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Executives

William H. Callihan – Director of Investor Relations

James E. Rohr – Chairman and Chief Executive Officer

Richard J. Johnson – Chief Financial Officer

Analysts

Matthew O’Connor – UBS

Nancy Bush – NAB Research

Betsy Graseck – Morgan Stanley

Jason Goldberg – Barclays Capital

Michael Mayo – Deutsche Bank Securities

Albert Savastano – Fox-Pitt Kelton

Robert Hughes – Keefe, Bruyette & Woods

Mike Holton – The Boston Company

Ron Mandel – GIC

PNC Financial Services Group Inc. (PNC) Q4 2008 Earnings Call February 3, 2009 9:00 AM ET

Operator

Welcome to the PNC Financial Group fourth quarter 2008 earnings call. (Operator Instructions) Mr. Callihan, you may begin your conference.

William H. Callihan

Welcome to today's conference call for The PNC Financial Services Group. Participating on this call will be PNC's Chairman and Chief Executive Officer, Jim Rohr and Rick Johnson, the company's Chief Financial Officer.

The following statements contain forward-looking information. Actual results and future events could differ possibly materially from those we anticipated in our statements and from our historical performance due to a variety of factors, including those described in today's conference call, in today’s press release and related materials and in our 10-K and 10-Q and various other SEC reports available on our corporate website.

These statements speak only as of February 3, 2009 and PNC undertakes no obligation to update them. We also provide details of the reconciliations to GAAP and non-GAAP financial measures we may discuss in today's conference call in today’s press release and financial supplement, in our presentation slides and the appendix for this call, and various other SEC reports and other documents. These are all available on our corporate website pnc.com in the Investor Relations section of about PNC.

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

James E. Rohr

In our presentation this morning, I will talk about the operating environment first, and then Rick will review our financial results and the marks that we have taken on National City’s loans, and he’ll also give you some guidance in terms of what the new PNC looks like. And following that, I will bring you up to date on our integration activities.

As you know, 2008 was a tremendously challenging year for our industry and it was for PNC as well. Frankly, we’re relatively pleased with our full year earnings of $1.3 billion, excluding the conforming credit provision for National City and the other integration costs. Frankly, obviously we’re not pleased with the absolute performance we do participate in this environment.

In the early weeks of the year, we’ve seen escalating difficulties as the economy and the financial services sector are experiencing unprecedented volatility. Since we can’t predict when the economy will turn around, we remain focused on managing what we can, reducing risk, strengthening our balance sheet, strengthening our capital and liquidity positions and serving our customers.

Our approach to managing the recent acquisition of National City reflects those strategies. PNC is now the fifth largest U.S. bank based on deposits serving more than six million retail customers. This provides us with a significant long-term opportunity to leverage our business model and grow customers and revenue.

An important part of the PNC business model is risk management. Over the years our shareholders have been well served by our focus on maintaining a moderate risk profile. With an economy in severe recession and our recent acquisition of National City, our balance sheet doesn’t currently reflect that desired risk profile. However, we remain committed to a moderate risk profile and we are working hard to bring our risk issues back into alignment.

Reflecting that approach, we conducted a comprehensive review of the risk of National City’s balance sheet following the close of the transaction. As a result, we identified $19 billion in impaired loans that are now priced at fair value on our balance sheet with a mark of $7.4 billion or 38% of the total. In essence, that $7 billion represents an additional safeguard, compared to our peers, against future losses.

And for our remaining loans, we increased our coverage of non-performing loans to 236%. This puts us in a strong position relative to our peers as we have marked a substantial portion of our balance sheet to market. Rick will provide more detail on this in his presentation.

With a [inaudible] economy, we expect the industry’s asset quality to continue to deteriorate and we’re not immune to those effects, but in that environment our strong liquidity and capital positions are even more important. We continue to be a core-funded bank with a loan-to-deposit ratio of 91%, and we ended the year with a Tier 1 capital ratio of 9.7%, a dramatic improvement from a year ago when our Tier 1 capital ratio was 6.8%.

We were well capitalized by the regulatory definition even before we received TARP money and the TARP money only increased our capital position. Given the current market conditions, our capital, liquidity and credit reserve positions are critical differentiators allowing us to actively pursue new credit customers in this difficult time. In fact, PNC originated approximately $9 billion in loans and commitments to land in the fourth quarter.

We are continuing to make credit available to qualified borrowers. For example, we have seen increased loan demand for first mortgages. In fact, PNC Mortgage’s December volume was 82% higher than November’s levels and we continue to reaffirm and renew loans and lines of credits. We’re actively engaged in the responsible loss mitigation and we’re working with customers who are experiencing financial hardship to setup new repayment schedules and loan modifications and we’ll continue these efforts over time.

In regards with National City, we are now again in the mortgage business. Yesterday, we announced internally that Saiyid Naqvi will return to PNC as the CEO of our mortgage company. You may remember that he led PNC Mortgage from 1995 to 2001 and we’re delighted to have him back. He will help us determine our long-term strategy in the mortgage business.

While we are intensely focused on the current economic challenges and the successful integration of National City, our organizational structure is helping us through this process. Under the leadership of our regional presidents, our local sales teams are working to meet customer’s needs and they’re doing a great job. In fact, we saw a strong growth in our Legacy sales markets last year with all of them meeting or exceeding sales goals, and this year our sales markets across our combined operations are off to a good start.

As we look ahead, we see the investments we made in products, such as Virtual Wallet in our retail segment and Healthcare Advantage in our corporate and institutional banking segment paying increasing returns in our expanded operations. We launched Virtual Wallet at PNC in August of last year and generated 30,000 Virtual Wallet accounts with more than 60% of them being new to PNC and with average balances that exceeded our expectations.

Our Healthcare Advantage product had double-digit growth in revenue and transactional volume. We’re excited about expanding these across the new footprint, and global investment services is expanding its offerings as it recently launched full-service processing for exchange traded funds. All of these initiatives will provide opportunities to grow customers, generate revenue, especially as the economy begins to recover.

