivative activity.

Noninterest income was also impacted by lower pretax gain of $54 million on the sale of 1 million Visa Class B common shares.

That compared with the $62 million gain on Visa shares that took place in the first quarter.

Noninterest income to total revenue was 44% in the second quarter, up 2 percentage points from first-quarter levels and it held steady from the same quarter a year ago when we experienced higher gains on asset sales and valuations.

This reflects the progress we are making against our strategic initiatives to increase overall fee income on both an absolute and relative basis.

Turning to expenses on slide eight, second-quarter levels increased by $64 million or 3% consistent with our guidance due to seasonal factors such as higher compensation and marketing costs during the period.

On a year-over-year basis, expenses are down $77 million or 3% reflecting strong benefits from our continuous improvement program and overall expense management.

As we previously stated, our CIP program has a goal to achieve $500 million in annualized cost savings in 2014.

We are halfway through the year and we have already completed actions relating to capturing more than two-thirds of our goal and as a result, we are confident we will achieve our full-year CIP target.

With these savings to date along with further planned activities, we intend to fund the significant investments we are making in our infrastructure and in our retail transformation.

As you can see on slide nine, overall credit quality continued to improve in the second quarter.

Nonperforming loans were down $146 million or 5% compared to the first quarter as we saw broad improvements across our commercial and consumer portfolios.

Total past-due loans decreased by $128 million or 6% linked quarter.

Net charge-offs declined by $41 million or 22% linked quarter and were 29 basis points at average loans on an annualized basis, down 9 basis points linked quarter.

Our provision of $72 million declined by $22 million or 23% on a linked quarter basis.

Finally, the allowance for loan and lease losses to total loans is 1.72% as of June 30.

While we were pleased with this performance and as we have acknowledged for some time, we continue to believe credit trends may not remain at these levels.

In summary, P&C posted a successful second quarter largely consistent with our expectations.

Going forward assuming a continuation of the current economic environment, we continue to expect that full-year revenue will be under pressure and as a result could likely down year-over-year due to further purchase accounting accretion declines and lower residential mortgage revenues.

Regarding purchase accounting, we continue to expect it will be down approximately $300 million for full-year 2014 compared to 2013 and for 2015, we expect purchase accounting accretion to be down approximately $225 million for the full year compared to 2014.

In this environment, we will remain focused on disciplined expense management and we continue to expect full-year expenses to be down when compared to 2013.

Looking ahead to the third quarter, we expect modest growth in loans primarily in our commercial portfolio.

We expect net interest income to be down modestly due to the continued decline in purchase accounting accretion and further spread compression.

We expect fee income to remain stable as we expect growth in our other fee-based businesses to offset the benefit of the elevated second-quarter gains in residential mortgage.

We expect noninterest expense to be up by low single digits as we will have some increase in the third-quarter expenses related to employee benefit seasonality and also some costs related to the automating of our regulatory submissions.

Finally, assuming a continuation of the current credit trends, we expect a provision for credit losses to be between $75 million and $125 million.

And with that, Bill and I are ready to take your questions.

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

(Operator Instructions).

John McDonald, Sanford Bernstein.

Good morning.

Bill or Rob, I was wondering if I could get some thoughts on the timing of buybacks and kind of your philosophy on how you will balance price sensitivity versus kind of a lack of other good options to deploy your growing excess capital in this kind of environment?

I guess some generic thoughts and I got asked this I guess in the first quarter and I think my answer was I'm going to be purposefully vague.

We obviously -- our program has been active and as Rob stated in his comments, we are going to continue that.

We look at relative price performance, outright price performance, other opportunities to deploy capital.

We are in a position where we are generating more capital than we are using so our first, second, and third alternatives are kind of capital return to shareholders through dividend and repurchase.

Having said that, we are sensitive to price and value certainly the extremes.

I don't think we are there now but that is something that we will look at through time.

Okay.

And Rob mentioned the flexibility to increase buybacks above the second-quarter level.

Just as we contextualize since you are just starting what you did this quarter, did you get a late start this quarter because of when you did the Board approval or is that part of why you had that comment?

No, it is simply mathematically, we had 1.5 billion we could do.

We did less than a quarter of that in the first quarter.

Various reasons as to why we did less, none worth worrying about.

So again just mathematically, we had the capacity within our nonobjective capital plans to do more.

That is all that comment was related to.

John, as you know, this is Rob.

As you know, you can carry over that excess capacity going forward.

Got it.

Okay, that is helpful.

