PNC Financial Services Group Inc (PNC) 2015 Q2 法說會逐字稿

Good morning, my name is Kayla and I will be your conference operator today.

At this time I would like to welcome everyone to the PNC Financial Service Group's earning conference call.

(Operator Instructions).

As a reminder, this call is being recorded.

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

Please go ahead.

Thank you and good morning, everyone.

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

Participating on this call are 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 trends 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 historical performance due to a variety of risks 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 call, earnings release, 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 Investor Relations.

These statements speak only as of July 15, 2015 and PNC undertakes no obligation to update them.

Now I'd like to turn the call over to Bill Demchak.

Thanks, Bill, and good morning, everybody.

As you've seen today, we reported net income of $1 billion or $1.88 per diluted common share for the second quarter.

And that compares with net income of $1 billion or $1.75 per diluted common share for the first quarter of 2015 and $1.1 billion or $1.85 per diluted common share for the second quarter of 2014.

Our return on average assets for the quarter was 1.19%.

In the second quarter -- the second quarter was largely a success for PNC despite low interest rates that continue to pressure net interest income across the industry.

We grew average loans slightly linked quarter driven by our specialty businesses in the Corporate and Institutional bank, and we were up 3% year over year.

Average deposits were up $4.8 billion or about 2% linked quarter.

Expenses were managed, although there are some moving pieces this quarter, and Rob is going to step through that in some detail during his comments.

Importantly, fee income grew 7% this quarter and 5% year over year as a result of our continued execution against our strategic priorities.

And as we said in the past, our priorities are aligned to deepen customer relationships and drive fee income growth, which enables us to create long-term shareholder value even in a low rate -- low interest rate environment.

And we are making important progress against each of our strategic priorities.

We continue to make good progress in building a leading banking franchise in the Southeast.

On the corporate side Southeast loans, revenues and cross-sell hit their highest quarterly level since the acquisition of RBC Bank USA.

In retail loan and deposit account growth continues to outpace their other markets.

Asset Management also had a good quarter with new primary client acquisition accelerating both year-over-year and linked quarter.

In addition fee income grew both quarter-over-quarter and year-over-year.

In retail we continue to make important strides to transform the customer experience in accordance with evolving customer preferences.

We continue to optimize our branch network.

In fact, by the end of this year we expect we will have closed or consolidated more than 400 branches, reducing the overall network by more than 10% since the acquisition of RBC Bank USA while continuing to serve our communities.

This includes plans to consolidate 100 branches this year.

In the second quarter we saw primary digital channel usage among our customers exceed 50% for the first time.

And non-teller deposit transactions, via ATM and mobile, are up almost 25% over the second quarter a year ago.

We now have more than 300 branches operating under the universal model.

Customers of universal branches have a higher percentage of deposit transactions via ATM and mobile and these branches complement the variety of touch points we have created to serve our customers in the ways that they want to bank with us.

We are proactively engaging with our customers to set appointments for them to come in to talk with us about their financial needs.

We have expanded this -- we started this last year and we expanded it across the retail network and our customers are responding.

To date through this program we've contacted more than 1.2 million customers resulting in more than 350,000 scheduled appointments, which in turn have led to more than 100,000 new product sales as we learn about their needs and they learn about the range of our products.

Importantly, throughout all this we remain a Main Street Bank organized around the relationships we enjoy with the people and businesses we serve.

Another area where you have heard us talk about improving the customer experience is in Residential Mortgage Banking.

We, and everybody else, have spent a lot of time the last few years looking backward at systemic problems that have plagued the mortgage industry for years.

And while there is still work to do we can now begin to think more strategically about the future of our home lending business and the relative experience for our customers.

In the second quarter we were very pleased with the OCC's announcement that PNC was one of three mortgage service providers that had satisfied all of their requirements under the OCC's mortgage consent orders.

As it relates to technology and operations, we are about midway through our multiyear effort to modernize our infrastructure and improve efficiency.

Our efforts are on plan and we are beginning to see the benefits of our investments to make our technology infrastructure more secure, more reliable and more scalable.

On the whole, it was a successful quarter for PNC.

From a macro perspective the operating environment is pretty much what we expected it to be at this point in the year.

We continue to [elate] some definitive indication of when interest rates will begin to rise, but in the meantime we are executing well on the things we can control.

Furthermore, remain sensitive to the revenue expense relationship and are in the midst of taking a number of actions to reduce operating expenses, particularly as we move into 2016.

And Rob is going to give you more detail on that in a few minutes.

As we look to the second half, I am confident that we have the right people, the right model and culture to continue to deliver a superior banking experience for our customers and to create long-term value for our shareholders.

And with that I will turn it over to Rob for a closer look at our second-quarter results and then we will take your questions.

Rob.

Thanks, Bill, and good morning, everyone.

Overall we had a strong second quarter with results that played out largely consistent with our expectations.

Second-quarter net income was $1 billion or $1.88 per diluted common share.

These results were driven by strong fee income performance, continued earning asset and deposit growth, well-controlled expenses and improvements in credit quality.

Our balance sheet is on slide 4 and is presented on an average basis.

As you can see, total assets increased by $4.6 billion or 1% compared to the first quarter.

Commercial lending was up $1.4 billion or 1% from the first quarter, which as expected was at a slower pace from previous quarters.

The growth was driven by our specialty businesses, including commercial real estate and asset based lending, and by strong volumes around M&A financing in our large corporate business.