Despite the current economic challenges, this remains an exciting time for our new organization. Our leadership team has led town hall sessions in every one of National City’s major markets meeting with managers and employees. Their people are enthusiastic, now our people, about the combination of the two companies as they are now partnered with a company that has the balance sheet strength and the products to meet the needs of their clients.

Immediately after the closing and as part of our opening day kickoff events, we initiated a sales campaign with a goal of gathering an additional $1 billion of corporate deposit relationships throughout our combined markets and we have already reached that goal. I want to thank all of our employees for their hard work that led to our successful year end close and for their continued efforts in our integration, which are well underway.

Moving on to the next slide, our commitment to fundamentals put us in a position that successfully acquired National City at the end of last year. Slide four highlights how we’ve been executing the basics of the banking business.

Looking at growth, from the second quarter of 2007, when many believe that the credit crunch began, and through the end of 2008, we grew average total loans, deposits and non-interest bearing deposits well in excess of our peers. In fact, our transaction deposits were up $5.9 billion or 10% during the fourth quarter as PNC saw a [inaudible].

On an annualized lend quarter basis, we continue to meet the needs of our clients and we’ve outperformed our peers. We’ve been open for business throughout this period adhering to our business model and leveraging our success at building long-term relationships with our clients, and by allocating capital based upon risk adjusted returns, we’ve delivered significant value to the shareholders over time.

Looking at our pre-tax pre-provision earnings growth on a one, three and five-year basis, by adhering to our basic banking philosophies our credit costs were substantially lower relative to our peers, and our growth rates increased at a time when the strength of the balance sheet became a true differentiator. We believe our business model, which focuses on the long-term, has served us well in the past and we see our acquisition of National City as yet another opportunity to fly that model.

I'll share more color about the integration efforts after Rick provides you with additional detail about our fourth quarter and full year financial results. Rick?

Richard J. Johnson

PNC reported a net loss of $248 million or $0.70 diluted earnings per share for the fourth quarter. Excluding $300 million after tax for the conforming credit provision of $504 million for the National City portfolio and other integration costs, net income would have been $132 million or $0.32 per diluted share.

Full-year net income was $882 million or $2.46 of diluted earnings per share, and backing out the conforming credit provision and other integration costs for all our acquisitions of $422 million after tax, 2008 net income would have been $1.3 billion or $3.68 per diluted share.

Clearly, our fourth quarter adjusted earnings were below our expectations as a rapidly weakening economy resulted in increased provisions and asset impairments. However, in today's market, we believe the primary driver of value is balance sheet quality, which you will see we continued to strengthen.

Now let me turn to my key messages for today. First, during 2008 we strengthened capital, liquidity and loan loss reserve coverage. Second, we delivered solid revenue growth from diverse sources, primarily driven by net interest income, and we grew revenues faster than expenses. This resulted in significant positive operating leverage that offset a substantial portion of the increase in credit costs.

Third, we remain focused on both sides of the balance sheet on risk adjusted asset returns and gathering deposits at the right price and in the process of transforming, our $291 billion balance sheet has already begun. And fourth, we believe our acquisition of National City is a very attractive financial transaction. In fact, we now expect the long-term benefits will exceed our original expectations.

Now let me begin with slide six and a review of our strong capital and liquidity positions. As Jim pointed out, we view these strengths as key differentiators, particularly at this point in the cycle. As you know, we manage the company using economic capital, and we feel Tier 1 capital best reflects our risk positions and related capital strength. As Jim mentioned, our capital position at year end was strong and increased significantly both linked quarter and compared to our December 31, 2007 levels.

Next, let me turn to our tangible common equity ratio, which was 2.8% at year end. As a result of purchase accounting on the National City loans, we recorded a $7.4 billion life of the loan charge on $19 billion of impaired loans. This compares to the $2.6 billion of credit reserves related to these loans on National City's books.

This resulted in a substantial charge to our tangible common equity ratio for the life of the loan expected credit migration, which lowered our TCE ratio by about one percentage point. These losses are now behind us, and that's different than most of the peer group.

In addition, the current market environment has put pressure on this ratio, resulting from greater accumulated other comprehensive loss marks, both in our securities held for sale book and in our pension assets. Excluding those marks, our tangible common equity ratio would have been 4.1%.

Now, given the overall high quality of our investment securities portfolio and the relatively short expected weighted average life of 3.1 years, we are comfortable with this ratio at this time. I should also point out that as spread should widen further, the impact on our ratio will be substantially less than it would have been on Legacy PNC for two important reasons.

First, we now have substantially more common equity, and second, the National City securities portfolio was primarily agency-backed securities. As indicated by the key liquidity ratios, we remain core funded at 91% and very liquid with investment securities comprising 15% of our total assets.

On December 31st, we issued $7.6 billion of preferred stock and a common stock warrant to the U.S. Department of the Treasury through the TARP program providing substantial liquidity. And as a result of the acquisition, our overall liquidity improved as National City was in a large fund sold position. We ended the year with over $14 billion in excess cash balances held on deposit at the Federal Reserve Bank. This provides us with adequate liquidity on hand to meet all 2009 debt maturities.

Capital and liquidity strength are vital in these difficult times. In 2009, we intend to continue to enhance our capital ratio through growth and retained earnings, while supporting our customers during this period of uncertainty. And we will continue to proactively manage our liquidity position to be more than adequate for potential funding requirements.

On slide seven, you can see we created positive operating leverage on a full year basis through a 7% growth in revenue. Our revenue streams are diverse and high quality. On a full year basis, we produced 47% of our revenues from non-interest income and approximately 80% from non-interest income and our deposit franchise.

With respect to net interest income, our liability-sensitive balance sheet was well positioned for the rapid decline in short-term rates that took place during 2008 and reduced our overall cost of funds. We also saw improved credit spreads and loan growth. This combination resulted in strong net interest income growth of 31% over 2007.