And then on loan growth, Bill, any more color on the degree of follow through on kind of the green shoots of better line utilization that you started to see at the end of last quarter?

Did that follow through to the same extent you had hoped it would or can you just give some color on that?

We didn't see the -- short answer is utilizations are up quarter to quarter largely across all lines.

So it did hold and it went up a bit more.

It didn't grow to the same extent as we saw just at the end of the first quarter.

But I think what you see in our book is pretty consistent with some of the comments I have seen on other calls where utilization generally is up.

Still below historical potential so it is not as if the economy -- people are using their lines to the extent they did back in 2004 or 2005 but it is higher than it was and continues to trend up.

So for the year, I guess, Rob, are you looking for loan growth to kind of be similar to last year in the mid single-digit range for the full-year this year as far as you know right now?

As far as we know right now relative to our third-quarter guidance in terms of modest increase is consistent with what we have been experiencing.

Okay.

Then just a quick one, Rob, on the fee income outlook for that stable next quarter, are you embedding some expectation that you will continue to harvest the Visa gains when you say fee income stable?

No, any Visa sales are not part of that guidance.

But what I am saying there is that we did have some elevated gains there in the mortgage business so the expected growth that we see in the other fee businesses we look to offset that.

Okay, got it.

Thank you.

Erika Najarian, Bank of America.

Good morning.

Thank you.

My first question sort of has to do with where you are on the LCR with regards to the current proposals.

Could you give us an update on where you are and sort of how you are thinking about future investments in terms of your excess deposits in your bond portfolio.

I did notice that your cash is up and your securities balances are down on an average basis.

Rob, why don't you hit just the LCR and then I will talk a little bit about the (multiple speakers).

Erika, I think you can see, we have continue to make progress in terms of increasing our liquidity against these proposed rules that still aren't finalized.

We have been doing that now for the better part of the last three quarters or so and you have seen the effect in terms of the NIM compression related to that which was greater in past quarters than it is now.

So as you know, the final finish line is fluid but we believe we are well-positioned and that is demonstrated by the liquidity that we have generated here over the last year or so.

Just with respect to deposits that we have at the Fed in the form of excess reserves and the decline in securities, it is kind of self-evident.

We could choose if we like the rate environment to buy Level I securities as opposed to put that cash on deposit and not have an effect on our LCR calculation.

Just given our view on rates and investment opportunities, we have been growing the balances at the Fed and I guess we are a bit of an anomaly in the industry with our security balances shrinking and for the most part maintaining the same de minimus convexity characteristics.

Put differently, we are not buying mortgages that put us at risk on a higher rate environment and we are happy with that.

The opportunity cost of forgoing some interest income today is a function of interest rates I think is a worthwhile trade relative to what will happen when rates rise.

Okay.

Just my follow-up question to that, it is clear that the strategic priorities implemented by the bank has -- we have seen it in the expense discipline and higher core fees but clearly the purchase accounting accretion and to your point the conservatism in terms of investment securities purchases has driven the efficiency ratio a little bit higher quarter over quarter and year over year.

And I guess the question here is if we take into account an interest rate environment that doesn't necessarily shift significantly over the next four quarters, marry that with the purchase accounting accretion rolloff, is there enough left in the till in both the revenue side and the expense side on these strategic priority front that we could see the efficiency ratio start to trend down?

It is a function of timing.

Practically what we have in place as it relates to the Southeast in growth and fees together with expense initiatives will serve us well as it relates to our efficiency ratio longer-term.

I can't sort of intuitive the top of my head what the next four quarters look like with respect to rate rolled out if rates don't move at all.

I don't know how to think about that.

What we have in place though is a long-term strategy independent of rates to make this Company more efficient and less dependent on net interest income and more dependent on fees and that is playing out.

Okay, thank you.

Bill Carcache, Nomura Securities.

Thanks.

Good morning.

Bill, I was hoping I could follow-up on the point that you made about the fee income growth playing out.

So the outlook is for stability in fee income growth in the third quarter versus the second quarter but that is something, that is an area where you expect to see continued growth as you look out further over time, correct?

Yes, that is correct.

We had some and we highlighted them in Rob's comments.

We had some probably non-repeatable fee items in mortgage related to frankly some scratch and dent stuff that had appreciated and we sold.

So we backed that out.

We think we can overcome that through growth in core fees quarter to quarter which leads to a flat result.

But through time, the trendlines in fees across basically all categories have been pretty strong for the last four to six quarters and we continue to play that card.