To a lesser extent modest utilization increases also contributed to the growth.

Consumer lending declined $1.2 billion or 2% of which more than $300 million was due to the runoff of nonstrategic assets with the balance primarily due to decreases in home equity and education loans.

Investment securities were up $2.3 billion or 4% linked quarter substantially funded by deposit growth.

And lastly, our interest-earning deposits with banks, primarily with the Federal Reserve, increased in the second quarter commensurate with our liquidity management activities and strong deposit growth.

On the liability side, total deposits increased by $4.8 billion or 2% when compared to the first quarter, driven by higher levels of demand in money market deposits.

Borrowed funds increased by more than $800 million or 1% on a linked quarter basis.

We optimized our funding structure in light of regulatory liquidity standards and a rating agency methodology change.

As such (technical difficulty) senior bank notes, bank borrowings increased and we reduced commercial paper.

Total equity remained stable in the second quarter compared to the first quarter as retained earnings were essentially offset by capital returns as well as a decrease in AOCI.

Our interest-earning deposits, primarily with the Federal Reserve, were $32.4 billion as of June 30, an increase of $17.7 billion or 121% compared to the same time a year ago.

In part to comply with the liquidity coverage standards but also reflecting strong deposit growth.

As you know, the Federal Reserve short-term liquidity coverage ratio went into effect on January 1, 2015.

And as of June 30 our estimated ratio exceeded 100% for both the bank and the bank holding company under the month end calculation methodology.

Turning to slide 5, we continue to made strong capital levels while delivering significant shareholder capital returns.

During the second quarter we repurchased 5.9 million common shares for approximately $600 million.

This is part of our repurchase authorization of up to $2.875 billion for the five quarter period which began April 1, 2015.

Period end common shares outstanding were 516 million, down 4 million linked quarter and 16 million compared to the same time a year ago.

Risk-weighted assets on a fully phased-in standardized approach were essentially flat on a linked quarter basis.

As of June 30, 2015, our pro forma Basel III common equity Tier 1 capital ratio, also fully phased in and using the standardized approach, was estimated to be 10%.

Finally, our tangible book value was $61.75 per common share as of June 30, a 6% increase compared to the same period a year ago.

Turning to our income statement on slide 6, net income was just over $1 billion and our return on average assets was 1.19%.

Our second-quarter performance delivered revenue growth of $135 million or 4% on a linked quarter basis.

These results were driven by strong fee income in virtually all categories, partially offset by a small decline in net interest income.

Expenses remain well-controlled and we experienced improved credit quality.

Let me highlight a few items in our income statement.

Core net interest income was relatively stable as higher earning assets were offset by lower yields and higher deposit expense.

Overall net interest income declined by $20 million or 1% compared to the first quarter due to lower purchase accounting accretion.

Noninterest income increased $155 million or 9% linked quarter due to strong fee income growth and higher gains on asset sales.

Noninterest expense increased by $17 million or 1% compared to the first quarter as we continue to focus on disciplined expense management.

This quarter's results include a change in the application of how we account for historic tax credits and I will have more to say about that in a moment.

Provision in the second quarter was $46 million, down $8 million or 15% from the first quarter.

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

Turning to net interest income on slide 7, average interest earning assets grew by $5 billion or 2% linked quarter, primarily due to increased security balances, higher liquidity positions and modest loan growth.

Core NII was relatively stable compared to the first quarter driven by growth in earning assets funded by core deposits.

Purchase accounting accretion declined by $17 million linked quarter.

And as a result total net interest income decreased by $20 million linked quarter.

Net interest margin declined 9 basis points linked quarter primarily due to purchase accounting accretion and our increased liquidity position.

Regarding purchase accounting, given the higher than anticipated cash recoveries we experienced in the first half of the year, we have revised our forecast by $25 million.

As a result we now expect purchase accounting accretion to be down for the full year approximately $200 million when compared to 2014 versus the previous guidance of $225 million.

In terms of our interest rate sensitivity, our duration of equity remains negative.

As you know, our balance sheet is asset sensitive reflecting our view of the interest rate environment.

And as we've said for some time, we recognize this has and will possibly continue to constrain our NII growth in the short term.

However, when interest rates do begin to rise we are well positioned and will continue to apply a measured approach to higher levels of investment activity.

Turning to noninterest income on slide 8, overall strong performance across our diversified businesses generated an increase in fee income of $91 million or 7% this quarter.

Equally important, year-over-year fee income increased by $73 million or 5% reflecting our strategic priorities to grow higher quality more sustainable revenue streams.

Total noninterest income increased by $155 million or 9% linked quarter driven by core fee growth and higher gains on asset sales.

Asset management fees increased by $40 million or 11% on a linked quarter basis.

During the quarter we had a substantial trust settlement resulting in fees of approximately $30 million.

In addition, market performance and new sales production also contributed to the increase.

Compared to the same quarter a year ago asset management fees increased by $54 million or 15%.

Excluding the substantial trust settlement in the second quarter, asset management fees were up $24 million or 7% primarily due to market performance, net new business and BlackRock's earnings.

Assets under administration were $262 billion as of June 30, up $5 billion or 2% compared to the same period a year ago.

Reflecting our strategy of growing share of wallet in retail, consumer service fees were up $23 million or 7% linked quarter with increases in all primary categories reflecting seasonality and higher client activity.