While non-interest income was down for the full year, driven by valuation charges related to securities impairments, commercial mortgage loans held for sale, proprietary trading loses, and lower earnings from our BlackRock investment, our client-based fee income categories, which include fund servicing, asset management, consumer-related activities, and middle market corporate products, posted good overall results for the full year.

This reflected our success in growing and deepening relationships across the franchise. We also benefited from gains on our valuation of our LTIP obligation versus a loss in the prior year. Overall revenue growth was partially offset by a 3% increase in expenses as we invested in new products and markets, while maintaining our cost discipline.

Expense management is critical, particularly in this environment as credit costs continue to increase. At PNC, we built a culture of continuous improvement, and we plan to leverage that culture as we move forward with our integration efforts. Our past success in this area gives us a high level of confidence that we can capture the $1.2 billion of cost saves identified in the acquisition. As a result of our efforts, we created a 4% positive operating leverage or a $351 million increase in operating leverage on a full year basis, which partially offset Legacy PNC's increased credit costs.

Now let's turn to our balance sheet. Slide eight shows our consolidated starting point for 2009. As Jim mentioned earlier, while the categories and mix have changed in the light of the acquisition, our approach to balance sheet management has not changed. We remain committed to bringing our overall balance sheet back in line with our desired moderate risk profile and staying core funded with a strong liquidity position.

Our loans represent only 60% of total assets, which continues to be at the low end of our peer group. And while the risk in the loan portfolio remains, the fair value cost of $7.4 billion currently assigned to the $19 billion of impaired loans, has already been recognized through purchase accounting, and the credit reserve coverage of 2.23% of total loans is one of the highest in our peer group. So we believe the risk in this loan portfolio has been appropriately reserved, and I'll talk more about this in a second.

Turning to other balance sheet assets, our loans held for sale represented 1.5% of our balance sheet compared to 2.8% last year. While the securitization market remained essentially frozen, we did not incur any additional marks related to commercial mortgage loans held for sale in the fourth quarter.

We did have some valuation losses from our equity investments in the quarter totaling approximately $90 million, which included an additional $14 million write-down of our investment in GMAC. And we essentially closed down proprietary trading positions resulting in trading gains in the quarter of $36 million, which was driven by our customer trading activities.

Our deposits now represent 73% of total liabilities. However, our non-interest bearing deposits, as a percentage of total deposits, decreased and we now have a larger portfolio of interest bearing deposits. The change is primarily due to high rate promotional certificates of deposit that we acquired. We see opportunity in this portfolio as we realign pricing to our relationship-based strategy.

Effective January 2, 2009, all deposit pricing practices are controlled centrally on the PNC model. Our business model emphasis relationship-based checking deposits, and over the next several quarters we plan to re-price those high cost deposits as they mature.

Now turning to credit quality, slide nine shows our credit metrics. Due to the December 31st close, the net charge-offs on the first line represent PNC performance only. All other numbers include the impact of the required loan portfolio.

Clearly, we saw accelerating credit migration during the fourth quarter in line with the weakening economy, especially as it relates to residential real estate development. As a result, Legacy PNC recorded a provision of $486 million and net charge-offs of $207 million in the fourth quarter.

While we expect the challenging economy to continue, we continue to outperform our peers as our fourth quarter charge-off rate of 1.09% was substantially below our peer group. Going forward, our protection from higher credit cost has been enhanced by our reserve coverage and the fair value marks on National City’s impaired loans.

Let me remind you how purchase accounting for loans works, according to a rule known as SOP 3-3. We marked $19 billion of impaired loans to fair value resulting in a $7.4 billion reduction in principal. We will be accreting to net interest income, the difference between the future value of the expected cash flows and the present values of the present cash flows over the life of these loans. As such, they will not be classified as non-performing assets even though they are delinquent.

However, there may be future credit cost involved in the future value of expected cash flows should they decrease from current levels. While we believe the credit risk in our portfolio has been appropriately priced, our objective now is to transition this portfolio to a risk profile which meets PNC’s moderate risk profile.

Now let’s take a look at our investment securities portfolio. As we show on slide ten, our $43.5 billion of investment securities represents 15% of our balance sheet at year end. The net unrealized losses on this portfolio increased from $3.6 billion to $5.4 billion in the fourth quarter, primarily due to liquidity issues in the market. Despite those marks, the underlying assets are of overall of high quality.

First of all $23 billion are agency-backed securities. Second, 91% of the securities in the total portfolio are agency-backed or AAA rated equivalent and with the non-agency having relatively high levels of subordination. And third, the remainder of the portfolio is granule and well diversified.

In addition, the expected weighted average life of the fixed income securities was 3.1 years at year end, which we believe is one of the shortest in the industry. Clearly, we have the liquidity to be patient as the short dated assets pulled apart and we recapture much of the market valuations.

As you would expect, we did take some impairment charges during the quarter related to this portfolio. Most of the charges were related to the impact of market liquidity factors and were not necessarily representative of credit quality concerns with the underlying assets.

Now, as slide eleven indicates, we believe our acquisition of National City is very compelling. In fact, we expect it will exceed the long-term financial expectations we established at announcement. When we announced the transaction, our loan valuation assessments were made on a portfolio basis using data as of August 31, 2008, and were intentionally conservative given the limitations of due diligence and uncertainty in the markets.

While the market has not improved, our comprehensive loan analysis after the announcement combined with actions taken by National City in the third and fourth quarter resulted in lower fair value adjustments at closing, as well as a lower conforming credit provision than we had anticipated.

From September through December of last year, National City sold almost $5 billion in loans and charged off a total of $1.8 billion in the third and fourth quarters of 2008. Their provision for credit losses in the third and fourth quarters was more than $3.2 billion. Clearly, those activities effected the necessary impairments and valuation reserves that we booked at closing compared to what we said when we announced the acquisition in October.

Page eight of today’s financial supplement provides detailed information on our purchase accounting marks. While we continue to expect additional credit costs related to these portfolios, they should be substantially below historical expected levels due to the fair value marks.

