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Executives

William Callihan – Executive Vice President, Director Investor Relations

James Rohr – Chairman, Chief Executive Officer

Richard Johnson – Executive Vice President, Chief Financial Officer

Analysts

Michael Mayo – CLSA

William Wallace – FBR Capital Markets

John McDonald – Sanford Bernstein

Matthew O’Connor – Deutsche Bank

Edward Najarian – ISI Group

Matthew Burnell – Wells Fargo

Kenneth Usdin – Bank of America

Heather Wolf – UBS

Meredith Whitney – Meredith Whitney Advisory Group

Rick Weiss – Janney Capital Markets

PNC Financial Services Group, Inc. (PNC) Q1 2010 Earnings Call April 22, 2010 8:30 AM ET

Operator

I would like to welcome everyone to the PNC Financial Services Group first quarter earning conference call. (Operator Instructions) Mr. Callihan, you may begin your conference.

William Callihan

Good morning everyone. Welcome to today’s conference call for the PNC Financial Services Group. Participating on our call will be PNC’s Chairman and Chief Executive Officer Jim Rohr, and Rick Johnson, Executive Vice President and Chief Financial Officer.

The following statements contain forward-looking information. Actual results and future events could differ possibly materially from those we anticipate in our statement and from our historical performance due to a variety of factors. Those factors include items described in today’s conference call press release and related materials and on our most recent 10-K and various other SEC filings available on our corporate website. These statements speak only as of April 22, 2010 and PNC undertakes no obligation to update them.

We will also provide details of reconciliations to GAAP and non-GAAP financial measures we may discuss. These details may be found in today’s conference call press release and financial supplement in our presentation slides and appendix and in various SEC reports and other documents. These are all available on our corporate website pnc.com in the investor relations section.

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

James Rohr

Good morning everyone. Thank you for joining us. First of all, I’d like to just say how pleased we are with the quarter. The financials speak for themselves and I think they’re relatively straightforward, but the quarter was actually even better than that.

A year ago at this time, I said that our goals were to successfully integrate National City and achieve our cost savings goal, build out capital positions and repay TARP, transition our balance sheet to reflect a more moderate risk profile, have our credit costs normalized in line with the economy and to deliver a return on assets of greater than 1.3%.

Our first quarter performance reflects the tremendous progress we’ve made against all of these strategic objectives. We posted well-diversified revenue, reduced expenses and improved credit costs. In addition, we had several major accomplishments.

First, this quarter we redeemed our TARP preferred stock and issued common equity. Second, we announced plans to sell Global Investment Servicing at an attractive multiple, which will allow us to focus our capital more on our banking businesses.

And third, the conversion of National City is now three-quarters complete with more than 1,000 branches and more than four million National City business and consumer customers now onto PNC’s technology platform. The final branch conversion wave is slated for early June.

On our next quarterly call, I expect to tell you that we’ve successfully completed the branch conversion process almost six months ahead of our original schedule, and at the same time, we remain confident that we will exceed our annualized run rate acquisition cost savings goal of $1.5 billion, well ahead of plan.

This is truly a result of the great work of our 56,000 employees and they also produced strong first quarter earnings of $671 million or $0.66 per diluted common share, and financially, the quarter was even better than that.

The early redemption of our TARP preferred shares resulted in a $0.50 reduction in our earnings per share excluding integration costs of $0.15 per diluted common share, first quarter earnings per diluted common share would have been $1.31, an increase of 46% on a linked quarter basis, and up 18% compared to the same period last year, and that is after adjusting those quarters as well for integrations costs and the fourth quarter gain of course from the Blackrock BGI transaction. Page 16 of the press release summarizes these few adjustments.

Now our $1.31 in diluted earnings per common share this quarter reflected a final TARP dividend payment of $89 million or $0.18 per diluted common share. These results were driven by a larger distribution platform, which helped us deliver $3.8 billion in first quarter revenue. Our first quarter net interest income reflects our continued success in re-pricing our deposit while maintaining yield on our earning assets. Our balance sheet is highly liquid and well positioned to support increased demand for credit as the economy recovers.

In non-interest income improvements in the equity markets drove higher first quarter asset management fees. We also saw year over year growth in corporate fees, reflecting success with our cross selling efforts.

Consumer fees were down linked quarter primarily due to seasonally lower credit card fees, and lower brokerage fees. These trends show us that as the economy recovers, there are greater opportunities for growth in client related fee based income.

With regards to credit costs, our first quarter provision was $751 million, down 28% on a linked quarter basis. Assuming a moderate growth in the economy, it appears that our provision may have peaked in the fourth quarter of 2009.

When we turn to our business segments, they performed well for our customers. Retail banking remains focused on winning in the payment space. We saw strong relationship deposit growth as average transaction deposits were up $1.4 billion linked quarter.

Further, we grew core checking account relationships this quarter in legacy markets and we expect similar growth with legacy National City as we apply our business model to those newly converted markets.

Our business bankers are actively prospecting customers and we recently added dedicated business development officers to support growth in our newly integrated National City markets. Approval rates are up 20% from a year ago, and we’re seeing increased customer growth in merchant services, especially in our new markets.