Corporate services fees increased by $25 million or 7% linked quarter and compared to the same period a year ago they increased by $26 million or 8%.

In both periods the growth was primarily due to increases in treasury management and capital markets advisory fees.

Residential mortgage noninterest income was flat compared to the first quarter as double-digit originations growth was offset by a first-quarter portfolio sale.

Mortgage originations were $2.9 billion in the second quarter, up from $2.6 billion the same quarter a year ago, a 14% increase.

Services charges on deposits grew by $3 million or 2% linked quarter primarily due to seasonality and higher client activity.

Compared to the same quarter a year ago, deposit service charges declined slightly as a result of evolving customer behavior related to product changes.

Other categories of noninterest income increased by $64 million primarily from gains on the sale of VISA stock offset by lower net securities gains.

Total noninterest income to total revenue was 47% in the second quarter, up 3 percentage points both linked quarter and the same quarter a year ago.

Turning to expenses on slide 9, second-quarter levels increased by $17 million or 1% as we continue to focus on disciplined expense management.

We recorded a $43 million increase in personnel cost in the second quarter resulting from higher variable compensation costs associated with elevated business activity.

In addition, equipment costs increased reflecting our investments in technology in the Retail Bank transformation.

Partially offsetting these increases was a change in the application of $54 million of year-to-date historic tax credits to related asset investment balances.

This had the effect of lowering impairment expense and correspondingly increasing income tax expense.

In simple terms, because of this change, noninterest expenses decreased by essentially the same amount of the income tax increase and by definition is EPS neutral.

We made this change in presentation to better align with industry practice.

As a result our second-quarter effective tax rate was 28.2%, up from 24.4% in the first quarter.

With this change we now expect our full-year effective tax rate to be 26%.

As you know, the goal of our 2015 continuous improvement program is to reduce cost to fund the investments we are making in technology, infrastructure and retail transformation.

In our first quarter earnings call we referenced an effort to enhance expense savings over and above the CIP target of $400 million.

During the last couple of months we've identified initiatives that support increasing our CIP goal by an additional $100 million.

As a result we have raised our 2015 CIP goal to $500 million.

So when looking at the full year 2015 expense forecast take into account the benefits of the tax credit change and the additional CIP, partially offset by higher variable incentive comp and investments related to equipment expenses.

We have revised our full-year 2015 guidance from stable expenses to down approximately 1% compared to full-year 2014 expenses.

As you can see on slide 10, overall credit quality improved in the second quarter compared to the first quarter.

Nonperforming loans were down $153 million, or 6%, compared to the first quarter as we saw continued improvements across our commercial and consumer loan portfolios.

Total past due loans decreased by $109 million or 6% linked quarter.

Net charge-offs of $67 million declined by $36 million or 35% primarily due to strong recoveries in commercial lending.

In the second quarter the net charge-off ratio was 13 basis points of average loans down from 20 basis points in the prior quarter.

Our provision of $46 million declined $8 million or 15% linked quarter as overall credit quality improved.

Finally, the allowance for loan and lease losses to total loans is 1.59% as of June 30, this compares to 1.72% at the same time a year ago.

As you know, the Shared National Credit exam has been completed and our results are fully reflected in this quarter's reserves.

In regard to our oil and gas exposure, we have a total of $2.6 billion in outstandings which is down about 10% from the first quarter and still represents about 2% of our total commercial lending portfolio.

Of the $2.6 billion, approximately $300 million is not asset based or investment grade.

In our view these loans have the potential to be the most impacted by the drop in oil prices and we continue to monitor these loans closely.

Importantly, we remain comfortable with our current reserve levels based on our continuing review of the portfolio.

In summary, PNC posted strong second-quarter earnings consistent with our expectations.

We continue to believe the domestic economy will expand at a steady pace this year.

Our plans assume the federal reserve will begin to raise short-term interest rates beginning in September.

Given this background we expect total revenues to continue to be under pressure primarily as a result of lower purchase accounting accretion.

And as I said earlier, we now expect full-year 2015 expenses to be lower compared to full-year 2014.

Looking ahead to the third quarter, and when compared to the second-quarter reported results -- we expect modest loan growth, we expect net interest income to remain stable, we expect fee income to be stable as we anticipate the continued growth in business activity in the third quarter to effectively equal the elevated second-quarter trust settlement fees.

We expect expenses to be stable and we expect provision to be between $50 million and $100 million.

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

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

(Operator Instructions).

Erika Najarian, Bank of America.

My first question is on the base for the fee income guidance for next quarter.

Are we keeping the $30 million unusually large trust settlement in the base?

And if so, what is the usual run rate of trust settlements that you typically recognize?

And where is the core growth coming from if that is indeed included in the base of your guidance?

Good morning, this is Rob.

The answer to part one of your question is, yes, it is in the base.

So we do expect across all of our fee categories in the third quarter to effectively growth those, consistent with our strategies in an amount equal to that $30 million trust fee.

And that is why we have guidance in terms of being stable.

In regard to the second part of your question in terms of the trust settlement fees, that is a routine thing that happens in terms of any trust business.

What is unusual about this one is it happens to be one of our largest trusts, and the period in terms of -- which was involved was particularly long.

So that is why we call it out.

The usual run rate of trust settlement fees is in the low millions of dollars in a particular quarter, so this one is unusual by its size.

Got it.

And my second question is for Bill.

