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The PNC Financial Services Group, Inc. (NYSE:PNC)

Q2 2014 Earnings Conference Call

July 17, 2014 10:00 AM ET

Executives

Bill Callihan - Director of Investor Relations

Bill Demchak - Chairman, President and CEO

Rob Reilly - Executive Vice President and CFO

Analysts

John McDonald - Sanford Bernstein

Erika Najarian - Bank of America

Bill Carcache - Nomura Securities

Matt O’Connor - Deutsche Bank

Keith Murray - ISI

Eric Wasserstrom - SunTrust Robinson Humphrey

Ken Usdin - Jefferies

Paul Miller - FBR

Gerard Cassidy - RBC

Moshe Orenbuch - Crédit Suisse

Betsy Graseck - Morgan Stanley

Mike Mayo - CLSA

Matt Burnell - Wells Fargo Securities

Terry McEvoy - Stern Agee

Operator

Good morning. My name is Christie and I will be your conference operator today. At this time, I would like to welcome everyone to The PNC Financial Services Group Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded.

I will now like to turn the call over to Director of Investor Relations, Mr. Bill Callihan. Sir, please go ahead.

Bill Callihan

Thank you and good morning. Welcome to today's conference call for the PNC Financial Services Group. Participating on this call is PNC's Chairman, President and Chief Executive Officer, Bill Demchak and Rob Reilly, Executive Vice President and Chief Financial Officer.

Today's presentation contains forward-looking information. Our forward-looking statements regarding PNC's performance assume a continuation of the current economic conditions and do not take into account the impact of potential legal and regulatory contingencies. Actual results and future events could differ, possibly materially, from those anticipated in our statements and from other historical performance due to a variety of risk and other factors.

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

These are all available on our corporate website, pnc.com, under the Investor Relations section. These statements speak only as of July 16, 2014, and PNC undertakes no obligation to update them.

And now, I’d like to turn the call over to Bill Demchak.

Bill Demchak

Thanks Bill and good morning everybody. As you have seen this morning, we reported net income of $1.1 billion or $1.85 per diluted common share for the quarter with the return on average assets of 1.31%. For the first half of the year we are largely trending in line with our planning assumptions you have seen that we have grown loans by more than 5 billion and we are growing our fee businesses as planned. Credit quality continues to improve and we are managing expenses well in spite of a modest increase this quarter due in large part to seasonality. At the same time interest rates remain low and we are seeing the market moving beyond what our risk return appetite will tolerate in some asset categories and it’s been particularly true in certain parts of consumer and small business lending and on the pricing side in the corporate bank. Still in the Southeast loan and client growth basically across all lines of business continue to exceed our expectations.

In retail we are on target to have completed more than 150 universal branch conversions by the end of this year and more than 300 by the end of the first quarter next year. For mortgage we focused on growing our percentage of new purchase originations as refinance activity declines for the industry and we are pleased that the new purchases were 50% of our originations in the second quarter. Having said that lower volumes and continued elevated cost structures related to foreclosure activity will continue to make this a difficult business in the near-term.

Finally we continue to see strong growth in fees out of our asset management group with total non-interest income in this business up 11% year-to-date versus the first half of 2013. So on the whole we are trending as we expected through the first half. Still, we are in the same boat as all of our competitors recognizing the continuing credit quality improvement and lower provision have basically enabled us to mitigate the impact of low rates, but these conditions aren't going to last forever.

The great unknown as we look towards the end of the this year and into 2015 is when credit quality will begin to normalize and whether rates will rise in time to offset the higher credit costs that will naturally be the result when this occurs. Nobody knows how this rates will play out, but we are mindful of it as we focused on delivering a differentiated customer experience in creating long-term shareholder value.

To that end, we continue to strengthen our Basel III capital position in the quarter and in keeping with our previously stated intention to return more capital to shareholders we increased our quarterly common stock dividend by 9% to $0.48 per share for the second quarter of 2014. We also repurchased 2.6 common shares.

And with that I'll turn it over to Rob for a closer look at our second quarter results. Thanks.