Our asset management group had a strong quarter, driven by improvements in the equity markets and client growth. Strong revenue reflected increased assets under management and continued new business generation.

Expenses continue to be well managed and the business pipeline remains strong, and in February, AMG successfully completed its first and largest of the National City trust system conversions, and its institutional clients will be converted this weekend.

On the residential mortgage front, business posted good first quarter results largely as a result of increased loan servicing and loan sales revenue over the linked quarter. The business continued to make great progress in transitioning its operations. We piloted a new mortgage origination system in the first quarter and expect to implement it by mid-year. This system will provide an enhanced experience for customers and better data to manage our originations pipeline.

The corporate and institutional bank had a very good quarter. On the loan side, the decline in utilization levels by middle market and large corporate clients has slowed, and that’s good news. Business credit revenues exceeded the same period last year by 14% and is well positioned to post strong second quarter results.

The corporate bank also saw a 55% increase in new clients compared to the same period last year. We’re deepening our selling efforts as capital market sales were up 31% year over year. Additionally, we added more new clients names to our portfolio in the first quarter than any quarter before. While the majority came from legacy markets, we’re seeing a steady increase of clients from new markets as brand awareness begins to take hold.

Regarding our distressed asset portfolio, we continue to make progress in reducing our foreclosed assets. The portfolio is now $18 billion, down $500 million from December 31, primarily as a result of pay downs. We’re focused on maximizing the value of our distressed loans and have evidence that the marks we’ve taken on these assets overall, continue to be appropriate.

We’re also beginning to see more activity in the distressed market, which could help us reduce these assets even faster.

Turn to Blackrock, as you know, they released their earnings on Monday, and based on public comments, we expect Blackrock to report continued good progress on its integration of Barclay’s Global Investors. Overall, we achieved an excellent strategic and financial results in the first quarter.

Now, I’d like to spend a few minutes talking more in detail about our well-positioned balance sheet. Turning to Slide 4, we believe our balance sheet differentiates us. It remains highly liquid and well positioned for the current environment.

On the asset side, we continue to invest some of our available liquidity in short duration agency and government securities. Total loans were flat in the first quarter and this is as a result of bringing credit card securitizations and Market Street funding onto the balance sheet effective January 1.

However, we do see some positive signs. In a recession, loan demand typically picks up about 12 months after GDP turns positive, so our loan utilization remains soft across the country primarily in commercial and residential real estate. We saw signs of stabilization in loan balances and increased M&A activity in the first quarter, and those two items are key drivers of future loan growth.

We remain committed to responsible lending to support economic growth. We recognize the vital importance of credit to our country’s economic growth and we continue to work closely with main street businesses and consumers during these financially difficult times. We originated and renewed approximately $32 billion in loans and commitments in the first quarter.

And, we’re committed to working with homeowners to help them avoid foreclosure where appropriate. As of March 31, we completed $600 million of refinancing under the Home Affordable Re-finance program and we also set out approximately 22,000 work out packages to troubled borrowers under the Home Affordable modification program.

On the deposit side, we continued to benefit from re-pricing. Retail CD’s are expected to continue to decline throughout 2010 as higher rate CD’s run off, but at a slower pace than 2009. Transaction deposits were flat compared to the linked quarter, which we see as positive. The declines we typically see due to seasonal payments were offset by gains in our retail segment, and importantly, we’re not seeing any shifts in client behavior at this time.

We have a strong deposit franchise and we remain core funded with a loan deposit ratio of 86%. We’re well positioned for any uptick in loan demand from our customers.

On the balance sheet in general, as of March 31, we continued to be asset sensitive with an estimated duration of equity of negative 1.7 years. It positions us very well for either a rising or a steepening yield curve.

Overall, our first quarter performance was very strong, and reflects our ability to successfully execute our business model, and we have the capacity to support clients as the economy gains momentum.

Now Rick will provide you with more detail about our first quarter results beginning with our ability to deliver high quality earnings.

Richard Johnson

Good morning, everyone. Today I’m going to focus on three key messages; first, our strong performance and the key drivers in our pre-tax, pre-provision earnings; second, the stabilization of our credit quality and the adequacy of our reserve levels; and third, the improvements we have made in the quality of our capital structure.

As an aside, based on this improved capital structure and our progress to date on the National City acquisition three out of four rating agencies recently reaffirmed our ratings and two of them, raised their outlook on PNC. These positive changes were among the first for large cap banks.

In the first three months of the year, our ability to produce well-diversified revenue and effectively manage expenses continued to deliver pre-tax, pre-provision earnings that more than doubled our credit costs. As you can see on Slide 6, we delivered $3.8 billion revenue and $1.7 billion in pre-tax, pre-provision earnings compared to our provision of $751 million.

Let’s begin with the components of revenue. Net interest income of $2.4 billion was higher than we expected, primarily as a result of better loan and deposit re-pricing and better than expected payoff’s and gains on sales of impaired commercial loans.

A decrease in our cost of funds of 14 basis points and an increase in asset yields of 10 basis points resulted in a net interest margin of 4.25% in the first quarter, an increase of 19 basis points linked quarter.