We have been asking your peers over the past few calls in terms of their take on deposit betas and hopeful anticipation of a rising rate environment in the back half of this year.

JPMorgan mentioned that they think that the beta's are going to be much greater because regulatory -- new regulatory standards.

Wells took a softer stance saying that we are coming from zero and USB was somewhere down the middle.

Where do you stand?

We are probably closer aligned to JP.

And I think there is going to be a pressure, particularly on the retail side, just given the differentiation in LCR qualification of retail deposits versus wholesale.

Got it.

Thank you.

Scott Siefers, Sandler O'Neill & Partners.

Rob, maybe best for you, just want to make sure I am starting off the right base on the expense guidance for the full year down 1%.

Yes.

So is that off the reported $9.488 billion from last year?

Or I seem to recall in the fourth quarter last year you had something like $125 million of unusual costs, which would have taken it lower, but whatever the base is.

Sure.

No, it is off the reported number.

Okay, perfect.

Thank you.

And then maybe just another question on kind of how you are thinking about the margin and balance sheet growth dynamics as we look for stable NII into the third quarter.

So I appreciate your updated thoughts on the purchase accounting down -- I think it was down $200 million.

But as you look at things, is margin pressure abating in part because of that which allows you to do NII?

Or are you thinking you'll grow the balance sheet (technical difficulty) at a more rapid clip?

How do you see the interplay coming out?

Well, a couple of things going on there.

On the purchase accounting accretion, the revision there really reflects greater than expected recoveries in the first half of the year.

So that is a good thing.

We keep saying as we get deeper into this the opportunity for recoveries becomes less.

But because they were so substantial in the first half we have revised that down $200 million versus $225 million.

In terms of the stable NII, it is pretty much consistently the theme that we have been seeing all year -- fighting the lower rates, offsetting that with modest growth in our loan portfolio which we expect to continue, albeit at a somewhat slower rate than what we have done historically, and putting some more money to work in investment securities in a measured approach.

Okay.

Okay, good, I think that is great.

Thank you very much.

Matt O'Connor, Deutsche Bank.

Can you just talk about the desire to deploy some of the liquidity?

Last quarter I know you added to the securities book.

But if we look over a longer-term period, it doesn't seem like you have built the securities or mortgage book as much as we have seen some other banks.

And obviously rates have backed up a little bit here.

So just curious on thoughts of easing into it around these levels.

Yes, we have tactically, if you go back, look through time the securities book would kind of go up or down depending on where we were in long-term rates independent of the front rate being zero.

We have obviously sawed off in the back end a lot since the end of the first quarter and that is part of the reason you see our security balances increasing.

And you will likely see them increase as we go forward and just kind of step our way into what we think is going to be a rising rate environment.

We have an ability against -- I don't know what it is -- $32 billion we have sitting at the Fed today.

We could obviously redeploy most if not all of that into other interest-bearing assets, Level I for LCR and then some percentage of Level II where we still have -- what is it, 40% --?

About $13 billion -- 13.

So a big number that we could put into Level II.

But that is all against -- we don't think of where you put the cash; we think about it in terms of the duration of the balance sheet and where we are investing in long-term rates, which can be done through swaps, through loans, buying securities and reducing cash.

Okay and then just separately on expenses.

As we look maybe a little bit more than just the next couple of quarters and think about next year, maybe we get less benefit from rates than folks saw just six months ago.

What are your thoughts on being able to control costs in a still low rate environment as we look out beyond this year?

Yes, sure, Matt, this is Rob.

We are not in a position to be able to give guidance on 2016 specifically yet.

We will get to that when we set our budgets up in the fall and get a feel for where we are particularly around interest rates.

But the message that we want to convey again this morning is that we are very mindful of the revenue expense relationship.

We do feel in terms of the way that rates were pushed out, or our expectations of a rate rise were pushed out there in that first-quarter earnings call necessitated this additional push on expenses, which is why we raised our CIP target.

Yes.

Just as an aside, part of the story on expenses this quarter and variable comp -- Rob talked about basically coming out of variable incentive as well as pretty much expected equipment cost increases as we continue with the technology agenda.

But on the variable comp piece, perversely at the start of the year we changed some of our incentive programs in retail to drive deposit growth which we have absolutely gotten.

You see the acceleration in our deposit growth on the retail side.

What we haven't gotten is the value from that growth in deposits as rates against our original forecast have remained lower for longer.

So we got the pop in incentive comp but we didn't get the offsetting revenue, and it is something that we have an ability to dial as we go through the rest of this year.

Yes.

And what I would add to that too is I would encourage you to focus on the full-year expense management.

We can get -- I have said this for a number of years, we can get quarterly fluctuations around those types of things and also our pace of investments aren't necessarily uniform through the quarter but are for the year.

Okay, thank you very much.

Gerard Cassidy, RBC.

Can you guys share with us your thoughts -- you mentioned that you are likely to close I think another 100 branches this year for a total of 400 over the last three or four years.

Can you share with us the deposit retention?

What kind of numbers are you seeing when you consolidate these branches?

Are you keeping 90%, 95% of the deposits?

Yes, hey, Gerard, it is Rob, a couple of things there.

One is, as Bill mentioned, we have plans to consolidate 100 branches in total for 2015, 50 of which have already been consolidated.

So there is an additional 50.

So far in terms of what we have done in terms of these consolidations, the deposit retention has been very high.