Rob Reilly

Thanks Bill and good morning everyone. Overall we had a solid second quarter that continued many of the trends we saw in the first quarter. Importantly our second quarter results were in line with the guidance we provided during our last earnings call and demonstrate a consistency of performance that supports our growth strategies.

The sustained low interest rate environment continues to affect our net interest income. However we saw a strong fee income growth this quarter that more than offset the net interest income declines, resulting in revenue growth on a linked quarter basis.

Expenses remained well controlled and credit quality was favorable. Our capital ratios increased even after returning $479 million in share buybacks and dividends to our shareholders in the second quarter compared to $234 million in the same period a year ago.

Now let me start with our balance sheet on slide four. As you can see total assets on our balance sheet increased by $3.6 billion or 1% on a linked-quarter basis and included net loan growth of $2.7 billion or 1.4%.

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

Compared to the same quarter a year ago, overall loan growth was $11.2 billion or 6%. Investment securities decreased by $2 billion or 3.5% in the second quarter as net payments and maturities exceeded our reinvestment activity, reflecting the current low interest rate environment. And lastly, our balances with the Federal Reserve increased to $16.5 billion in anticipation of proposed rules on liquidity coverage standards.

On the liability side, total deposits increased by $172 million when compared to March 31st driven mostly by increases on the consumer side. We saw growth in demand, money market and savings deposits partially offset by lower retail CDs.

Shareholders’ equity increased by $884 million in the second quarter, primarily due to growth in retained earnings. This helped to drive our capital ratios higher. Our pro forma Basel III common equity Tier 1 ratio fully phased-in and using the standardized approach was estimated to be 10% as of June 30, a 30 basis-point increase from the end of the first quarter.

As you know, from a regulatory capital perspective, we’re subject to the transitional Basel III rules; our transitional B3 common equity Tier 1 ratio was estimated to be 11% as of June 30th, an increase of 20 basis points from March 31st.

As I mentioned, our balance sheet reflects our efforts to comply with the proposed liquidity coverage ratio and support continued loan growth. For example, our interest-earnings deposits with banks, which are primarily with the Federal Reserve, increased by $2 billion from March 31, and by more than $13 billion compared to the same time a year ago.

We increased total borrowings by $2.3 billion or 5% linked-quarter, a substantial portion of this supported our enhanced liquidity position as well as loan growth. As you know, the LCR rules are still in proposed form, however we believe we are well positioned in relation to the proposed targets.

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

Under our existing common stock repurchase authorization we repurchased approximately 2.6 million common shares for approximately $225 million during the second quarter against our capital plan of $1.5 billion. We remain committed to shareholder capital return and expect to continue our buyback program with the flexibility to increase repurchases over our second quarter levels through the first quarter of 2015.

Turning to our income statement on slide five, net income was $1.1 billion or $1.85 per diluted common share and our return on average assets was 1.31%. Our second quarter performance for net interest income and expenses were as expected, while exceeding expectations on fee income and provision. As a result, total revenue increased by $33 million or 1% linked-quarter.

Let me highlight a few items in our income statement. Net interest income declined by $66 million or 3% compared to the first quarter. Of that $31 million was due to the impact of an accounting change to reclassify certain commercial facility fees from net interest income to corporate service fees. Importantly, this change is revenue neutral.

The remaining NII decline of $35 million was primarily attributable to lower purchase accounting accretion and lower loan yields and security balances. Non-interest income increased by $99 million or 6% linked-quarter, primarily due to fee income growth in corporate which includes the reclassification as well as increases in consumer fees and residential mortgage revenue. Non-interest expense increased by $64 million or 3% in the second quarter following seasonally lower cost in the first quarter. Overall, expenses continue to be well managed.

Finally provision in the second quarter declined to $72 million due to continued overall positive credit trends. Now let’s discuss the key drivers of this performance in more detail.

Turning to net interest income on slide six, total net interest income decreased by $66 million or 3% for the reasons I just highlighted. As you can see, purchase accounting accretion declined on a linked-quarter basis consistent with our expectations. Regarding our core NII excluding the $31 million impact of the accounting change, the net impact was a decline of $19 million which is primarily related to lower security balances, spread compression and liquidity related actions.