The key driver on the funding side is the re-pricing of our deposit base. Our cost of deposits was 81 basis points. This is down 12 basis points linked quarter and down 63 basis points year over year. We also have approximately $19 billion of relationship base CD’s with an average rate of 2.4% that are scheduled to mature during the remainder of this year.

Assuming rates stay low, I believe we will continue to re-price these deposits and lower our funding costs even further. We expect to retain more than 80% of our relationship based CD’s in 2010, which is comparable to our year to date results.

Non-interest income for the quarter of $1.4 billion are the sources of our non-interest income remain high quality while diversified. Asset management grew more than 18% on a linked quarter basis due to improvements in the markets and client flows along with the impact of Blackrock’s earnings.

Corporate services fees were up 3% linked quarter or 12% on an annualized basis, primarily due to special servicing revenues from commercial real estate loans serviced by Midland, which is one of the largest providers of commercial real estate loan servicing in the U.S.

We expect Midland to provide us with a counter cyclical fee income source through the course of the year. As residential mortgage fees were up 37% linked quarter, mainly due to lower pay off volume and lower additions to recourse reserves. As expected, consumer service fees and service charges on deposits were down primarily due to seasonality.

While trading and private equity fees were within our expectation, fees and other were down on a linked quarter basis, primarily due to lower gains on loan sales. I would expect other non-interest income to trend in this range going forward.

Turning to credit costs, our first quarter provision was $751 million, which was down almost $300 million from the fourth quarter driven primarily by economic factors that are beginning to stabilize. As Jim said, we believe our provision may have peaked in the fourth quarter of 2009. Future provision levels will depend on the level of non-performing loans and our related coverage ratios, and as I will discuss further in a moment, we continue to do a great job managing our expenses.

Clearly our ability to deliver well-diversified revenues and manage our expenses and credit costs, continues to drive positive operating leverage and increase common capital.

Now let me take a moment to talk about our focus on expense management. As we have said before, achieving our cost savings target is an important element of this year’s plan. Our first quarter non-interest expenses were $2.1 billion, were down 2% year over year and down 4% linked quarter.

As you can see on Slide 7, we captured some $800 million in integration related cost savings in 2009 and our original goal for 2010 was $1.3 billion. We have already achieved a running rate of savings for 2010 of at least $1.4 billion, which is $600 million higher than the prior year. This is a $100 million increase to year over year savings versus our last update.

And by the end of 2010, we expect our running rate on expense savings to exceed $1.5 billion. This is $300 million higher and six months earlier than we originally planned. This reflects our commitment to continuous improvement and the ability we have as an enterprise to manage expenses effectively.

Let’s take a look at our credit quality trends on Slide 8. Overall delinquencies and non-performing loans continue to show signs of stabilization as both were essentially flat linked quarter, and as we have discussed before, our moderate risk philosophy calls for keeping our loan portfolio very granular. For example, none of our non-performing loans were greater than $32 million as of March 31.

Net charges were down 17% linked quarter and are at 1.77% of our average loans, which is one of the lowest ratios among our peers. Our provision for credit costs this quarter exceeded net charge offs by $60 million. This, along with additional allowance of $141 million related to the credit card securitizations, which were consolidated, resulting in an increase for the allowance for loan losses to $5.3 billion or 3.38% of loans.

Given net charge offs in the first quarter, we have reserve coverage of nearly two years which is one of the coverage levels in the industry. We continue to be comfortable with the marks on our impaired book as the linked quarter estimates of cash flows continue to perform better than expected.

We also continued to strengthen our capital structure in the first quarter. As shown on Slide 9, our tier one common ratio at the end of the first quarter of 2010 is estimated to be 7.6% as a result of first quarter earnings and our common issuance. Our tier one common ratio increased by 270 basis point since the first quarter of 2009 and by 160 basis points since year end.

The pro forma ration of 8.3% reflects the pending sale of Global Investment Servicing, which is expected to improve our capital by approximately $1.6 billion. We believe that transaction will be complete in third quarter.

The tier one risk based capital ratio declined to an estimated 9.9% at the end of the first quarter as a result of redeeming the TARP preferred shares. On a pro forma basis, reflecting the impending GIS sale, it should be back up at an estimated 10.6%.

We now have higher quality capital base with 77% of our tier one risk based capital in common equity. This is up from 49% a year ago. Our capital position provides us the flexibility for future growth while investing in innovative products and services. At PNC, we have a disciplined approach to capital management which we believe serves us well during these uncertain times.

Finally, let me provide some guidance around the sustainability of our performance. Our forecast reflects our assumptions regarding a moderate economic recovery and manageable regulatory reform.

First, we are feeling more confident in our ability to keep revenue performance stable year over year, given the strength of our net income interest performance and the diversification of our non-interest income revenue stream. This expectation excludes the impact of last year’s gain on the Blackrock PGI transaction and the expected gain from the sale of GIS this year.

Second, we continue to feel comfortable that credit costs this year will be below those of last year. This quarter clearly gets us off to a great start.