I don't have an exact number for you, but obviously that is one of the sensitivities.

And we manage it pretty closely.

And what type of feedback have you received from your customers, whether it has been positive or negative, on these consolidations?

Well, more often than not it is not positive.

But having said that, we have very long lead times and advance warning to affected customers and warm handoffs on moving to other branches.

So as you would expect, we get the occasional complaint when we do consolidations, but we are quite thoughtful about how we go about it and the lead time -- the lead times associated with notifications and follow-up customer service.

You have talked over the last couple of years about the upgrading of the internal technology.

And it looks like the light at the end of the tunnel comes possibly in the second half of next year or toward the end of next year.

And can you -- after that is finished can you give us your views on what you are thinking about mergers and acquisitions once this task is behind you and you may have a better ability of doing something on a go forward basis?

Sure.

I think -- we said looking backwards that our technology agenda trumped our desire to look at retail bank acquisitions.

We didn't want to stop what we were doing to do an integration.

When the technology agenda is at a point where we can in fact do that it doesn't mean that we are then going to get into an acquisition game.

We will look at the environment at that point in time, look at values in the market and look at our strategic needs and opportunities and have a view.

But that is a year and a half from now.

It will depend on rate environment, it will depend on the continued change in retail preferences and the transformation we are going through and we will evaluate it when we get there.

And just one final thing on the technology.

Some banks that have done similar projects that you are doing right now talk about the capacity of their systems now are twice the size of their current bank balance sheet.

Do you have any guidance on what your system will be capable of -- not to suggest you are going to do something really big, but can you give us some flavor for how big your system could handle in terms of assets?

You know, that is too broad a question to answer specifically because it obviously depends on the type of activity.

But I would tell you historically our challenge was we couldn't scale our activity without scaling the costs along with it because we had much more manual process than we otherwise wanted.

A big part of what we are building out in technology through automation is the ability to scale without adding variable costs associated with it.

So I think we could do material -- once completed we could do material -- more volume than we are doing today, importantly without adding the personnel cost that typically comes along with that.

And that is what we are building into this plan.

Great, thank you.

Matt Burnell, Wells Fargo Securities.

We have heard on a couple of calls the challenges that a lot of the banks are seeing in terms of generating loan growth on the commercial side.

And I know that you all feel quite comfortable being able to bring more of the fee income component to these relationships so that you are not just sort of chasing rate.

But can you give us an outlook on sort of how you are thinking about commercial loan growth specifically within the C&I space?

And I guess also sort of where the M&A financing outlook might be to drive further growth in the commercial side of things?

Yes, I mean I guess a bunch of comments into that space.

First off, if you look at our growth in C&I relative to peers, at least peers that have reported this quarter and it doesn't surprise us, we look light.

And that is coming off of -- it is interesting, if you go back through time our growth outpaced peers during the crisis and has slowed down as everyone else has accelerated, which is typical of our strategy in the sense that the highest returning loans typically are made in times of crisis.

What has happened are a couple things.

One is a lot of the volume increase you see particularly at the large banks is on the back of large corporate M&A activity.

We have some of that in our growth rate, but we are more of a middle market bank than a large corporate bank.

So we participate less in large corporate growth than some of the big banks.

And the middle market space specifically has been really competitive.

We haven't had outright growth in vanilla middle market loans I think going back five or six quarters, Rob.

Easily.

And instead have continued to have and still have growth in our specialty segments of business credit and leasing and real estate and some other things we do.

Interestingly one thing that has impacted the front half of this year, which is somewhat new, is some of the loan only relationships put on during the crisis at very wide spreads, a lot of them in the financial -- we report them as financial space, but some of them can be securitization type activity.

They have refinanced and repriced at levels that make no sense to us, particularly in light of the penalties associated with those types of loans under LCR.

So we purposefully shrunk our FSAB balances while we focused on cross-sell broader commercial relationships and that is part of the reason you see the slowdown in our growth line.

I think the growth going forward, and Rob talked about this, is we expect kind of moderate growth in the C&I space and continue to be challenged in the retail space as we continue to see run-off and education loans in some of our legacy looks.

And then if I can just follow up on credit.

Rob, you mentioned the energy exposure or oil and gas exposure is down about 10% and it is a pretty -- still a pretty modest portion of the overall portfolio.

And I presume given the fairly meaningful decline in NPAs and provision this quarter suggest you didn't do much in terms of reserve increases on that portfolio.

But could there be a second borrowing base review later in the year that could drive further reserving on that portfolio?

Yes, yes, a couple of things there.

One is the 10% decline is in our outstandings that I mentioned as opposed to our exposure.

And we feel good about the reserve levels I had mentioned, particularly on that roughly $300 million of loans which is an asset base or investment grade.

We have done reserving -- you will recall in the first quarter we had mentioned we had done some QFR, qualitative reserves, and we changed some of that around, around some specifics, but no net big change.

We will continue to monitor the portfolio closely going forward, but there aren't any plans for a big change, we will just continue to watch it as it develops.

Thanks very much.

John Pancari, Evercore ISI.

Want to see if you can give us some additional color on the incremental $100 million in the CIP saves.

Just generally where is that coming from, what type of programs?

Also, does it have a revenue impact at all from these items?

And then lastly, it does imply that the tail end of the year the fourth quarter should decline substantially in terms of expenses in order to meet that number 1% down guidance.

So just wanted to make sure I understand that correctly and what is driving that.