However, as a result of the closing fair value adjustments and conforming credit provision, the lower share value at the close of the transaction and our increasing confidence that we will meet our cost saving targets, we now believe the acquisition will be accretive in 2009 with an estimated internal rate of return of more than 15%. With this, we are increasingly confident in the long-term opportunities of this transaction.

Our overall PNC performed well on a relative basis in 2008, given the extreme market volatility deteriorating economic and market conditions. As we focus on 2009, our economic assumptions are that the U.S. economy will remain in a severe recession with unemployment well in excess of 8%. In looking at the balance sheet, we expect consumer loan demand, including mortgage net of refinancing, to be tepid as we expect customers to remain cautious.

On the corporate side, we expect companies to continue reducing inventory levels and to build liquidity. On the other hand, continued dislocation in the capital markets may lead to a return of traditional bank financing for more of these clients. Overall, we expect earning asset growth to be soft as originations and higher utilization are offset by potential run-off from our distressed portfolio.

In light of recent actions by the Federal Reserve and our actions to re-price and transition the balance sheet, we currently expect our net interest margin to improve on a year-over-year basis. We expect our full year net interest income to benefit from the current interest rate environment and from the impact of interest accretion due to purchase accounting marks.

We expect non-interest income to reflect customer growth offset by softening consumer fees and by ongoing volatility of market-related categories. As a result, we are currently forecasting total revenue to exceed $14.5 billion. Expense management will be a key driver in 2009, as we intend to maintain our focus on continuous improvement and to achieve cost savings targets associated with our integration.

We expect full year expenses to be about $9 billion, excluding integration costs driven by cost reduction initiatives. This would result in pre-provision pre-tax operating income of roughly $5.5 billion. With a soft economy, we expect credit migration will continue throughout the year as credit quality improvements will lag any economic turnaround.

We are forecasting a full year provision of around $3 billion with the outcome largely dependent on the strength or weakness of the U.S. economy. We also expect our effective tax rate to be around 26% for 2009. This is the result of the tax beneficial items, such as tax exempt income and income tax credits causing us to be below the statutory tax rate.

It is important to recognize that all these forecasts are subject to a high level of economic and market uncertainty. In any case, with all the comments about the environment we are in, our internal forecast show that we will continue to support our customers and enhance our capital position throughout the year.

And with that, I’ll turn it back to Jim.

James E. Rohr

I would like to briefly just share our integration plans at this point, beginning with our accomplishments leading up the close and our expectations for the first quarter. Immediately following the announcement, our teams went to work completing the balance sheet reviews and securing all of the necessary regulatory and shareholder approvals.

We also announced our executive team. We identified Tom Whitford as our integration leader, his experience as Chief Risk Officer and Chief Administrative Officer have positioned him very well for this role. And he’s put together a very strong team with a wealth of banking and integration experience. This was a tremendous amount of work and it was completed in less than 70 days.

Since the closing, our pace has even gotten faster. We made organization announcements at the business, market and staff levels and launched a comprehensive communications plan with our customers and employees. Our product and our data mapping processes are nearly complete already and our system decisions are 95% complete. Clearly, this integration is on track.

Slide 14 shows objectives that we believe are key to a successful integration. We will update you quarterly on our progress against these goals. The process of transitioning to a moderate risk profile began on January 2nd throughout National City's operations. Under the leadership of Chief Risk Officer Jack Wixted we're now requiring dual signatures from both the relationship and the risk manager on all loan offerings and we have centralized the loan deposit pricing process.

This will help insure that we offering credit to consumer and commercial customers consistent with our policies. This approach is consistent with past integrations and our highly successful one PNC project, which delivered more than $400 million in value and helped to instill our culture of continuous improvement. The one PNC project was a process led by Tim Shack and Marty Laser and we have tapped them to lead our effort to reach our cost saving target of $1.2 billion and we expect to capture about 50% of the savings this year.

As part of the cost savings plan, we are looking to reduce about 5,800 positions from the combined National City and PNC workforce of approximately $60,000. Keep in mind that National City already had announced with their third quarter earnings plan to eliminate 4,000 positions over the same period. Those positions are included in the 5,800. Of that 5,800, we've already identified about 500 positions that will be eliminated through the planned branch divestitures.

I should point out that just because a position is eliminated does not mean that a person loses a job. Of the remaining 5,300 positions, we expect a substantial number to be reduced through attrition. The historical attrition rate at our combined companies is around 15%.

Regarding technology in the branch network, we’re in the process of developing a technology integration plan. The systems discovery and application selection process are nearly complete and a conversion timeline has been set. Once programming and testing are completed, we will be positioned to begin the conversion of National City branches. As part of this process, we will also eliminate redundant branch locations and overlap markets primarily in southwestern Ohio and western Pennsylvania.

As Rick mentioned, we've identified and re-priced a substantial portfolio of impaired loans and we now need to take steps to maximize the value of this portfolio, and Bill Demchak has that assignment as part of his overall asset and liability responsibilities.

Last but now least Joe Guyaux, the leader of PNC's retail business segment, and Randy King from our asset and liability management team, are looking to reduce the high cost deposits. We look forward to keeping you updated on our progress against these very specific objectives. As I've said to you in the past, we believe our investing is for the long-term and we see a tremendous growth potential for our newly expanded franchise.

Let me outline a few items. Slide 15 lists several revenue opportunities in retail and wealth management. We see checking account relationships as a cornerstone product in our retail client acquisition strategy, and we are pleased with the sizable number of accounts that we now have.

We see opportunities with these customers to cross-sell PNC's other products generating higher fee-based revenues. Online banking is a great source of customer retention and at year end PNC had 57% of its Legacy customers using online banking and 41% using online bill payment, and in our combined organization, we opportunities to leverage this technology platform as a means to deepen customer relationships.

Serving small businesses is something else that we think we do well at PNC and we see opportunities to offer a broad array of products to additional business customers. Now we have one of the largest brand distribution networks in the United States supported by an increased number of ATMs providing additional services for our customers.