And third, we are already on pace to exceed our cost savings plan for 2010 by $100 million, bringing our total year over year cost savings improvement to $600 million, and we are even more confident that we will exceed our $1.5 billion goal in 2010 than our original expectation of $1.2 billion in 2011.

As a result, we continue to believe our pre-tax, pre-provision earnings, will continue to substantially exceed credit costs.

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

James Rohr

Thank you, Rick Turn to Slide 10. This slide is a scorecard that we use to measure our progress in building our company. I’m very pleased with the progress we’ve made against these objectives in the first quarter. With the conversion of National City three-quarters complete, we’re in an enhanced position to deepen the cross selling of fee based products throughout the larger franchise, we expect to increase the percentage of non-interest income to total revenue over time.

Our return on average assets for the first quarter was 1.02%. That’s a 15 basis point increase in our ROA for the year of 2009, or a 40 basis point increase after adjusting for the Blackrock PGI transaction, which makes the achievement even more impressive.

This shows the great progress we’ve made against our goal of a return on average assets of 1.3% or greater. Clearly, we remain confident in our ability to achieve these strategic financial objectives over time.

In summary, we continue to execute on our business model and we had an excellent first quarter. We’ve provided you with our full year guidance and assuming a moderate economic recovery and manageable regulatory reform, we believe we’re off to a strong start for 2010. We have a strong team and we are focused on excellent execution.

Clearly, we believe our enterprise will create tremendous opportunities for shareholder value as we continue to build a great company. And with that, we’ll be pleased to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michael Mayo – CLSA.

Michael Mayo – CLSA

Well you’re far along on the expense saves. Are you going to increase the target more? What do you have left there and how confident are you to still have positive operating leverage like you just had linked quarter?

James Rohr

We’ll update the number again probably after the conversion is completed in June, so with the second quarter release, we’ll probably have a clearer picture as to whether we can increase the number from 1.5%.

Michael Mayo – CLSA

One question that comes up relates to the accretable yield. I think there’s a lot of misunderstanding. Can you talk about the deposit retention at National City and the impact that has on accretive yield, whether that is sustainable or not.

James Rohr

Actually it is. We are retaining about 80% of our relationship based CD’s as we re-price them, and we’ve had an ability, we have about $19 billion still to re-price this year, and that’s on our books at an average contract rate of about 2.4%. Right now, we’re re-pricing them down to about 80 to 90 basis points.

If you recall, the marks on those deposits were about 1.90 or around 2% I should say, and so I’m still very comfortable we’re going to be able to bring down the overall cost of deposits for at least the next quarter or two. I think after that it’s going to start to slow down towards the end of the year.

Michael Mayo – CLSA

So what you lose in accretable yield, you should retain through the lower funding costs on retained National City deposits?

James Rohr

Yes, we will far exceed the amount of accretable yield on the deposit base to the point where we’ll probably cover most of the accretable yield that we’re getting through loans than deposits.

Michael Mayo – CLSA

Midland services, I don’t quite understand why that’s so counter cyclical. What’s fueling that?

James Rohr

We do special servicing at Midland. We have about $10 billion to $12 billion of assets there where we’re doing special servicing and when those assets work through the margins are a lot higher, and when you settle the transaction, you get a pretty sizable payoff fee on that. So that’s a good business for us.

Michael Mayo – CLSA

When you say work through you mean actually sell, or what do you mean by work through?

James Rohr

Midland was originally set up back in the early ’90’s as an RTC servicer, so they were a special servicer for troubled loans, and then became the second largest commercial mortgage servicer in the country. As special servicing diminished obviously over time, and they simply became a commercial mortgage servicer.

Now frankly, with troubled assets going up over a two-year period of time, the affect of this special servicing has gone from zero to $12 billion and it can pay very, very nice fees for working through those trouble assets for a whole myriad of customers across the country who don’t have that capability.

Operator

You're next question comes from William Wallace – FBR Capital Markets.

William Wallace – FBR Capital Markets

Thanks for the color on the deposit accretion and how you can retain as they price down. I wanted to dig in a little bit more to some of the other accretion questions. One of them is related to the margin contribution versus the guidance for I think it was mid 3.7 or so versus expansion up to 425. What surprised you in the quarter versus your guidance.

Richard Johnson

Three things happened. One is deposit re-pricing just continues to outperform. The group’s doing a great job. Work on the asset and liability group management liquidity for the company and doing the right thing for the customer, so that has actually done better.

I think if you look on Page 7 of our supplement, you’ll see that we made $75 million on pay downs and sales of impaired loans. We weren’t anticipating further amounts related to that, so that was an increase.

And also, one of the other items in the margin is, you’ll notice that our balance with the Fed is down about $4 billion as we fuse that liquidity elsewhere, and that has an upward lift in the margin as well.

Jim Rohr

If you go back to the middle of last year, our deposits with the Fed were around $10 billion to $11 billion so if you think about getting paid an eighth of one percent on that asset, it’s almost a non performing asset. So that’s been reduced dramatically and it helps the margin.