Yes, sure.

A couple of things there.

One is generally speaking the additional $100 million is the result of a broad belt tightening across the organization.

We announced it on our first-quarter earnings call, our employees all heard and we all rallied around that.

So there isn't any big number that is driving that.

What I would say is a big portion of it is coming from reducing our planned expenses around staff services, which have grown over the last couple of years which we've told you about.

Don't really count for a take change in revenue as a result of that.

So our revenue guidance stays the same.

And then, if you take a look at expenses in terms of sort of the second half of the year around that 1% sort of math, approximately second half expenses need to match our first half expenses, which is what we are saying.

Okay.

All right, that's helpful.

The other thing I would mention is the $100 million of incremental CIP that we focus on this year is in fact what we will realize this year.

That gives rise to an entry level as we get -- plan for 2016.

A big part of this exercise was to make sure we were holding expenses down in 2016 given that rates not only were going to start going up later, but also go up slower.

So, in many ways this was less about what we were going to do this year and more about what we were going to do in 2016 in the out years.

Being positioned to a -- yes, gradually rising rate environment, shallower than what we had previously thought.

Yes.

As an example, inside of that 100 branch closure number that we put forth, that is inside of our expense rate.

So there is no one time, we buried the costs associated with shutting those down and canceling leases and so on and so forth as opposed to announcing a one-time charge associated with closing 100 branches which other peers have done.

Okay, all right.

And then, Bill, getting back to your comments you just made around competition in the midmarket space in C&I -- I know you have been talking about that and it certainly sounds like it is still competitive.

So my question is, from your perspective what changes that?

I mean does the -- as the size of the pie grows and demand improves across the board here does that allow you to step back in or are you skeptical of that as well?

You know, I don't know exactly what is going to change.

I would tell you it is interesting to me that spreads for the first time in, I don't know, 10 quarters were basically flat this quarter.

So maybe we have hit the bottom at least in this rate environment.

If you go way back in time you would see that deposit balances and loans inside of banks historically have roughly been equal with -- given your loans might faster than deposits, but they kind of tend to equal out.

We've been in a period of five years where deposits have massively outgrown loans.

You will hear different people -- the dialogue in the industry is as it normalizes to mean revert, is that going to happen by deposits shrinking or by loans growing.

So US Bank thinks there is going to be a big loan growth spurt, I hope they are right.

Morgan and ourselves are probably on the camp that we are probably going to see deposits shrink.

But somewhere in there, as we play forward here -- status quo, I don't know what is going to change to cause pure middle market lending only relationships to be any more attractive, which is why we are focused so much on growing fee income in the cross-sell relationship.

Okay, all right.

No, that is helpful.

One last quick thing.

Did you provide updated purchase accounting accretion expectations for 2015?

2016.

We have not --.

2016, no, not yet.

Okay.

And for full year 2015?

For full-year 2015 down $200 million, that changed from the previous guidance of down $225 million.

Got it.

Okay, all right.

Thank you.

(Operator Instructions).

Paul Miller, FBR Capital Markets.

Can you go back a little bit on the follow-up question on the competition out there?

You define yourselves as a middle market type of bank.

What -- can you define what really middle market is?

Because I think it has different definitions for different people.

Yes, that is a fair question.

You know, internally we probably think about it just in terms of the way we organize ourselves from call it $30 million to $50 million up to $500 million, practically it is $50 million to $1 billion --.

In terms of annual revenues (multiple speakers).

Yes, sorry, annual revenues.

So our sweet spot that kind of fits our product set and that we target is $50 million to $1 billion in revenues.

Having said that we have a number of clients given our treasury management capability and some of the specialty products we have in [TM] that are obviously much, much larger than that.

And then you have really -- I think of you guys -- you might not think of it -- you have the legacy part of your institution and then the southern part where you got with RBC.

Are you seeing -- I mean that is an area you said you have gone in and really got a lot of credibility and some influx really quickly.

Have you been able to bank that middle market down there also or is that also just as competitive as you are seeing in your traditional sites?

We have actually grown it faster by every measure into our newer markets.

It is just as competitive.

But I think having an alternative offering in some of those markets, bringing the other products that we can to bear, particularly in the treasury management side, makes a difference.

So having great teams of people that are a combination of terrific people we hired during the downturn and legacy PNC employees that we moved down there.

So, no, in the end we're actually outpacing our more mature markets in the newer markets.

And some of that just is reflective of a smaller base (inaudible).

Yes.

Now -- and then the last question is what do you think drives out some of the -- what do you think that -- that some of this competition gets driven out?

Just solid economic growth?

Or what can we look for in the outside to see that you started getting some pricing power in this middle market area?

Well, I think you have to be careful to not just focus on loans.

So one of the things we look at internally a lot is our loan growth versus our total revenue growth inside in the CNIB space.

You can't have a sustainable environment where you are growing loans at 10% and your revenue at 1%, which if you dig through some income statements you will see a lot of people doing that.

So we focus a lot on making sure that we are growing total revenue at a pace that is commensurate with the capital we are deploying, which I think ultimately allows us to provide a good return to our shareholders.

I think people who are chasing loan growth and the thing that ultimately changes is they realize that is not sustainable in terms of providing a return on equity to shareholders.

I don't know that people have figured that out yet.

But lending only relationships in the middle market space, if that is your business plan, without a product set to support it I don't think is sustainable.

Okay.