PNC was already one of the top bank wealth managers in the country. A combination of PNC and National City with $110 billion in assets under management clearly strengthens that position and creates additional potential in the many high net worth markets that we now serve. These are just a few ways that we believe we can leverage the strength of our combined organization in retail banking and wealth management.

While we're in the process of evaluating the mortgage business that we acquired from National City, the third-party portion of the servicing portfolio we acquired is approximately $173 billion and we valued the servicing rights at approximately 60 basis points with appropriate hedges, which have been reviewed by our New York based treasury team and assistance from BlackRock.

We are seeing increased refinancing activity all of which is directly originated and underwritten. Mortgage company is no longer engage in the wholesale or broker origination business. We have a team in place that’s reviewing the business case and the long-term strategy for the mortgage business and we're looking at how it fits with our desired risk profile in terms of providing adequate risk adjusted returns and the overall composition of our balance sheet.

Turning to the corporate and institutional environment, National City's current sales efforts are similar to the situation we faced a few years ago at PNC. We believe our experience now in transitioning a cross-functional sales culture will help to transform this business segment to a relationship-based approach, and we see opportunities to increase fee-based income in this segment. Treasury management will be able to leverage our combined strengths and we see tremendous potential for our Healthcare Advantage product in the new markets.

In capital markets, PNC is recognized as a premier provider to middle market companies. PNC's Legacy penetration of these products is much higher than National City's, and we've developed a more robust product set that includes being a leading provider of loan syndications. Additionally, Harris Williams, one of the top M&A advisory firms servicing middle market customers, will also be a plus. Harris Williams generated revenue of more than $100 million in 2008.

Despite the market turmoil, the revenue was down less than 11% from the record levels in '07. So now we see additional opportunities to deepen relationships with existing customers and offer our products and services to new ones.

As spreads in the general corporate sector are improving, creating opportunities to offer credit to a great number of commercial clients that meet our moderate risk profile standards. As we look at our combined strengths, we see an organization that is more than the sum of its parts. We see a powerful diversified financial services institution with a strong regional banking franchise. We believe in our business model with its commitment to a moderate risk profile and growing revenue faster than expenses, we believe that served us well.

We have a proven expertise in exporting this model and effectively executing our business strategies in our prior banking acquisitions. Now the current economic recession will make 2009 a tough year, but that does not diminish our enthusiasm about this opportunity.

We remain confident that the organization of our established business model and the guidance that Rick discussed with you will continue to differentiate our results on a relative basis. Working together, we will continue to enhance capital strength and long-term shareholder value and we will continue to build a great company.

With that, we'd pleased to take your questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Matthew O’Connor – UBS.

Matthew O’Connor – UBS

Just a couple of clarification questions on the guidance. The pre-provision earnings number of $5.5 billion that wouldn’t include the roughly $400 million of after tax preferred dividends, right?

Richard J. Johnson

That would not include that. We would have to take those as a charge to net income available to preferred income and that would be about, you're right, I think somewhere around $400 million.

Matthew O’Connor – UBS

And then separately, you had mentioned there would be a boost to net income from the purchase accounting adjustments, I think from the interest rate marks that you took at closing. Roughly how much do you expect that to be in 2009?

Richard J. Johnson

Well, we haven't disclosed that, Matt. I would say that the total amount of the marks, as you saw, were about 7.4 billion on the impaired portfolio and then we had another 2.4 billion on the others. So you had a total mark of about 9.8 billion in total, and I would say that you're going to see probably at least 50% of that coming back into earnings over the next four to five years.

Matthew O’Connor – UBS

And that would be that 50% that was impairment more from a rate point of view rather than a credit point of view?

Richard J. Johnson

That's correct.

Matthew O’Connor – UBS

Just separately here again, National City was known for having very high deposit rates partly because of some of their Legacy liquidity issues and partly just the market environment out there. I got to imagine there’s a very large opportunity to bring down those deposit rates. I’m just wondering how much of that you’re factoring into your estimates?

Richard J. Johnson

Well, we haven’t factored a lot of it in at this stage. We basically assumed that CDs who’d be replaced at whatever the current market environment is, so I think we do see opportunity there. In fact, National City CD rates were about, on average, 3.9% relative to PNC’s average of about 3.2%. So I think as you can tell from that, and given the fact that we’re now controlling all that pricing centrally, I think there’s certainly some upside potential related to that, and we did not factor all that into these numbers.

James E. Rohr

National City had to continue, they were required to continue issuing CDs to maintain a strong liquidity position through the end of the year till closing. So, they continued to issue high cost, what we would think of as high cost CDs. We already reduced the pricing in our markets and we found that they were adding deposits and the customers are coming back to us. So we’re pleased about that.

Matthew O’Connor – UBS

Lastly, if I may here, I can appreciate you saying that you don’t need to raise capital as you think you’ll build capital organically this year. At the same time you’re probably one of the few banks that could raise capital at a reasonable price just from my perspective, and I’m just wondering under what circumstances would you take advantage of this relatively strong position to do so?

James E. Rohr

We think we are very well capitalized at this point in time. I think Rick’s description of how we’ve taken marks to mark the balance sheet to market makes us relatively unique in the industry, and with such large percentage of our balance sheet mark-to-market and it’s already gone through our tangible ratios, we think that our tangible ratio is more than adequate. Our ASCI number should come back.

We clearly have the liquidity to hold those assets to maturity and our 9.7% Tier 1 capital ratio, which really reflects the economic environment that we’re in and our economic capital certainly is well capitalized by any measures. So we’re pleased with where we are and our budget just shows us moving forward from here.

Richard J. Johnson

I think, Matt, per the guidance that I’ve provided, I think we also have confidence at this time, with our ability to grow earnings through this cycle. And obviously we’ll have to keep updating you on our confidence level with respect to that to that as we go through the year. But I think we’d much rather grow earnings as a basis for accruing capital than accessing the markets at this time.

Operator

You next question comes from Nancy Bush – NAB Research.