William Wallace – FBR Capital Markets

Specific to the $75 million in cash recoveries, what are your expectations moving forward and also what are your expectations on the, I guess you could think of it as sort of the normal purchase accounting accretion?

Richard Johnson

I would say in the second quarter we’re estimating that number to be about $340 million in total. That includes deposits, loans, everything, impaired loans. I think that is easily achievable through a lot of the deposit re-pricing we’ll do. So I don’t see that going away at all.

In terms of the pay offs and the sales, that’s a very difficult number to predict, and I think if you go back on Page 7, you’ll see we broke that out for the last quarter. It was about $150 million. We anticipated this quarter to be down around $25 million. It came in at $75 million, so we did a lot better.

So that’s a difficult number to put a mark on, so I’m going to stay conservative and assume that will be about $25 million a quarter going forward, but we could always outperform that.

William Wallace – FBR Capital Markets

Is it most repayments or most sales or is it a fairly even mix?

Richard Johnson

It’s a mix between the two, and obviously we’re aggressively looking for opportunities to reduce our exposure in the distressed portfolio and where we see an opportunity to do that, we’re doing it. And by the way, it’s entirely in the commercial book because where we have a loan sale on the consumer book that will go back into the pool and show up in accretable yield over time.

James Rohr

Most of it has come so far through payments, but the market has picked up a bit in terms of being able to sell loans and we’re fairly confident. We’re feeling better and better about the marks that we’ve put on our portfolio.

William Wallace – FBR Capital Markets

Do you think you’ll start to adjust the non-accretable difference down and put that into accretable yield more aggressively moving forward?

Richard Johnson

Every time I think I’m going to adjust accretable yield down, we get the valuations on the portfolio and it goes up. So we end up increasing it. I know everyone thinks it’s something we can’t repeat. I would say that it seems every quarter we say that, we turn around and price our deposits in a way that ends up covering any reduction in that amount.

Operator

You're next question comes from John McDonald – Sanford Bernstein.

John McDonald – Sanford Bernstein

One more thing on the purchase accounting just looking for the full spoon-feed here. If the schedule accretion goes down $340 million and the cash recoveries are at $25 million as you expect, does that imply that the NIM stays flattish in this 4/24 range that you had this quarter?

Richard Johnson

We’re pretty comfortable that the net interest margin is going to be flat to maybe a little bit of pressure towards the end of the year, but we’re pretty comfortable it’ll stay flat at least through the second quarter.

Again, the deposit re-pricing continuing to add benefit to the margin, but there could be pressure on this at the end of the year I think because deposit pricing has to slow down, and then maybe some little loan and security re-pricing will catch up to them. That’s going to depend on loan line.

John McDonald – Sanford Bernstein

I assume your outlook on earning asset growth is still pretty sluggish to down a little bit?

Richard Johnson

Yes, I think it’s probably maybe it goes down another quarter but we’re hoping we can get it back up into low single digits.

John McDonald – Sanford Bernstein

Did you say earlier how low are your line utilization is now? Did you quantify that at all just relative to a longer-term average?

Richard Johnson

Every business we have has a different expectation around utilization, but if I were to do an average, I’d say we probably operate it in the low 50’s traditionally. We’re down to 38% now, just to give you an idea of the movement, and obviously the opportunity when the economy recovers.

John McDonald – Sanford Bernstein

On credit, are you near the end of reserve build? If charge offs continue to come down, which seem like in your outlook, and the loans aren’t growing, is it fair to assume you’re done building and maybe towards the end of the year start releasing some reserves if the loans aren’t growing?

James Rohr

The issue for us is we’ve seen a dramatic slowdown in the flow of non-performing assets and we’re very pleased about that. Delinquencies are stable to down. Charge offs are down. So I think the statement about, I think the provision assuming a reasonable economy, the provision will peak in the fourth quarter of last year.

If those trends continue, I think the provision could continue to flow down. The other part is that we’re pretty comfortable with our marks on our impaired assets now. As time goes by, those marks are proving out to be more and more accurate so I think in terms of credit quality, I would hope that we would see continued improvement in credit quality.

Operator

You're next question comes from Matthew O’Connor – Deutsche Bank.

Matthew O’Connor – Deutsche Bank

A strategic question here, as you think out over the next one to two years, I’m just wondering where some of the opportunities are. There’s obviously a recovery underway. The capital is strong now. It builds very quickly. Just as you think about new businesses or new products or new markets, where you can deploy some of this capital, where might some of the opportunities be?

James Rohr

First of all, hopefully our customers are going to do some borrowing and to the extent that we get utilization rates to go from 38% to 50% as they did historically, that would be a wonderful thing for the balance sheet for our net interest income.

The other thing as I mentioned, we have a negative duration of equity of 1.7 years. To the extent that we get a higher or steeper yield curve, we can invest liquidity that we have with an 86% loan to deposit ratio into higher yielding assets in it because we’re so short, we could simply roll them into higher assets. And that’s a terrific opportunity as well. So I think those two items just from a balance sheet point of view are very powerful.

If you take the franchises that we’ve purchased through National City, there’s a number of products that we get through conversion that we can cross sell to National City customers. It’s just started to take off with treasury management capital markets, university banking, work place banking, and as the conversions have taken place, and a we mentioned, they’ll be over at the end of the second quarter, I think there’s tremendous opportunity for customer growth.