Net interest margin declined 14 basis points linked-quarter; of that amount approximately 5 basis points was due to the commercial fee reclassification. Of the remaining 9 basis-point decline in NIM, 3 basis points was attributable to purchase accounting accretion and additional 3 basis points was due to liquidity related actions and the remaining 3 basis points was primarily due to spread compression.

In terms of our interest rate sensitivity, our balance sheet remains asset sensitive as we have maintained a duration of equity of approximately negative 2.5 years. Although we recognize this may constrain our NII growth, we will continue to remain disciplined with the focus on achieving appropriate long-term risk adjusted returns.

Turning to non-interest income, we saw a strong fee income growth this quarter, reflecting progress we continue to make against our strategic priorities. Total non-interest income increased by $99 million or 6% linked-quarter. Now in fairness, $31 million was related to the commercial fee reclassification. However the remaining growth reflected momentum across our diversified businesses.

As Bill mentioned our asset management group had another good quarter with growth driven by increases in the equity markets and sales production. As you know the asset management fee category reflects the combination of fees generated by our asset management business along with the earnings attributable to our interest in BlackRock.

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

Consumer services fees and deposit service charges were higher in both the linked-quarter and year-over-year comparisons. Compared to the first quarter these fees increased by $42 million or 10% as we saw strong growth in credit and debit card, merchant services and brokerage fees due to broadly higher customer activity.

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

Corporate services fees were up $42 million or 14% linked-quarter, as I mentioned $31 million of that was attributable to the reclassification. However excluding that, fees increased $11 million or 4% linked-quarter primarily due to higher treasury management fees. Compared to the second quarter of last year and again setting aside the rate class corporate services fees were down by $14 million or 4% primarily driven by lower net CMSR valuations.

Residential mortgage banking, non-interest income increased $21 million or 13% primarily driven by higher loan sales revenue. A couple of items to point out here in regard to our mortgage revenue. First, we recorded a production income increase of approximately $11 million reflecting higher quarter over quarter originations. Second we had elevated loan sales and fair value mark increases on portfolio loans totaling $61 million in the second quarter compared to $24 million in the first quarter or a $37 million linked-quarter increase. And third partially offsetting these items was a net $21 million reduction of repurchase reserve assets compared to the linked quarter.

Origination volume increased to $2.6 billion in the second quarter up from $1.9 billion in the first quarter but down from $4.7 billion in the same quarter a year ago. Importantly, purchase originations production of $1.3 billion in the second quarter essentially equaled to same quarter a year ago reflecting our strategic focus in this area and purchase originations represented 50% of our total originations.

The gain on sale margin was 538 basis points in the second quarter. Our margins benefited from the gains associated with the loan sales and fair value marks that I just mentioned. We continue to expect our margin to trend closer to the 300 basis points through the remainder of 2014.

Other non-interest income increased $19 million or 8% primarily due to higher revenue related to asset sales and higher credit valuations from customer related derivative activities. Non-interest income was also impacted by lower pre-tax gain of $54 million on the sale of $1 million Visa Class B common shares that compared with the $62 million gain on Visa shares that took place in the first quarter.

Non-interest income to total revenue was 44% in the second quarter up 2 percentage points from first quarter levels and it held steady from the same quarter a year ago when we experienced higher gains on asset sales and valuations. This reflects the progress we’re making against our strategic initiatives to increase overall fee income on both an absolute and relative basis.

Turning to expenses on slide eight; second quarter levels increased by $64 million to 3% consistent with our guidance due to seasonal factors such as higher compensation and marketing costs during the period. On a year-over-year basis expenses are down $77 million or 3% reflecting strong benefits from our continuous improvement program and overall expense management.

As we have previously stated, our CIP program has a goal to achieve $500 million in annualized cost savings in 2014. We're half way through the year and we've already completed actions relating to capturing more than two-thirds of our goal. And as a result, we're confident we will achieve our full year CIP target. With these savings to-date, along with further planned activities, we intend to fund the significant investments we're making in our infrastructure and in our retail transformation.

As you can see on slide nine, overall credit quality continued to improve in the second quarter. Nonperforming loans were down $146 million or 5% compared to the first quarter as we saw broad improvements across our commercial and consumer portfolios. Total past due loans decreased by $128 million or 6% linked-quarter. Net charge-offs declined by $41 million or 22% linked-quarter and were 29 basis points of average loans on an annualized basis down 9 basis points linked-quarter.