Understood.

I was hoping, Bill, to get your thoughts on a different topic switching over to LCR and really the interplay between LCR and capital return.

In a pre-crisis world, excess liquidity sitting on the left-hand side of balance sheets could be returned to shareholders to the extent that banks were sitting on excess capital.

But in a post-crisis world, and I guess let's set CCAR aside for a second and just focus on LCR, it seems like that liquidity on the left-hand side of the balance sheet is needed for LCR purposes.

Maybe can you comment on that dynamic and the extent to which you see LCR could potentially act as a constraint to capital return or at least make it more expensive?

I don't think it will act as a constraint at all.

I mean the margin I suppose it's more expensive because I am borrowing at LIBOR plus something to the extent I don't have the cash on hand.

But practically if you just think of the size of the two different things, we have $16 billion, $17 billion sitting in the Fed today and out total capital deployment and non-objective plan is $1.5 billion in repurchase and $1 billion in dividends plus or minus.

So at the margin, it impacts it but practically it doesn't really enter into our thinking as it relates to what we will return to shareholders.

Got it.

Thanks very much for taking my questions.

Matt O'Connor, Deutsche Bank.

Good morning.

On net interest income here when we put together all of the moving pieces of pretty good loan growth, the lower purchased accounting, and obviously still low rates, at what point do we get just kind of naturally an inflection of the net interest income dollars?

We have been waiting for it.

I think off the top of my head, we wouldn't have been far away from it this quarter had we chosen to carry security balances flat.

We would still see a drop in margin as I think through it just because of our borrowings for LCR accretion accounting and the outright spread on loans.

But we were pretty close this quarter when you back out the non-controllable and had we chosen to reinvest, we probably would have been there.

Just to expand on that, Matt, so that $19 million decline of that $15 million was securities balances related.

I guess a question -- I don't blame you for wanting to stay short but just assuming the medium and the long part of the curves don't move and you kind of stick to your practice of staying short, you still probably reach a natural level where the NIM is not going to go lower, NII dollars are not going to go lower -- I'm just trying to get a gauge?

That is right.

We have been -- I mean you have also seen the curve flattening so with the rally in the long end over this quarter and the belly of the curve selling off which at the margin we have been positioned for and has helped us.

At some point you are right if the curve stays just where it is forever, we have some fairly long-dated securities in there, particularly the sub investment grade.

It would take a while to grind through the yields on those were we just to replace everything we have with that market rates.

Okay.

Just separately on the capital deployment side of things, how should we think about looking out over the next two or three years?

It feels like for banks that don't use their approved buyback in any given year under CCAR, it is almost like a use it or lose it.

And then you've got to go back and start over the CCAR process.

So like assuming we can't get payouts in excess of 100% of earnings, it feels like your capital is going to build to levels higher than you would like.

Yes.

That is a fair statement.

I think that is an issue the whole industry faces that eventually even if you use your full -- assuming you use your full allocated buyback, you get yourself to a position of without over 100% payouts you will continue to build capital levels in the industry.

We also have and we have talked about this before that even the dividend soft constraint at 30% of your earnings, it is a constraint against your base case CCAR projections which often in our case are below what our potential to earn is.

So there's a number of issues on the table.

I think eventually over 100% is possible coming from the Fed and as we have mentioned before, the alternative to choosing to do that through share repurchase is through a special dividend one-time approval.

I don't think that happens next year but I think mechanically that is possible as well.

And we have seen some banks carve out gains from selling down positions to be used for additional capital deployment.

So for example like in your case, the Visa gains might enable you to deploy more capital.

Are there any nuances like that that you are thinking about for the next round?

I mean the next round is the next round.

I would tell you that during the course of putting together this year's plan, while perhaps we were conservative on our ask, we did look at the potential of how we might include Visa inside of that and some other things.

So we think about that.

I think an issue independent of what we do but my understanding of the process by the Federal Reserve is you need a pretty hard contractual context to realize that gain.

So if you think about our Visa situation since it is our choice and it is dependent on future price, it is tough to count that one.

Okay.

All right.

Thank you.

Keith Murray, ISI.

Thanks.

Good morning.

Just ask you on the credit side whether the shared national credit review results were included in this quarter?

Yes, this is Rob.

Yes, we did conclude that and the SNC results although we don't get specific in regard to those, are fully accounted for in our reserves.