So I think the franchise we have, there’s just a lot of opportunity within the franchises we have.

Matthew O’Connor – Deutsche Bank

I guess with the National City deal going better than expected, and it sounds like the conversions and cost savings will be realized sooner, do you have an appetite for additional deals whether it’s to pick up some products or to pick up new markets or fill in existing markets?

James Rohr

I think banks are sold not bought and I think what we’ve learned over time is it’s all about price and fit and timing and we just have to – as we go down the road we just have to look at what might become available. But right now, we’re focused on executing the opportunities we have before us.

Operator

You're next question comes from Edward Najarian – ISI Group.

Edward Najarian – ISI Group

First question is kind of nuance. It has to do with looking at your early stage delinquencies and pretty good stability. In fact a lot of categories improved, but we did see a pretty good size pickup in commercial real estate early stage delinquencies. Any concern there or what are your thoughts in terms of that increase over the last three months?

James Rohr

Not particularly concerned about it. As you know, commercial real estate assets are smaller for us than our peers at only 8% of our total assets, so that’s a good thing. Secondly, I think the commercial real estate portfolio as an industry will be a problem for the next two or three years. But for us, it will be smaller.

In this case, it’s not a big number. And I think you’ll see volatility in those numbers going up and down. I think the markets appear to be re-opening. There might be an opportunity to do a little more re-finance than might have been the case certainly even six months ago.

So I think you’ll see volatility in those delinquency numbers, but I don’t think it will have a dramatic impact in our ability to perform.

Edward Najarian – ISI Group

As those migrate through and potentially become 90 days, you start to reserve for them after 90 days delinquent, is that correct?

James Rohr

We might reserve for them before they’re 90 days delinquent. It depends upon – the interesting thing about commercial real estate is that each property is its own animal and you don’t know who the guarantors are. You don’t know when leasing takes place, re-leasing takes place. So additional capital is added.

All of those things come into play with each commercial real estate property as you know, so sorry to really generalize about how and when you reserve because sometimes you may reserve just based upon the appraisal even before it goes delinquent because you’re so concerned. So each one is rate independently on a continuous basis.

Edward Najarian – ISI Group

Once the Global Servicing business gets sold in the third quarter obviously you’ll have a very strong tier one common ratio. Any thoughts that subsequent to that time frame you may be able to start returning capital to shareholders either via dividend increase or buy backs or what have you. So I guess the question would be what are your thoughts as a management team regarding that once you get to that high tier common ratio, and have you had any discussions or even hints from your regulators if that would something you would be able to do towards the end of this year?

James Rohr

First of all, we haven’t had any discussions with the regulators about that. Our commitment to the regulators included the capital increase through the sale of GIS, which takes place in the third quarter, so I think we need to continue executing on that.

The other thing is, we still have almost a 10% unemployment rate in the country and we’ve got some regulatory changes in the wind clearly. So both of those things I think we’re going to have to take a good look at. Our Board will have to take a good look at before they would consider a dividend increase.

And I think frankly, what we need to do is we need to show consistent increase, consistent ability to generate significant capital, and I think with the TARP charges in the first quarter, that capital build wasn’t as strong as perhaps the earnings in the quarter, so we’ll get that behind us. If we are able to continue to deliver a couple more quarters of solid capital generation, we complete the GIS, we get some sense of what the regulatory environment is about, the economy continues to improve, I think those are the kinds of things we’d like to check off before we start talking about how we might return capital to the shareholders.

But as you know, we would love to return capital to the shareholders as we have in the past. I just think there’s some variables right now that we’d like to check off.

Operator

You're next question comes from Matthew Burnell – Wells Fargo.

Matthew Burnell – Wells Fargo

In terms of loan sales, there were a couple of comments during your prepared remarks that the markets for loan sales appears to be opening up a little bit. Can you give a little more detail as to what products or what geographies are benefiting from that?

James Rohr

It all depends on price. Clearly certain markets, and strangely enough the markets in the middle of the country where real estate appears to have stabilized have had the opportunity to generate loan sales. There’s a number of people out there who are asset hungry, so we’re starting to see bids on that.

We’re moving forward with real estate. I think we moved almost 1,000 properties, around 900 properties in the first quarter, 871 to be exact, and those come from all across the country. We’re getting bids in every market. The good news is, we’ve marked our assets, which appear to be appropriate, so we’re able to move these assets as the markets kind of open up.

So I think it’s a national event. A year ago, you couldn’t get, other than gold bullion, you couldn’t get a bid, but now there’s a lot of bidders for properties all across the country.

Richard Johnson

We’re feeling pretty good about right now in the property sales is we’re actually getting book value in terms of the appraised value, so we’re not losing any further money on those marks.

Matthew Burnell – Wells Fargo

In terms mortgage purchase reserve costs, you mentioned that as a part of the mortgage business. Can you give us an update on the trends in those repurchase reserves or the losses that you’re taking on those?