Our provision of $72 million declined by $22 million or 23% on a linked-quarter basis. Finally, the allowance for loan and lease losses to total loans is 1.72% as of June 30th. While we were pleased with this performance and as we've acknowledged for some time, we continue to believe credit trends may not remain at these levels.

In summary, PNC posted a successful second quarter largely consistent with our expectations. Going forward assuming a continuation of a current economic environment, we continue to expect that full year revenue will be under pressure and as a result could likely be down year-over-year due to the further purchase accounting accretion declines and lower residential mortgage revenues.

Regarding purchase accounting, we continue to expect it will be down approximately $300 million for full year 2014 compared to 2013 and for 2015 we expect purchase accounting accretion to be down approximately $225 million for the full year compared to 2014. In this environment we will remain focused on disciplined expense management and we continue to expect full year expenses to be down when compared to 2013.

Looking ahead to the third quarter we expect modest growth in loans primarily in our commercial portfolio, we expect net interest income to be down modestly due to the continued decline in purchase accounting accretion and further spread compression. We expect fee income to remain stable as we expect growth in our other fee based businesses to offset the benefit of the elevated second quarter gains in residential mortgage.

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

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

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

Bill Callihan

Operator could you give our participants the instructions please?

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions). Our first question comes from the line of John McDonald with Sanford Bernstein. Please go ahead with your question.

John McDonald - Sanford Bernstein

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

Bill Demchak

I guess some generic thoughts and I got asked this I guess in the first quarter and I think my answer wasn't going to be purposely vague. We obviously -- our program has been active and as Rob stated in his comments, we're going to continue that. We look at relative price performance, outright price performance other opportunities to deploy capital. We're in a position where we're generating more capital than we're using. So, our first, second and third alternatives are kind of capital return to shareholders through dividend and repurchase. Having said that, we are sensitive to price and value certainly the extremes. I don't think we're there now, but that's something that we'll look at through time.

John McDonald - Sanford Bernstein

Okay. And Rob mentioned the flexibility to increase buybacks above the second quarter level, just as we contextualize since you’re just starting, what you did this quarter; did you get a late start this quarter, because of when you did the Board approval or is that part of why you had that comment?

Bill Demchak

No, it's simply, mathematically we had a $1.5 billion we could do, we did less than the quarter of that in the first quarter. Various reasons as to why we did less, not worth worrying about. So again just mathematically, we have the capacity within our non-objected capital plans to do more, that's all that comment that was related.

Rob Reilly

Yes. And John, as you know, this is Rob, as you know we can carry over that excess capacity going forward.

John McDonald - Sanford Bernstein

Got it. Okay, that's helpful. And then on loan growth, Bill anymore color on degree of follow through on kind of the green shoots of better line utilization that you started to see at the end of last quarter or did that follow through to the same extent you’d hoped it would or can you just give some color on that?

Bill Demchak

We didn’t see that -- I mean short answer is utilizations are up quarter-to-quarter largely across all lines. So we didn't -- it did hold and it went up a bit more, it didn't grow to the same extent as we saw, just at the end of the first quarter. But I think, what you see in our book is pretty consistent with some of the comments I've seen on other calls where utilization generally is up, still below historical potential. So it's not as if the economy, people are using their lines to the extent they did back in 2004 or 2005 but it's higher than it was and continues to trend up.

John McDonald - Sanford Bernstein

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

Rob Reilly

As far as we know right now relative to our third quarter guidance in terms of modest increases, consistent with what we've been experiencing.

John McDonald - Sanford Bernstein

Okay. And then just a quick one Rob, on the fee income outlook for that stable next quarter. Are you embedding some expectation that you'll continue to harvest the Visa gains when you say fee income stable?

Rob Reilly

No. Any Visa sales are not part of that for that guidance. What I'm saying there is that we did have some elevated gains there in the mortgage business. So the expected growth that we see in the other fee business is we look to offset that.

John McDonald - Sanford Bernstein

Okay. Got it. Thank you.

Rob Reilly

Sure. Thank you.