And then go back to the efficiency ratio question just specifically on the retail banking side, obviously you guys continue to work on branch closings and becoming more efficient but when you look long-term, let's assume a more normal rate backdrop, what do you think a reasonable range for the efficiency ratio in that segment should be?

We are looking at each other on what the number ought to be.

I ought to clarify the effort inside of retail isn't about closing branches per se to save money, it is about converting our contact points with clients.

So we are reducing square footage, closing certain branches, opening others that are less square footage and we are investing a lot of that saved money into technology, digital touch points with consumers.

The end result of that is our expense base basically shrinks and our interaction with our clients increases and that is a good thing.

But I just want to clarify we are not closing branches as an isolated expense saving exercise.

The efficiency ratio long-term as you mentioned, particularly for retail is largely driven by the value of the deposits they generate which in turn are driven by where interest rates are.

So they are materially under earning their potential today vis-a-vis rates.

I don't know that I have a percentage as to where that ought to go through time.

The only thing that I would add to that qualitatively is with the migration of more and more technology and mobile deposits and alternative channels, there are lower costs vis-a-vis the traditional teller interaction over time.

Fair enough.

And then just lastly, maybe your crystal ball is better than others but knowing what you know today, piggyback on Matt's question, when you look out, do you think net interest income could turn the corner first before credit goes the other direction?

That is a big question.

We can give you several answers to the same question and obviously we are focused on it but it is not new.

These last several quarters it has been a race between loan growth and the spread compression and then in this quarter, a little bit more on the rates on the security side.

But it is plus or minus 20 million, 40 million, 1%, 2% and I think that is the environment that we are in.

I would tell you that across our credit books notwithstanding some of my comments on competition and certain asset classes getting tough, the credit performance has been really good and improving largely across everything that we do.

So it is not as if we are warning that somehow that is going to turn around and I don't expect that to be the case anytime in the near future.

But at the same time, we kind of know that we can't persist -- I would love to but I don't expect to persist to 29 basis points (multiple speakers) it is just not going to happen.

By the way I don't expect Fed Funds to be zero forever.

So all we are pointing out is one of those is a positive item for us in the form of rates but a lot of leverage on it for us and the other one is a negative item on normalized credit costs.

That is who we are, that is what a bank does.

Understood.

Thanks very much.

Eric Wasserstrom, SunTrust Robinson Humphrey.

Thanks.

I just wanted to circle back to the NII dollars for a moment.

Rob, so it seemed that all of the balance sheet dynamics ultimately pointed to what was essentially a down $4 million NII figure when you adjust for the security impact.

But I guess the question that that raises is to the extent that you are putting up very strong loan growth but getting price compression and at the same time funding that increasingly in a wholesale format and therefore despite the balance sheet expansion not actually generating incremental dollars of revenue, how do we think about that dynamic?

Rob, you can pile in here but we are generating incremental dollars of revenue.

We are just doing it at a lower NIM than we had with loans at higher spreads and with free deposits from floated checking accounts.

Okay, perhaps I will circle back with you because I may have misunderstood but it seemed that the NII dollars were effectively flat once you made all the adjustment.

Yes, I think that is right.

I think Bill was speaking specifically to the loan book there.

So again, you just look back at the dynamics in terms of loan growth being what helps us, spread compression and rates hurting us and it is a race between those three items.

You also have to remember that inside of -- so we have net loan growth, we also have repricings within the loan book, right?

So part of the reason you see the 3 or 4 basis point average spread compression in the loan book, it is not all of the new balances that are coming up that is causing that.

A lot of it is just repricing of existing balances with refinancing.

And spread compression.

Right.

And as your loan to deposit ratio is creeping up a bit here into the low 90s, how are you thinking about that particularly as you contemplate higher rates and is there some concern about what may happen with deposits under those circumstances?

I think -- we spend a lot of time thinking about that.

I think when rates start to move in conjunction with a shrinking of the Fed's balance sheet so a shrinking of QE, we are concerned about deposit flows generically across the industry.

As the Fed shrinks its balance sheet, it is going to pull deposits out of the industry.

I think offsetting that somewhat is I think that the banking industry will take advantage of some of the changes in the money fund industry and actually retain balances that historically would have moved both from corporates and from individuals.

The dynamics between all that are pretty complex.

We spend a lot of time thinking about it.

We have strategies in place to make sure that we remain core funded in our deposit profile.

I think we will be able to do that but at the same time, I would tell you this will be different this time.

We are going into an environment of potentially rising rates as they drain liquidity in a way that hasn't been attempted before.

And just my last question is just on credit.