Richard Johnson

If you recall at the end of the year we booked about $50 million in the mortgage company. We added another $25 million to that this quarter and we were pretty comfortable that we had the reserve right. We saw a little more activity there, so we topped up the reserve.

All in all, all of the losses related to this is coming from the underwritings we had in 2007, obviously prior to changing all the underwriting practices in 2008. We’re seeing about 1.2% net put back of loans to the company with the loss in the range of about 45 to 50 basis points. So total expected loss is about 75 bits on that activity, and we’re fully reserved for that today.

James Rohr

The good news is that National City stopped buying broker loans in early 2008, which was a real plus.

Matthew Burnell – Wells Fargo

In terms of net interest margin going into 2011, assuming rates rise and you get some loan growth in 2011, can you maintain the margin at that current levels or relatively near current levels or might we actually see some benefit given the re-pricing environment for loans?

James Rohr

There’s a lot of assumptions in there. As long as demand comes back and rates rise, we could see a nice lift in net interest income next year.

Operator

You're next question comes from Kenneth Usdin – Bank of America.

Kenneth Usdin – Bank of America

With regard to your continuing to be comfortable with the valuation marks on Nat City, can you break down the portfolio and give us some color on either side or better or worse than expectations, because on average that it’s okay?

Richard Johnson

Our commercial book has been doing very, very well. We’ve added some additional reserves but you’ve seen the amount of money we’ve made on pay offs and sales of loans and so on. So we’re very comfortable there.

On the consumer side, it’s primarily mortgages where we’ve seen some stress, added additional reserves on that side of the book. Most of the other portfolios are continuing to perform well and you’re seeing that because we keep up in the yield.

If you look at Page 7, one of the things I keep trying to point out is the fact that while we’ve added $600 million of reserves on all these impaired loans, additional allowance since the marks, we’ve also added almost $2 billion to the accretable yield going forward.

So you look at cost of credit and then you recognize the cost of NII over time. So all in all, these books are performing better than we anticipated.

Kenneth Usdin – Bank of America

On the home equity portfolio, it continued to see very stable trends in terms of delinquencies and a little improvement. I’m just wondering your views from the broader picture of home equity, potential reform impact on first and second so to speak if we do get changes to the rules.

James Rohr

Two things about that. One is that a lot of our home equity book is in our footprint and our footprint didn’t see the dramatic increase in price, real estate prices that were shared in the California, Arizona, Florida.

But the other part is speculating on how regulatory reform might come out is pretty hard to do these days. I mean, I have no feel for what might come out of the regulatory reform around mortgages. I think we just have to look at our customers and they simply continue to pay which is what they’re supposed to do.

Operator

You're next question comes from Heather Wolf – UBS.

Heather Wolf – UBS

Did the consolidation of off balance sheet vehicles impact your margin at all

Richard Johnson

Not really. We picked up some benefit from the consolidation of the credit card fees, but when we consolidated Market Street, we gave it right back, so it was a net nothing in effect. And that impact on our balance sheet was only about $4 million, so it’s not big enough to have an impact.

Heather Wolf – UBS

I know you had some footnotes on your non-accruing TDR’s. Can you give us some color on the dollar value of your accruing TDR’s this quarter versus last quarter?

Richard Johnson

That’s actually about $217 million. I think you’ll see that in the note right after the one you looked at, so note C on that page lays out for you the accruing TDR’s.

Heather Wolf – UBS

So the $217 moved from non accruing to accruing. Those are the only TDR’s you have?

Richard Johnson

That’ correct.

Operator

You're next question comes from Meredith Whitney – Meredith Whitney Advisory Group.

Meredith Whitney – Meredith Whitney Advisory Group

You moved a bunch of loans into foreclosure. Can you talk, that would be suggested the foreclosure environment accelerating or is this just long overdue and can you give some color on what you’re experience is in the foreclosure market are states facilitating greater pace on foreclosures.

Richard Johnson

The main effect in the first quarter, the pace of what’s moving into foreclosure is not accelerating at the moment, but what happened was we didn’t have – there wasn’t a lot of sale activity in January and February given the winter months, and so that’s why you’re seeing a little bit on an uptick in the balance.

But the sales we had in the month of March were over 600 units, so we had a very strong March, and we think that’s the level at which we’ll continue to sell going forward.

Meredith Whitney – Meredith Whitney Advisory Group

On the commercial real estate market, you’ve given a great picture in the past about your outlook on that. What I’m hearing in the industry is you’re really got a bifurcated market. The A properties are doing well. They’ve been very resilient, but the B properties are still lagging. Is that what you’re seeing and then from a pricing movement, is there bifurcation between both markets and what do you see on the lower end and how is your portfolio exposed?

James Rohr

A, B, and C is exactly the way we think about it as well. The A properties are doing well and probably are doing better than anybody might mark them, so actually we’re not in the business of selling those even though we might have taken a mark on them when we took them in. Those properties tend to come back with the economy, and that’s the right thing to do.

The C properties, you just sell. C property rarely come back so you take very strong marks on those right up front and you just sell them because they always have trouble recovering at all. So we’ve been actively doing that and we’re comfortable with our marks.