Operator

Thank you. Our next question comes from the line of Erika Najarian with Bank of America. Please proceed with your question.

Erika Najarian - Bank of America

Yes. Good morning. Thank you.

Bill Demchak

Hi Erika.

Erika Najarian - Bank of America

Hi. My first question sort of has to do with where you are on the LCR with regards to the current proposals. Could you give us an update on where you are and sort of how you are thinking about future investments in terms of your excess deposits in your bond portfolio? I did notice that your cash is up and your securities balances are down on an average basis.

Bill Demchak

Yes. Rob, why don't you hit just the LCR and talk a little bit about balances?

Rob Reilly

Well Erika, I think you can see, we continue to make progress in terms of increasing our liquidity against these proposed rules that still aren’t finalized. We've been doing that now for the better part of the last three quarters or so and you've seen the effect in terms of the NIM compression related to that which was greater in past quarters than it is now. So as you know, the final finish line is fluid, but we believe we're well positioned and then that's demonstrated by the liquidity that we generated here over the last year or so.

Bill Demchak

Just with respect to deposits that we have at the Fed in the form of excess reserves and the decline in securities, I mean it's kind of self evident. We could choose if we like the rate environment to buy level one securities as opposed to put that cash on deposit and not have an effect on our LCR calculation. Just given our view on rates and investment opportunities, we've been growing the balances at the Fed. And I guess we're bit of anomaly in the industry with our security balances shrinking and for the most part maintaining that the same de minimis convexity characteristics or put differently, we're not buying mortgages that put us at risk in a higher rate environment, and we're happy with that. The opportunity cost to foregoing some interest income today is a function of interest rates I think is a worthwhile trade relative to what will happen when rates rise.

Erika Najarian - Bank of America

Okay. And just my follow-up question to that, it's clear that the strategic priorities implemented by the bank has -- we've seen it in the expense discipline and higher core fees, but clearly the purchase accounting accretion and to your point the conservatism in terms of investment securities purchases has driven the efficiency ratio a little bit higher quarter-over-quarter and year-over-year. And I guess the question here is if we take into account an interest rate environment that doesn’t necessarily shift significantly over the next four quarters, marry that with the purchase accounting accretion roll off; is there enough left in the tail in both the revenue side and the expense side on the strategic priority front that we could see the efficiency ratio start to trend down?

Bill Demchak

I mean it’s a function of timing. Practically what we have in place is it relates to the southeast and growth and fees together with expense initiatives will serve us well as it relates to our efficiency ratio longer term. I can’t sort of intuit over the top of my head what the next four quarters look like with respect to rate roll down if rates don’t move at all. So I don’t know how to think about that. What we have in place though is a long-term strategy independent of rates to make this company more efficient and less dependent on net interest income and more dependent on fees. And that is playing out.

Erika Najarian - Bank of America

Okay, thank you.

Bill Callihan

Next question please?

Operator

Our next question comes from the line of Bill Carcache with Nomura Securities. Please proceed with your question.

Bill Carcache - Nomura Securities

Thanks, good morning. Bill, I was hoping I could follow up on the point that you made about the fee income growth playing out. So the call is for the outlook is for stability in fee income growth in third quarter versus second quarter but that is something that is an area where you expect to see continued growth as you look out farther over time, correct?

Bill Demchak

Yes that’s correct. We had some and we highlighted them in Rob’s comments. We had some that we highlighted them in Rob's comments, we had some probably non-repeatable fee items in mortgage related to frankly some scratch and debt stuff that had appreciated and we sold. So, we backed that out, we're going to, we think we can overcome that through growth in core fees quarter to quarter which leads to kind of flat result.

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

Bill Carcache - Nomura Securities

Understood. I was hoping Bill to get your thoughts on a different topic on just switching over to LCR and really the interplay between LCR and capital return. In the precrisis world excess liquidity sitting on the left hand side of balance sheets could be return to shareholders to the extent that banks were sitting on excess capital. But in a post crisis world and I guess let's say CCAR side for a second and just focus on LCR, it seems like that liquidity on the left hand side of balance sheet is needed for LCR purposes. Maybe can you comment on that dynamic and the extent to which you see LCR could potentially add to the constraint to capital return or at least make it more expensive?