Nancy Bush – NAB Research

Rick, I’ve got an annoying accounting question for you first. If I take a $248 million loss and divide it by 350 million shares, I get $0.71. Is there a preferred dividend in there, or is this one these weird share account issues?

Richard J. Johnson

Yes. There’s a preferred dividend in there related to the issue we did during the course of the year, our Series K preferred stock. So the exact amount on that was 12 million.

Nancy Bush – NAB Research

Secondly, Jim, this is related to the capital question and I just want to get your philosophical take on dividends, maintaining the dividends. I know you can’t raise it for a while but what are your thoughts about dividends should you get into a really tough spot here and not be able to cover it.

James E. Rohr

Well, the dividend question is a good one and, as you know, the board makes those dividend decisions and I think we look at our budget today and the budget would show that, as we sit here, that we will increase our capital levels over the year through earnings and maintain the dividend at the current level. That’s our budget today. We’re in a highly volatile environment, as you know, and whether it’s a credit environment or the securities environment or the regulatory environments.

I think we’ll have to look at the earnings quarterly as you should, but that’s not a short-term decision. I mean dividend management is a long-term decision and I think we’d have to look at how the quarter works out, what our forecast looks like, what our capital ratios look like. And the good news is from the board point of view, they’ve got two more months before they have to think about that.

Nancy Bush – NAB Research

You outlined a little bit about your expectations for the combined asset management possibilities. Can you just give us some of the, sort of the structural issues there? Have they been worked out yet as far as what’s going to remain in Cleveland, what you guys are taking over, if you could just flush out the view on asset management I’d appreciate it.

James E. Rohr

All the asset management activities, National City as well as PNC, now report to Rob Reilly, who reports directly to me and we’ll be putting together, we have a funds operation in Baltimore that came with Mercantile and we have Allegiant. We’ll be combining those activities from a managerial point of view, and we’ll be combining also some of their strategies. Ours was more of a wealth management business theirs was more of a private banking business, so I think we’ll probably merge both of those concepts together for customers.

Operator

Your next question comes from Betsy Graseck – Morgan Stanley.

Betsy Graseck – Morgan Stanley

A couple of questions, one is on how you are looking at growing the loan book and dealing with the loan book of Nat City that you’ve acquired. I realize that the impairment charge was taken against loans which were already in the process of being past due, and obviously you’ve acquired a footprint that’s a little bit slower than the core footprint, Legacy footprint, of PNC. So is there anything different that you’re going to be doing in that footprint, either monitoring, managing or acquiring new loans?

James E. Rohr

We’re open for business for customers that meet our credit profile and I think that’s really not necessarily a footprint concept. A lot of the businesses in National City’s footprint, we would think in part of that footprint whether it’s Cleveland or Detroit, being highly automotive related. But, they’ve got an awful lot of activity, now we’re the second largest bank in Indiana and we’re the largest player in Kentucky, very large in Cincinnati.

We’re the triangle in the Cincinnati, Louisville, and Lexington in one of the fastest growing markets in the United States. I think, really, just looking at the appropriate credit criteria, and adding new customers as we evaluate them and making sure that we have a granular approach to additional credit.

Also, our business credit, our secured lending activity is a tremendous opportunity across the National City footprint as well. So, I think there are a number of things like educational loans with high quality credit National City, because of their highly leveraged position and lack of liquidity, really didn’t participate in that market as well as we might.

So I think there are a lots of different types of customers that we can access with excellent credit quality and actually with good spreads in today’s environment. So it’s really about segmenting the market by credit type.

Richard J. Johnson

Betsy, I’d just simply add that starting January 2nd of this year we moved to PNC’s risk process as it relates to new originations, which means that we have dual signature on all the credit extensions we make. We have pre-screen committees depending on the materiality of the lending we’re going to do. So PNC’s culture around originating new credits is what is operating today.

Betsy Graseck – Morgan Stanley

I’m just thinking, given the fact that the new footprint is a little bit of a more essential slower grower than your core footprint, should we anticipate that there would be a little bit of a lower growth rate in your new footprint than you had historically in your Legacy PNC?

James E. Rohr

I don’t think so because of their positions in places like Indiana, Chicago, and St. Louis, which are significantly different. You think of National City as a Cleveland/Michigan oriented company because of the First American acquisition they did, but then you think about southern Ohio and Kentucky and Indiana and Chicago and St. Louis very different markets than what you would think of as National City, which they really made a mistake as they went outside their footprint and did an awful lot of consumer loans, home equity broker loans and things like that make up a large portion of that impaired portfolio.

Betsy Graseck – Morgan Stanley

On the $3 billion in provision estimate for this year knowing that, obviously, there is a wide range around that based on circumstance and the economy. Could you just shed some light as to what your base case expectations are for either macro or your own portfolio that leads you to that $3 billion number?

Richard J. Johnson

We are basically expecting to continue to see negative GDP through the entire year. I think somewhere probably would be 1% to 2% throughout the entire year in terms of negative GDP. Unemployment, we are expecting that I would say no lower than 8.5% or above. So we’ve taken a pretty aggressive view, I would say, the dire view, I guess, in terms of where we think the economy’s going to be.

It’s not only in the credit book, I think that each of our business managers in those assumptions took a look at what was going to happen to equity values on some of our fee income categories, and they’ve taken a pretty conservative view as to what they thought that would do to revenue growth as we move forward as well.

Betsy Graseck – Morgan Stanley

The 1% to 2% negative GDP is for the full year?

Richard J. Johnson

Yes.

Betsy Graseck – Morgan Stanley

You mentioned that you anticipate Nat City to be accretive in ’09? Did you give a level?

Richard J. Johnson

No we didn’t and a lot of it really has to do with just exactly how these purchase accounting marks will creep back into earnings over time. A lot of it has to do with the level of Legacy PNC earnings. We’re confident it will be accretive, but putting a number on it could change tomorrow.

Operator:

Your next question comes from Jason Goldberg – Barclays Capital

Jason Goldberg – Barclays Capital

With respect to provision guidance, can you maybe talk to what level of loan losses you’re expecting equal to that or how much more provisions would be than charge-offs?