The B properties, obviously the majority of the portfolio, but those are the ones you mark down and you have to manage one by one. One of the advantages we have is that Midland was originally commercial mortgages across the county to securitize. So we have staff in markets all around the country and when we marked the National City portfolio, it gave us a great advantage because we had people, experienced people actually going in and testing the markets and actually giving us real numbers, in some cases actually bidding on properties to find out what somebody might accept.

So that’s a plus, and I think the commercial real estate business over time, if a property loses a tenant, clearly that property has less value as you know. But then they go resign somebody else at a lower lease rate, so the property is worth less, but it’s not like it falls off the planet. There is some cash flow. So I think those B properties, I think will work their way through for the most part.

The big issue two or three from now is liquidity. There’s a lot of those commercial mortgages, they’re typically seven years minimum that are coming due and if you look back a year ago, there was no ability, I mean the scary part was there was no re-financing opportunity. In today’s environment there is some re-finance opportunity and because the capital markets are just barely coming back.

But on the other hand, assets and we’re looking at Midland, I mean Midland with their commercial servicing capability, they know the cash flows asset by asset and they know the maturity date. So nobody wants to re-finance too quickly because the price of the credit is going to go up pretty significant.

But I think we’ll be aggressive in pursuing commercial real estate, high quality real estate loans as they come due in the next one to three years.

Meredith Whitney – Meredith Whitney Advisory Group

I remember a year ago having conversations with private equity firms looking to buy distressed assets from banks. Maybe it’s over a year, and a year later, the activity is coming. Now you’re starting to see Bank of America had an announcement this morning, you’re starting to see more activity actually transact. What was the delay? So they were hanging around the rim. Are their prices coming up or did they not have their act together until now.

James Rohr

I can’t speak for the private equity, but when you’re buying distressed assets, the best time to buy them is when you see the market turn. There’s no sense trying to catch the falling knife because the sellers are going to be sellers even after the turn. So to the extent that you can come in at the bottom or just after the turn, is a lot safer and better investment to make than it is while the prices are still falling.

I think if you look at what’s happening in a lot of markets, clearly the prices are stabilized, and that’s the time that you would see distressed buyers come in. it’s the same thing that happened in the early 90’s.

Richard Johnson

To your point about our overall exposure, we’re about 8% commercial real estate asset to total assets, and about 3.5% allowance on that. When you had the mark we have on the impaired side, it goes over 6% so we’ve got some good coverage on our own risk.

Meredith Whitney – Meredith Whitney Advisory Group

Just the exposure in terms of the bip bucket, and Jim explained that pretty well, the commercial exposure, where were you exposed?

James Rohr

One of the questions asked I think last quarter was the decline, how might the distressed portfolio work out if you extrapolate it over time. But what really happened in the early 90’s was it went down for awhile and then it really plummeted. Distressed buyers came in and bought in bulk.

Meredith Whitney – Meredith Whitney Advisory Group

Do you think actually when the buyers come in, prices go down further?

James Rohr

I think prices will rise. The balances go down because they buy in bulk.

Operator

You're next question comes from Rick Weiss – Janney Capital Markets.

Rick Weiss – Janney Capital Markets

Just to clarify, it sounds very good for credit, but I’m still wondering why the non performing assets actually went up a little bit this quarter. Were they up higher midway through the quarter and are starting to come down now?

Richard Johnson

That was driven primarily by the OREO asset going up $150 million, and that was just because we didn’t have sales in January and February. The much lower sale volume in January and February so the balance ticked up $150 million.

The answer on non performing loans, were pretty flat. I think they were up 60 or something like that. It wasn’t much at all.

Rick Weiss – Janney Capital Markets

Overall all though, you would expect that number to start declining. I guess that’s what I’m hearing on this call anyway.

James Rohr

If you look at the trends of flow of non performing assets going back to the first and second quarter of last year, the flow has dropped precipitously and so if that trend continues, I think we would expect that.

Rick Weiss – Janney Capital Markets

So it’s stable now. I think we’re all happy that’s stable. I think that’s good, but the decline is not yet occurring.

Richard Johnson

That’s correct.

Rick Weiss – Janney Capital Markets

I wonder if you could help us out with the taxes, what kind of tax rate we could use going forward. And also, do you see any benefit on tax carried forward as a result of the Nat City acquisition?

Richard Johnson

The tax rate you can anticipate going forward is about 27%. That’s what I would expect. The only reason the fourth quarter last year was higher was because we had the gain on the PGI deal, so that drove the rate up a bit.

We didn’t have any carry forward. We did do some carry back on Nat City and we did get benefit from that and got the cash flow related to that, only the two year period. We didn’t do the five year because we were under TARP, but we got some of that, but not a big carry forward benefit.

James Rohr

I think it was a very fine quarter for us. We not only did well financially, but also strategically and accomplished a lot of the goals that we had set out to shareholders a year ago and our plan is just to continue to execute and I think there is a lot of shareholder value we can create.

Thank you very much everyone for joining us this morning.

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Source: PNC Financial Services Group, Inc. Q1 2010 Earnings Call Transcript
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