The low figure that you put up in provision this quarter was driven primarily by just a low level of NCOs and so I just wonder with respect to your guidance given that you had very little reserve release, does that reflect the expectation of some increase in NCOs maybe from lower recoveries or does it reflect the fact that you anticipate some increasing build in reserves given your balance sheet growth?

We have been wrong on our provision guidance for four quarters running.

I think it reflects the fact that we continue to look at where we are and just kind of say it can't be this good.

I think that's right.

And the only thing I would add to that is we did have a release this quarter.

Assuming the economic conditions stay the same, we would expect to have further releases although not necessarily at these levels.

Got it.

So it sounds like your bias would be low-end or possibly below low-end of the current guidance?

I don't know that we have a bias.

We don't have a bias, we are in day one here.

Okay.

Thank you very much.

Ken Usdin, Jefferies.

On the expense side, can you guys detail a little bit more about the automation costs that you are expecting in the third quarter, whether that is a new run rate, kind of how that is being funded by the continuous improvement expenses?

And then the bigger question for next year, how much of this automation expense can we see as an acceleration to costs going forward?

Why don't I -- before we hit on the third quarter, one of the things that we are doing here as you think about our technology and operation streamlining agenda, we are basically using technology which eventually will give rise to greater depreciation costs.

To simplify what we do, lower manual costs, people, and that will play out through time.

The third-quarter comment kind of relates to some stuff that we need to do near-term just on increasing demands and expectations as it relates to CCAR data requirements from Fed.

We just want to stay on the top of our game as it relates to requirements in the new regulatory regime.

So this is kind of some near-term consulting help and some other things just to get some stuff over the hump.

And Bill, to follow-up on that as you do think further out from a big picture perspective understanding that it aids efficiency over the long term, do you believe that you will still be able to offset that incremental intermediate-term spend with incremental continuous improvement expense once you get past this year where you have been pretty clear on the ability to do that this year?

That is the plan.

The whole idea here is that we will not only have that offset but then built into our core technology and operations the ability to scale this Company with positive operating leverage.

One of the challenges we had was we were losing our ability to do that because of the manual intervention it took to grow things, we were putting everything back in the expense line.

Through automation, we ought to be able to scale it.

Just to add to that just in terms of expenses just overall in terms of where we are, I do want to emphasize that expenses remain a focus point for us.

We have had a good first half of the year as you can see by the first and second quarter.

We have got a couple of expenses specifically that Bill just talked about in the third quarter but it is a focus point.

And as I said in my opening remarks, we continue to believe we will finish down year over year even with those investments.

Okay, great.

And then second question just to drill down a little bit more into loan yields and understanding the shift of the move to fees from NII this quarter, can you catalog for us explicitly where competition is pressuring loan yields the most versus the amount of lingering negative rollovers you are having from maturing loans and so is it just that competition is still really punching down?

Yes, but let's distinguish between a couple of things.

Rob can maybe give you some examples but one issue is that the spread on what is otherwise a good loan so that is a pricing issue and we are seeing competition pretty aggressive inside of the middle market space.

By the way, we could be accused of that as well.

We will protect our existing clients where we have a lot of cross sell by being aggressive on loan pricing.

The other issue out there that concerns me more is on structure.

We are seeing in small business and smaller commercial, tenors extending, collateral values deteriorating, a lot of things going into those structures where we would just choose not to compete independent of what the price was.

The consumer side we are seeing -- you will see our growth in auto has slowed.

We expect that to continue as tenors and LTVs on car loans have worsened.

So pricing, we can deal with.

A good loan is a good loan, you don't earn as much today but you do tomorrow through the relationship.

Structure worries us.

What I would add to that is I would just focus on sort of the core compression, spread compression which has been around 3 basis point so that excludes the reclassification and also some purchase accounting around the yield.

So I would just go right at that 3% which has been largely consistent with what we have been experiencing for the better part of the year -- 3 basis points -- I'm sorry -- 3 basis points which has been largely consistent with what we have been experiencing, actually a basis point lower.

It has been around 4 to 5.

Got it.

Okay, thanks, guys.

(Operator Instructions).

Paul Miller, FBR.

Thank you very much.

Can you talk a little bit about -- I have been jumping all around, I don't know exactly everything you said -- but on your re-performing loan sales, I know there is a lot of people feel that there is a great opportunity to be selling reperforming loans into the market.

Do you foresee selling more loans going forward?

Yes, they are difficult things obviously to project or forecast.