Bill Demchak

Look, I don't think it will act as a constrain at all, I mean if margin I suppose it's more expensive because I'm borrowing at Libor plus something to the extent I don't have the cash on hand. But practically if you just think of the size of the two different things, we have around $16 billion $17 billion sitting at the [Multiple speakers] capital deployment and non-objective plan is $1.5 billion and repurchase is $1 billion in dividend plus or minus. So, at the margin it impacted but practically it doesn't really enter into our banking as it relates to what we'll return to shareholders.

Bill Carcache - Nomura Securities

Got it. Thanks very much for taking my questions.

Bill Callihan

You're welcome. Next question please?

Operator

Thank you. Our next question comes from the line of Matt O’Connor with Deutsche Bank. Please proceed with your question.

Matt O’Connor - Deutsche Bank

Good morning.

Bill Callihan

Good morning Matt.

Matt O’Connor - Deutsche Bank

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

Bill Demchak

Boy, we’ve been waiting for it. I think off the top of my head we would have been far away from it this quarter had we chosen to carry security balances flat. We still see a drop in margin as I think through it just because of our borrowings for LCR accretion accounting and the outrage spread on loans. But we were pretty close this quarter when you back out the non-controllable and had we chosen to reinvest, we probably would have been there.

Rob Reilly

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

Bill Demchak

Good guess.

Matt O’Connor - Deutsche Bank

I mean I guess the question is I don’t blame you for wanting to stay short but just assuming kind of the medium to long part of the curves don’t move and you stick to your practice of saying short. You still try to reach the natural level where (inaudible) going to go lower than net add dollars are not going to go lower. I am just trying to get the gauge or…?

Bill Demchak

That’s right. I mean you’ve also seen the curve flattening, so with the rally and the long end over this quarter and the belly of the curve selling off which at the margin we’ve been positioned for and has helped us. At some point you’re right I mean if the curve stays just where it is forever we have some fairly long dated securities in there particularly the sub-investment credit would take a while to grind through the yields on those where we just to replace everything we have with that market rates.

Matt O’Connor - Deutsche Bank

Okay. And then just separately on the capital deployment side of things. I mean how should we think about looking out over the next two to three years, I mean it feels like for banks that don't use their approve buyback in any given year under CCARs almost like use it or lose it and you've got to go back and start over the CCAR process. So like assuming we can't get payouts in excess of 100% of earnings it feels like your capital’s going to build to level higher than you would might have?

Bill Demchak

Yes. That's a fair statement, I think that's an issue the whole industry faces that eventually even if you use your full, assuming you use your full allocated buyback, you get yourself to a position of without over a 100% payouts, you will continue to build capital levels in the industry. We also have and we've talked about this before that even the dividend, soft constraint at 30% of the earnings is a constraint against to your base case CCAR projections which often in our case are below what our potential to earns is.

So there is a number of issues on the table, I think eventually over a 100% is possible coming from the Fed and as we've mentioned before the alternative to choosing to do that through share repurchases is through a special dividend one-time approval I don't think that happens next year, but I think mechanically that's possible as well.

Matt O’Connor - Deutsche Bank

And we assume some banks carve out gains from selling down positions to be used for additional capital deployment. So for example like in your case to be the gains might enable you to deploy more capital, are there any nuances like that that you are thinking about for I guess for the next round?

Bill Demchak

I mean the next round is the next round. I would tell you that during the course of putting together this year’s plan while perhaps we were conservative under our (inaudible) we did look at the potential of how we might include these inside of that and some other things. So we think about that.

I think it issue independent of what we do but my understanding of the process by the Federal Reserve is you need a pretty hard contractual context to realize that gain so if you think about our Visa situation since it is our choice and it is dependent on future price it’s tough to count that one.

Matt O’Connor - Deutsche Bank

Okay alright, thank you.

Bill Callihan

Okay. Next question please.

Operator

Our next question comes from the line of Keith Murray with ISI. Please proceed with your question.

Keith Murray - ISI

Thanks, good morning.

Bill Demchak

Good morning.