Richard J. Johnson

These are always difficult to put together, but I’m going to give you somewhere between $2 to $2.5 billion worth of charge-offs during the course of the year. So we’ll still be reserve building through the year.

Jason Goldberg – Barclays Capital

With respect to National City’s results, are you guys going to include those in your K or can you give us more detail with respect to what they’re quarter will looked like?

Richard J. Johnson

Well, the primary piece, I think, what’s important is the fact that they actually took approximately a $2 billion provision in the fourth quarter. So if that helps a little bit. Overall, of course, they lost money in the quarter of approximately, I’m just trying to get the actual amounts here, they lost about $2 billion in the quarter and I think it was about $6 billion for the year.

Jason Goldberg – Barclays Capital

With respect to GMAC stake, where does that stand at now?

Richard J. Johnson

Right know it’s at $30 million.

James E. Rohr

With regard to the guidance, Jason, it wasn’t like we wanted to be more aggressive than other banks, but we felt that from an income statement point of view, because we had no combined income statement for National City in the fourth quarter, we felt that it was only appropriate to give ranges so you could kind of have a framework around which to base your expectations.

Jason Goldberg – Barclays Capital

Jim, you kind of mentioned in your opening remarks the escalating difficulties so far in 2009. Is that beyond we read in the papers? Maybe just flush that out a little bit.

James E. Rohr

No. I think that is just consistent with what you read in the papers. Clearly, the fourth quarter saw escalating credit quality problems across the industry. It just doesn’t appear to me that I don’t know that they would accelerate or slow down. It just appears that given the rising unemployment rates, I think that the deterioration and overall credit quality for the industry will continue to deteriorate. I don’t have any specific examples.

Operator

Next question comes from Michael Mayo – Deutsche Bank Securities

Michael Mayo – Deutsche Bank Securities

Two factual questions and then some color. First, what is tangible book value per share?

Richard J. Johnson

Tangible book value per share, I think, is about $39.

Michael Mayo – Deutsche Bank Securities

That’s stated book value right?

Richard J. Johnson

We’ll get that for you. What’s your next question, Mike?

Michael Mayo – Deutsche Bank Securities

What are combined revenues with National City for the fourth quarter? However you look at it, just give us kind of a core number or just both companies combined.

Richard J. Johnson

We’ll get back to you on that too. We did really look at that to be honest with you.

Michael Mayo – Deutsche Bank Securities

I’m just trying to get a sense of where you were in the fourth quarter relative to your expectations of like $5.5 billion of revenues. Then the color is just on credit quality because you’re certainly doing better than the industry on credit. On the other hand, the third to fourth quarter trend is a pretty big acceleration and it seems like commercial loans are having more problems. So if you could just elaborate on what’s taking place in the commercial loan category?

Richard J. Johnson

This is really, again, the same story, which is the residential construction development. As well as what we are starting to see now, I think, is more migration of credit around suppliers to that industry and so, therefore, you are starting to see the impact there.

Also, if you look at overall middle market lending for the company as a whole, you’ll see some migration there simply because of the economy is having an impact on everyone. So I’d say there is really three parts to it, like I said. Residential construction is becoming more challenging, the suppliers to that industry but then the overall economy is having an impact on all of our small to middle market customers.

James E. Rohr

Also, remember that we have a relatively large business credit unit that is secured by inventory and receivables. When the market deteriorates, they have a disproportionately large affect on our non-performing loan rate category but they don’t have a disproportional affect on our charge-offs. That is an issue for us and we did see deterioration in the business credit portfolio. As a matter of fact, I believe our largest addition to the MPA list was a business credit group that’s well secured. That’s just part of that business.

Michael Mayo – Deutsche Bank Securities

Were you going to get back on the call or do you mean after the call for tangible book value and the combined revenues?

Richard J. Johnson

Tangible is about $17 per share.

Michael Mayo – Deutsche Bank Securities

And the combined revenues?

Richard J. Johnson

This is a bit misleading because what we had, as you know, PNC was $1.6 billion, National City was $400 million but that’s because you had substantial charges in there in terms of mortgage servicing rights, as well as other activities that were charged off in that quarter. I don’t see those as a decent indication of a running rate going forward.

Michael Mayo – Deutsche Bank Securities

If you were to back out, whatever you considered not core, where would you think of National City’s revenues in the fourth quarter?

Richard J. Johnson

We’ll get back to you, Mike, offline.

Operator:

Your next question comes from Albert Savastano – Fox-Pitt Kelton.

Albert Savastano – Fox-Pitt Kelton

Two housekeeping questions and a bigger question, could you tell us with CDI and the deferred tax asset is?

James E. Rohr

What’s your other question so we’ll look those up?

Albert Savastano – Fox-Pitt Kelton

The other question is on the accretion look at the guidance and with the TARP coming up with an EPS somewhere around 325ish and just that was kind of lower than where the street was, so I’m just wondering where the accretion is and how are you thinking about that as a base?

James E. Rohr

We are not giving any guidance in terms of earnings per share. The guidance that we gave was really around ranges in terms of where we thought the net interest income might come in. I think you need to think of the guidance that we gave as ranges as opposed to specific range per share numbers.

Richard J. Johnson

And to your previous question, CDI is about $600 million. It was much lower than you would have expected, given the fact the rates came down dramatically in the fourth quarter. And on the differed tax asset, that was about $2.7 billion.

Operator:

Your next question comes from Robert Hughes – Keefe, Bruyette & Woods

Robert Hughes – Keefe, Bruyette & Woods

Rick, in your projection for approximately $3 billion in provision in 2009, is there any way you can sort of parse through the differences between what you would expect to come from the Legacy PNC franchise versus what amount of provisioning might be attributable to the National City franchise going forward?

Richard J. Johnson

It's certainly going to be higher on the PNC Legacy piece because you can see we hit a new running rate at the end of the year in terms of where we're at. So I would say roughly 50/50.