We have had loan sales here in the last couple of quarters but what I wanted to point out was that the second quarter rather in our judgment had elevated levels around that.

They are fair value assets aren't they?

Yes.

So the fact if we sell them or not they are getting written up based on market values.

You might have talked about this already but utilization rates, we have heard from a couple of institutions that they are up.

I don't think you really disclose it in your documents.

Can you talk a little bit about are you seeing increased utilization rates?

We did talk about it.

They are up from the first quarter which was elevated from the end of the year pretty much overall categories.

It is not necessarily anything to write home about.

They are up 0.5%, 1% across different categories.

Still well below their potential relative to past cycles but the trend is good and that increase in utilization is part of what gave rise to the loan growth this quarter.

Okay, guys.

Thank you very much.

Gerard Cassidy, RBC.

Thank you.

Good morning, guys.

Can you give us an idea if we had 100 basis point move -- a parallel shift in the yield curve both the front end and the long end going up, what type of increase to net interest income could be achieved?

Do we have that in our Q?

It is 2% in the first year.

(multiple speakers)

The challenge with that measure that we disclosed in the Q assumes that we don't actually increase our investment profile, though, 2%.

So 2%, in effect, saying that we would just replace what we hold today as opposed to increasing what we hold which is, in fact, what we would do.

It is a material number.

The front end helps us in many ways near-term more than the backend.

Okay.

Coming back to Rob, you mentioned the gain on sale margin was obviously over 5% this quarter, which was helped by some of the fair value marks.

And on the fair value marks, I think, Bill, you said it was because of the scratch and dent loans.

Is that what helped you guys on the fair value marks on the mortgage side?

Yes, essentially it is loans that we took back for whatever reason from various government agencies and cured them through time and/or just through collateral values underlying the loan, because the house price appreciation allowed the value of those to increase.

Okay.

So, Rob, when you mentioned heading more toward the 300 basis points gain on sale margin going forward, is it primarily due to the fair value marks not being there?

That is exactly right, Gerard.

That is exactly right.

When you guys take a look at -- you gave us some guidance and I just want to get a clarification here on the fee revenue that is going to be stable in the third quarter.

You indicated that the Visa gains were not included in the third-quarter assumptions.

Is it also we should back them out of the second-quarter numbers then, when you say stable it would be apples to apples?

Yes, that is right.

That is right.

So the distinction there is just between fee income and then total other noninterest income or a total noninterest income, which includes other.

Visa is in the part the other.

Great.

Finally, obviously, your Tier 1 comment ratio is very strong at 10%.

Bill, is it safe for us to assume -- you mentioned that you are growing capital faster than you can redeploy it -- that the total ask in next year's CCAR should be closer to 100% than where we are today which I think is around 65%?

I don't know.

You shouldn't assume anything in the middle of July without any instructions coming out of the Fed or any expectations coming out of the Fed as it relates to the 2014 CCAR.

In our view for the industry.

Look, we are running at levels right now beyond what we would say is our need.

So I will leave that as a statement and we will see what plays out in the environment and the way be Fed comes back with next year's process.

Great.

Thank you, guys.

Thanks, Gerard.

Moshe Orenbuch, Credit Suisse.

Most of my questions have actually been asked and answered but just kind of a follow-up on the net interest income.

As I look back to what you said three months ago, you talked about the purchase accounting accretion.

That really didn't change.

And you talked about some of the other things.

I am not sure that you talked so much about the general kind of spread compression.

Did your kind of view on that kind of soften during this quarter or is that a change or is that not?

Am I just reading too much into it?

We have been rolling 3 or 4 basis points a quarter for the last year and a half.

So your view is that it isn't really a change that it is just pretty much --?

Yes, that is right.

All right.

Thanks very much.

Betsy Graseck, Morgan Stanley.

Just on the expenses -- and I know we talked a lot about that already today, you are obviously indicating that 2014 expenses anticipated to come below 2013.

You are two-thirds of the way through the CIP program, not as much of this quarter's CIP fell to the bottom line because of things like salary increase and all.

I am just wondering based on what I am hearing that expectation is that more of your CIP program will likely fall to the bottom line in 3Q and 4Q.

That is my read between the lines.

Is that accurate?

Yes, I think that is accurate.

It is an annual program.

We continue to go after expense savings that are part of that program and even beyond that.

So we would expect to get savings in the third quarter from our continuous improvement program.

And it would fall more to the bottom line than it did in the second quarter?