Hey, guys, thank you very much.

Ken Usdin, Jefferies.

Hey, Rob, I appreciate the color on the second half expenses.

And I was just wondering -- can you just help us understand that mechanism in terms of the tax change?

So the $54 million that was in the second quarter, was that a catch up, was it a one-time?

And then just in terms of how that goes forward.

He is so happy that you asked that question.

Yes, I am glad you asked that question, Ken, because the $54 million really reflects the total first half 2015 activity.

It is a lumpy business, so virtually all of our -- so our tax credit business in the first half of the year we did in the second quarter.

The best number that I can give you for the full-year number is $80 million, which is our budgeted number that we budgeted at the beginning of the year.

Again, it is a lumpy business, so we could do a little bit more than that, we could do a little bit less than that.

But that is not a number that you would annualize.

For some context, total tax credits in 2014 were $75 million, so that fits in with that $80 million.

Okay, that is helpful.

So it is (multiple speakers).

And also, Ken, just on that, that is -- the $80 million is what we use for the math to give you the guidance on the effective tax rate of 26%.

So that is why you will see (multiple speakers).

So that is what (multiple speakers), yes.

Right.

So right, the 28 (multiple speakers).

So probably your next question (multiple speakers).

Well, right.

No I was going to say that that was implied in the 26% for the year is that it wouldn't run at this 54 --.

Yes.

So you are just trying to give us a best understanding of kind of a generic -- what seems to be kind of volatile, but business you do on a recurring basis.

That is right, that is right.

Okay, okay, got it.

And then just a second question on investment securities.

So, you guys are in good shape on LCR and we see that you have been building.

When I look at the core interest, net interest margin, obviously there is still the negative roll over effect 11 basis points on the investment securities.

How are new investments coming on versus what is on the balance sheet?

And are we getting closer to kind of that stabilization with the rates up a little bit?

Yes, we are -- in terms of securities on and securities off, they are getting very close.

So that in the end we will start to lose that bleed as long as the long end stays about where it is.

Part of what you are seeing though of course is just the build in cash.

So the drop in NIM simply is a function of the build in cash, which is sitting earning 25 basis points at the Fed.

Right.

But your point, your front book back book is getting better?

Yes.

Or closer.

Yes.

Okay, thanks, Bill.

Bill Carcache, Nomura.

Can you guys discuss the quality of the money market and demand deposit growth that you saw this quarter from an LCR perspective?

And on a related note on the initiatives that some banks have undertaken to deemphasize non-operating deposits, do you have any thoughts on where those deposits are going?

Well, on the money market side it shows up in the retail segment, they are all LCR friendly.

All good there.

All good.

And we have been pleasantly surprised and tracking aggressively obviously the retention of new money, new clients.

Interestingly the balances for new households are higher given our product offerings than they have been in our history, partly changing our checking account mix.

As it relates to operating deposits for corporates, they are less valuable to us from an LCR standpoint.

They are still valuable and we still obviously have room on our leverage ratio and the ability to hold those.

So inside of our corporate space it wouldn't surprise me at all that we are getting some growth in corporate balances that is coming as a function of some of the others that are constrained pushing those away.

That is very helpful.

On a separate note relating to fee income, some folks that we have spoken with have expressed a little bit of skepticism surrounding the sustainability of your fee income growth.

Bill, could you discuss what is underlying your confidence in your ability to sustain the kind of growth trajectory that you guys are experiencing as we look forward from here?

In its simplest form we are simply suggesting we are going to continue to do what we have done for the last --

Maintain the trajectory.

-- yes, couple of years.

And each one of those line items kind of drills down to a specific business plan that doesn't assume heroic assumptions to be able to accomplish it.

On the corporate side the growth you are seeing, and we have talked about, is coming on the back of cross-selling all the new clients that we onboarded during the crisis.

We had 10% compounded primary client growth in CNIB for two or three years running during the crisis that were largely lending only relationships.

We now have the ability to monetize that through cross-sell.

In the retail side it is on the back of the continuum change of what we did with product offerings, the elimination of free checking, the continued growth in merchant, in debit, in credit card where we're underpenetrated.

In wealth it's (technical difficulty) repeat what we have now done for five years and using the rest of the organization to refer business in cross sell.

So we are -- there is nothing heroic in there, we are just hitting on all lines of business against this general notion that we put forth as a Company that we want to be less dependent long-term on net interest income to drive this Company and be able to get back to a more historical balance that we used to run at in terms of fees and net interest income.

So we just prioritized it and people get it is important.

That is great, thank you.

That really helps a lot.

If I can squeeze one last one in, relating to just a follow-up on your comments surrounding the deployment of your excess liquidity.

One of your peers indicated yesterday that the 10-year US Treasuries at around 2.5% represented an attractive asset in the rate environment that we find ourselves in and they were comfortable extending duration a little bit.

You mentioned, Bill, that your securities balances should start to rise from here as you step your way into a higher rate environment.

Does that mean that you are also feeling a little bit more comfortable extending duration now than you did say a quarter or two (inaudible)?

We like the 10-year a lot better at 240 than we did at 179 or wherever it hit towards the end of the first quarter.

I think -- and I listened to the conversation you are talking about.

Look, I think at the end of the day the long end is going to have a slow grind higher.

We have deployed, as you saw this quarter, a little more cash into the securities book.

We are never going to make a single big bet, it is not who we are.