Robert Hughes – Keefe, Bruyette & Woods

Back to liquidating portfolio, I know that the marks at announcement were considerable higher than what you were expecting today. A couple of questions, number one, it was my impression at the time of announcement that those were assets that you had marked very aggressively because your expectation was that you would be disposing of those?

James E. Rohr

Rick will reconcile that for you in a second, Bob, but remember when we talk about credit costs in 2009, the vast majority of the loans that were impaired were National City's and we took life of the loan impairment charges against those loans. So that's why in Rick's comment that you would expect that the credit costs might be 50/50 in the year because of the way we have advanced the credit losses into the balance sheet currently.

Richard J. Johnson

That’s particularly true on the impaired portfolio where we've taken life of the loan. So I think that's exactly right, Jim. I think the best way to answer your other question is page eight of the supplement where you see the differences portfolio by portfolio.

I'm not going to go through each one of these, but the $1.8 billion worth of charge-offs that National City took in the third and fourth quarter, were new charge-offs from our original review of the portfolio, which was as of August 31. So, about half of the gap between the two of those I would attribute to the fact that they had already charged those balances off prior to us picking up the balances at 12/31.

I'd attribute the other half basically to the point that you made before, which is we were pretty conservative in how we review this portfolio, certainly in making an acquisition decision that we were making. We wanted to be, obviously, we'd rather miss it being a little bit more conservative on the marks than miss being too aggressive.

Robert Hughes – Keefe, Bruyette & Woods

Is it accurate to say that maybe the marks today, not withstanding the actions National City has taken, would be somewhat more conservative by virtue the fact that you're not looking to divest of these assets immediately at this point?

Richard J. Johnson

Because of the fact that the assets have been marked appropriately, we don’t feel that there’s a need for a fire sale on these assets. I think we want to make sure that the return we get on that and that's why we set this up. Most of these impaired are in what we're calling our distressed portfolio, and obviously with Bill Demchak’s leadership, we're looking to get the right risk and return on that as we try to migrate out of that portfolio over time.

Robert Hughes – Keefe, Bruyette & Woods

Final question, can you give us an update on the status of the commercial real estate pipeline? I think it was my understanding you might have reduced that a little bit in the fourth quarter. Were there incremental marks taken in the quarter and did that impact the valuation of your entire CMBS holdings in the quarter?

Richard J. Johnson

No. It was relatively modest. You saw the spreads go out a little bit. So we took the little bit of minor gains on the hedges as we closed out a few of the hedges, but right now we’ve got that book marked to the loan market we had a couple of loan sales. As you know, securitizations are kind of done at the moment. So the overall inventory I think is about $1.4 billion at the moment.

Robert Hughes – Keefe, Bruyette & Woods

One final question, level three assets at year end?

Richard J. Johnson

We haven’t made that determination yet. We'll be doing that with our K filing.

Operator

Your next question comes from analyst Mike Holton – The Boston Company.

Mike Holton – The Boston Company

Two follow up questions the first is on the provision. On the PNC Legacy provisions in '09, am I assuming correctly that they won’t go down from Q4 levels to count Q4 as kind of a base given the state of the economy?

Richard J. Johnson

I think that's a pretty good estimate.

Mike Holton – The Boston Company

The second one, on the dividend question, Jim, you said your board meets in two months? So should we assume if you are earning substantially under your dividend in Q1, that the dividend question would come up this quarter?

James E. Rohr

I can't speak on behalf of the board. The board meets regularly. The board meets this week actually. I think the next dividend decision they is the first week of April. So they'll have two months of our earnings. That's two months of performance versus our budgets and two more months of earnings and two more months of performance versus our budget.

We'll have two more months of seeing how the market is. We'll have two more months of re-forecasting the rest of the year. So a lot will change, I presume, between now and then and I'm sure the board will think carefully about the dividend at that time.

Operator

Your next question comes from Ron Mandel – GIC.

Ron Mandel – GIC

I wanted to get back to the purchase accounting adjustments that you said 9.8 billion have come in over four to five years. If you make simple assumptions it’s a billion a year, and so I'm wondering if that has a ramp to it so it's more at the beginning whatever 1.5 billion for something and then ramps down to a low level at the end, or is it more cliff like or how does that work?

Richard J. Johnson

I think if I can repeat so that we're clear. Of the 9.8 that I mentioned, I said over a half of it would come back as accretable interest over time. And you're right it would be more front loaded, given the fact that you do it on the constant effective yield basis. So as loans in that portfolio mature, obviously, the interest would come down unless, of course, we're replacing that with new loans at new yields.

Ron Mandel – GIC

So could it be 1.5 billion or 2 billion in the first year.

Richard J. Johnson

We haven’t provided that yet.

Ron Mandel – GIC

But it sounds from what you said that it wouldn’t be a bad estimate.

Richard J. Johnson

I think you're pretty safe.

Ron Mandel – GIC

Then on the tax rate, you said the tax rate would be 26% it would include free income and also tax credits. So I'm wondering how much of the tax rate benefit versus the normal corporate rate would come from tax credits?

Richard J. Johnson

Well the tax credits at National City had the same amount of investments and tax credits as PNC did. So from that point of view, obviously, with earnings being a bit lower than we have traditionally seen, those tax credits are going to benefit the rate accordingly. So that's why rather than it be the statutory rate 35%, we're dropping that rate down to 26%.

Ron Mandel – GIC

So it sounds like what you're saying that as total dollars of pre-tax earnings increase the tax rate would go up just because there would be fewer tax benefits, but of course you'd still be earning more absolute dollars.

Richard J. Johnson

That's exactly right.

James E. Rohr

Operator, are there any other questions?

Operator

(Operator Instructions)

James E. Rohr

I think that’ll be it, operator.

Operator

There are no questions, sir.

James E. Rohr

Thank you very much, operator and thank you everyone for joining us.

Operator

Thank you for participating in today’s conference. You may now disconnect.

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Source: PNC Financial Services Group Inc. Q4 2008 Earnings Call Transcript
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