The danger with the continuous improvement program is because while we save the money, the better guidance is the direct guidance on what we expect expenses to do in totality -- in a quarter.

And the comments from going from second to third was we can see a slight jump on the back of this automation and regulatory stuff and some seasonality we are having in employee benefits and stuff.

Got it.

It is important internally because it gives employees something to focus on as it relates to recycled dollars but as a practical matter externally the way you model our income statement, I would just focus on the guidance.

Okay.

And then obviously continuous is important and the continuous improvement from our NIM.

So the fact that you are two-thirds of the way through this year, I don't think we should take that to mean that your original end game for this year is set in stone.

I mean that could increase.

That is possible.

That is what occurred last year.

We never give up

We never give up, that is right.

Okay, thanks.

Mike Mayo, CLSA.

My first question is a high level one.

One of your main strategic initiatives is to improve the performance of the new markets, the Southeast and the Midwest up to the level of the Northeast.

You've indicated in some presentations cross-sell rates and things like that but can you just give us a comparison of new markets versus legacy markets on efficiency, ROA or some other metric like that?

I'm trying to think back to -- we used some of this in one of the presentations.

About 10% of our Southeast represents about 10% of our revenues.

Today the region as a whole contributes to the bottom line in a healthy way but it is materially below its potential relative to what we see elsewhere if that is what you are kind of driving it.

At the same time, it is growing at a pace across every line of business so that it is faster than the legacy businesses.

If you are looking for longer-term potential, it is a material number to the Company with a high degree of difficulty and a lot of years to play out.

Yes, I was looking for a little more definition of material or below potential again just efficiency ratio by market.

Yes, we have that out in some public record somewhere.

Why don't you get that from Bill.

Mike, we can talk off-line.

I've got a couple of things out there from a presentation we can go through.

Sure.

I looked at that.

If in the future you are able to quantify even more with more specifics it might be helpful to communicate that.

But that is fine.

Separately, your efficiency ratio, it has gone the wrong direction from 59% to 61% in the past year second quarter versus second quarter and I guess in the third quarter it will still get a little bit worse and expenses will be up per your guidance and revenues will be down a little bit per your guidance.

And this is the same time you have gotten most of the savings from CIP.

I guess is that just per the prior question, you are just reinvesting the benefits or it is just a tough environment and you are making the best of a bad situation.

How should we think of that?

I mean look, at the end of the day, we are a cyclical bank inside of a cyclical industry with declining revenue that is coming on the back of spread compression rates and accretion accounting.

I can, we can control expenses which we are doing and we can run our Company.

The end result of that because of the cyclical factors is our expectation and we put that out there in our guidance.

It will get a little worse in the third quarter.

I could offset that and choose to do things that don't make long-term economic sense to us.

We could grow our securities book, we could start balance sheeting mortgages, we could make that number anything you wanted in the near term.

I just don't think that is the right way to run the Company.

And as a follow-up to that without using the word convexity, can you explain again why it makes sense for PNC to be an anomaly when it comes to shrinking the securities book.

And I do remember you were on a call before the financial crisis and you highlighted that correctly so maybe if you are an anomaly more people should pay attention.

I am curious.

All we are saying in the securities book --so disclosure around these books is not always terrific.

You basically have a notional amount and you have a categories and then we put out an average maturity or average duration.

What is missing is the convexity associated with it.

So the duration, the current duration of a current coupon mortgage is pretty short because of prepay rates.

If rates go up, it extends massively.

That is negative convexity.

So I could have the same notional securities book with the same average life as somebody else and we think we have a much better risk profile because our book does not extend.

In a rising rate environment, it will just roll down the curve and disappear on a low average life where other people's will extend.

The same way it will if you were balance sheeting mortgages as opposed to putting them through to the agencies.

That is all we are saying.

It is an opportunity cost.

We could choose to take that risk.

I just think that the risk return of the benefit or the probability of lower rates and being able to ride down this curve versus extending and higher rates, I think there is more downside than upside.

How much is that opportunity cost in your view?

If you did what some others do or what you could do, how much of a revenue pickup could that be?

A couple hundred million pretty easy.

That is per year?

Yes, pretty easy, yes.

So that is in a way an insurance policy against a negative impact from higher interest rates when they occur?

Yes, I would rather have the upside leverage in a higher rate environment rather than rates go up and you are basically bound because your assets have extended and you can't deploy into the new higher rates at the same time as your funding costs go up.

I get it.

The last question as far as the purchase accounting accretion, you said that should hurt 300 million this year.