We are going to increment our way in as rates change here.

And we have a large opportunity to do that relative to the way we are invested today.

One of the things that I should have mentioned when we talked about loan growth is our residential mortgage holdings on the whole loan side, which are obviously also a form of fixed-rate duration.

While we keep kind of jumbos in some of the production from our mortgage company it is a lot smaller percentage, and an opportunity for us, but it is a lot smaller percentage today than many of our peers.

So we have a lot of ways to play here.

I think by and large nobody is expecting a massive selloff in the long end, there is more value here today than there was a quarter ago.

And even on the mortgage side some of the adds we did were actually in mortgage backed securities.

The OAS spreads on mortgage backs are much, much wider than they were three months ago, so there's an opportunity there.

Thank you, very helpful.

Marty Mosby, Vining Sparks.

Rob, I wanted to go back to the deposit beta discussion.

The characterization of JPMorgan is a little bit skewed in the sense that Jamie did come back yesterday and said, look, there is gamma, which means early on the deposit betas are going to be much different than let's say after the first 50 to 100 basis points.

So I just waited to kind of re-context that for you and ask more specifically what happens initially versus maybe what happens generally over the whole rate increase.

So think about the first 50 basis points first.

Bill wants to jump in here a little bit too.

Marty, you and I have spoken about this a little bit.

First and foremost, nobody knows so we will see.

What we've spent a lot of time on is just being and planning for all sorts of outcomes, recognizing that it has been a long time since we have had an interest rate increase.

And that consumer behavior could be substantially different here 11 years later, particularly around the LCR, the attractiveness of deposits on LCR over and above the margin.

And then of course the increased technology which allows consumers to move deposits from bank to bank a lot more easily than they could have 11 years ago.

So I don't have an answer for you, but I do know that we plan around it obsessively.

That is a priority of Bills and we just have to be ready to go with however the scenario plays out.

I think missing from some of that analysis is -- go out and look today at where teaser rates are on new deposit money markets.

They are well over -- there is offers out there for a percent --.

Or higher.

Yes, so they are well over where rates are today meaning that the beta is 3x already.

The question is as rates rise are those teasers going to go straight up on top of that out of the gate, probably not.

The other thing that will lag is interest-bearing business accounts and so forth will probably lag somewhat.

But I think the core consumer interest bearing accounts given the demand for LCR friendly deposits, they are going to move pretty fast.

And we have got to be ready for that.

Yes.

Well, could you -- let me ask you another way.

Can you condition the way you will posture yourself?

In other words, we get a 25 basis point move in the Fed Funds rate will you be proactively moving your rates higher or will you react to what the market change is?

So if you don't see any outflow of deposits will you then --?

No, we are going to -- look, we and the rest of the market are going to feel our way around to figure out what is going to move balances or not for the first movement.

So it is not as if we instantaneously change all of our prices, if that is what your question is.

I just think we have proven ourselves because we have had leading offers in the market to grow deposits to complete our LCR process that money moves with slightly higher offers.

And not everybody in the market is LCR compliant.

If in fact deposits shrink in the system because QE goes away and/or loans grow, then (technical difficulty).

Understood, hello?

Please go ahead, sir.

Lastly, Rob, I just want to ask you on the shortening of the duration in the portfolio.

The yields on the securities portfolio have been moving down pretty significantly.

I just didn't know if you had also, in addition to adding cash over the last year, have you also been maybe shying towards a little bit shorter duration on your purchases of the portfolio and are you kind of through maybe that process?

(technical difficulty)

Thank you.

And our final question comes from the line of Eric Wasserstrom, Guggenheim securities.

Thanks very much --.

-- technology issue.

So we will answer Marty's question and then --.

Hang on, is Eric on the line?

I am, yes.

Is Marty on the line?

Eric, why don't you go ahead.

Yes, sorry, there was -- I think some of us got briefly disconnected.

Just to follow up on two issues very quickly as we wrap up the call here.

One, Rob, I just wanted to make sure I understood your commentary about loan growth across the newer geographies.

It seems like the -- sort of the run rate for the industry is somewhere in the sort of 6% to 8% annualized level.

But did I understand your commentary to mean that it is in line with that off of a low base?

Because intuitively it seemed like it should be somewhat greater than the industry average just given the starting point.

This is Bill and I think I was the one who was talking about that.

I actually don't know the percentages down there, but they have got to be higher.

Yes.

I think they're materially higher.

A little bit high.

It depends on what period you are looking.

From the start materially higher -- still higher but not by as much as we mature.

Okay, great.

Thanks.

And then my second question is, Rob, in the context of your commentary that as rate expectations changed you had to make some changes to your expense outlook.

But you may be at this point in the minority of thinking that the next Fed hike is coming in September.

If in fact that gets pushed out by a quarter or two, would that necessitate another change?

Or did the change you make anticipate potential additional slippage?

That is a good question.

The change that we made was a reaction in April when we pushed back those rates.

If rates don't rise in 2015 in that September hike, that is really not necessarily expense related.

We bracketed that around in terms of NII, it is not a huge number.

The bigger issue, as Bill pointed out, relative to 2016 and beyond in terms of the gradual rate rise, that is a much, much bigger impact to our revenue.

Great, thanks very much.

Okay.

With that we have passed the time so we are going to wrap up the call.

So thank you all for joining us and have a good day.

Thank you.

Thank you.

This concludes today's conference, you may now disconnect.