How much has that hurt already?

It is right about there, about 150 million.

We can get you the exact number but it is right on schedule.

It hurts every day.

Yes, it hurts every day but I get you the exact number but generally it is right at the half level.

And you said another 225 next year so next year, is that when conceptually the reported net interest margin this quarter 312 intersects with the core net interest margin 292 or is there more in 2016?

There will be more.

It trends to a level.

I mean it is going to trend in such a small percentage that it ought to be dwarfed by other things.

And those two NIMs will converge.

Is that more National City or RBC?

It is more National.

It is more the impaired books, Mike, than non-impaired.

Okay.

Great.

Thank you.

Matt Burnell, Wells Fargo Securities.

Good morning, guys.

Just one additional question on margin compressions for Rob I guess.

Rob, if you characterize your positioning relative to LCR, and I realize the rules are not final, if you had 3 basis points of compression this quarter from LCR, at what point do you think that might go down to no effect on margin quarter over quarter from your activity to prepare for LCR?

Of course that is hard to answer definitively because the final rules aren't established.

But what I said in previous earnings calls and I will say here is we believe the majority of the work is behind us and the majority of the NIM compression is behind us.

You can see that late fourth quarter, I think it was something like 7 basis points of compression and then it was 4, now we are at 3. We are closer and the majority of the work is behind us.

And then I guess a bigger picture question, if you look at your average consumer loan balances, they have been pretty flattish year over year not growing as much as the commercial side of things and I suspect some of that is demand rather than your underwriting.

But if the employment situation continues to improve, household net worth has improved fairly materially over the last couple of years, how are you thinking about potentially tweaking your lending standards on the consumer side to potentially grow that book at yields that are presumably a bit better than you are getting on the commercial side?

First off, inside of our consumer balance sheet as it were, we have sort of mechanical runoff in our education lending book which hits us every quarter so that is the old government guarantee program that no longer exists and that just rolls down.

We have had -- environmental is a function of rate declines or flat balances inside of home equity.

We have offset those with growth in credit card and auto and on the small business side, which ought to be a big piece of it, we have been kind of trending flat to down as runoff in some of the non-core books from RBC and still National City are offset by new business generation.

One thing we look at risk return on all of our credit products on a relationship basis so the notion that something yields more to us why don't I go chase that, it is kind of on a loss adjusted basis and we think we have had our credit box pretty much defined and consistent for the last bunch of years and I don't know that we are inclined to change it.

And within the areas of consumer lending that you are targeting, have you seen any greater level of demand based on the somewhat improved net worth situation and the jobs?

Look, we are seeing and the whole industry is seeing just on the back of the strength within auto which has kind of got back to pre-crisis levels.

We have seen growth in auto lending, we have seen partly as a function of our opportunity because we were underpenetrated in it, we have seen growth in card balances well beyond what you would expect in a normal environment.

Look, and Chairman Yellen spoke about it yesterday.

There is still a constraint on consumer wages notwithstanding an improved employment picture and until that changes and consumer spending changes materially which should drive the whole economy, I don't expect to see a big lift in consumer indebtedness.

Okay.

Thank you very much.

Terry McEvoy, Sterne, Agee.

Thanks.

Good morning.

Just a question, Bill, in your prepared remarks you said that the first half of 2014 was largely in line with plans and I am just wondering where you are not tracking within plant?

Is that just a function of issues out of your control.

We've talked about spread compression, etc.

or is anything connected to execution on expense cutting, growing in certain markets, etc.

that you had assumed would have fallen in place in the first half of the year?

No, I would tell you it is a great question and thank you for asking it.

The things within our control that we can execute on in our strategic priorities we feel really good about from the Southeast to the change in what we are doing in mortgage to wealth growth to the focus on cross-sell inside of C&I and importantly on our technology agenda.

So we feel good about that.

The environmental stuff we would have had in our forecast rates higher today, not front end rates but we would have the 10-year higher which would have lifted the whole curve and that would have had our net interest income higher than where we sit.

But that I can't do anything about.

The stuff that we can execute on, the Company and the employees have just done a phenomenal job and I couldn't be happier with them.

Thank you very much.

We are now past probably the time so I think, Bill, that is a great way to close the call unless you have any other comments?

No, we have been at this for an hour eleven.

We have talked as much about net interest income as I can think about it.

Thank you guys again for your time and your interest and we will see you again in the third quarter.

This concludes today's conference call.

You may now disconnect.