Keith Murray - ISI

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

Rob Reilly

Yes, this is Rob. Yes we did include that and the snick results although we don’t get specific in regard to those are not fully accounted for in our reserves.

Keith Murray - ISI

Okay. Then just go back to the efficiency ratio question, just specifically on the retail banking side, obviously you guys continue to work on branch closings and coming more efficient but when you look long-term right would assume a more normal rate backdrop what do you think a reasonable range for the efficiency ratio in that segment should be?

Bill Demchak

We are looking at each other on what the number ought to be. I have to clarify that effort inside of retail isn’t about closing branches per se to save money, it’s about converting our contact points with clients. So, we're reducing square footage, closing certain branches, opening others that are less square footage. And we're investing a lot of that saved money into technology and digital touch points with consumers. The end result of that is our expense base basically shrinks and our interaction with our clients increases and that is a good thing. But I just want to clarify; we're not closing branches as an isolated expense saving exercise.

The efficiency ratio long-term as you mentioned, particularly for retail is largely driven by the value of the deposits they generate which in turn are driven by where interest rates are and revenues again. So I mean they’re materially under earning their potentially today vis-à-vis grades, I don't know that I have a percentage as to where that ought to go through time.

Rob Reilly

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

Keith Murray - ISI

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

Rob Reilly

We can give several answers to the same question and obviously we're focused on it. But it's not new, it’s last several quarters, it's been a race between loan growth and the spread compression. And then in this quarter a little bit more in the race on the security side, but it's plus or minus 20 million, 40 million 1%, 2%. And I think that's the environment that we're in.

Bill Demchak

I mean I would tell you that across our credit books notwithstanding some of my comments on competition and certain asset classes getting tough, the credit performance has been really good and improving largely across everything that we do. So it’s not as if we’re warning that somehow that’s going to turn around and I don’t expect that to be the case anytime in the near future. But at the same time we kind of know that we can’t persist, I love to but I don’t expect to persist to what was a 29 basis-point…

Rob Reilly

Yes.

Bill Demchak

Charge off which is not going to happen. By the way I don’t expect fed funds to be zero forever. So, all we’re pointing out is those, one of those is a positive item for us in the form of rates with a lot of leverage on it for us and the other one is the negative item on normalized credit cards, that’s who we are, that’s what a bank does.

Keith Murray - ISI

Yes, understood. Thanks very much.

Bill Callihan

Next question please?

Operator

Thank you. Our next question comes from the line Eric Wasserstrom with SunTrust Robinson Humphrey. Please proceed with your question.

Eric Wasserstrom - SunTrust Robinson Humphrey

Thanks. I just wanted to circle back to the NII dollars for a moment. Rob, so with the -- it seemed that all of the balance sheet dynamics ultimately pointed to was essentially a down $4 million NII figure when you adjust for the security impact. But I guess the question that that raises is to the extent that you’re putting up very strong loan growth but getting price compression and at the same time funding that increasingly in wholesale format and therefore despite the balance sheet expansion not actually generating incremental dollars of revenue. How do we think about that dynamic?

Bill Demchak

I mean Rob will pile in here, but we are generating incremental dollars of revenue, right. We’re just doing at a lower NIM than we had with loans and higher spreads and with free deposits from floated checking accounts.

Eric Wasserstrom - SunTrust Robinson Humphrey

Okay. Perhaps I’ll circle back with you, I may have misunderstood, but it seems that the NII dollars were effectively flat once made all the adjustment?

Rob Reilly

Yes, I think that's right. I think Bill was speaking specifically to the loan book there.

Bill Demchak

Yes.

Rob Reilly

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

Bill Demchak

Yes. You also have to remember that inside of -- so we have net loan growth, we also have re-pricings within the loan book, right. So part of the reason you see the three or four basis-point average spread compression in the loan book, it's not all the new balances that are coming on that's causing that, a lot of it is just re-pricing of existing balances through the refinancing.

Eric Wasserstrom - SunTrust Robinson Humphrey

Right.

Rob Reilly

It's great compression.

Bill Demchak

Yes.

Eric Wasserstrom - SunTrust Robinson Humphrey

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

Bill Demchak

I think we spent a lot of time thinking about that. I think when rates start to move in conjunction with shrinking of the fed's balance sheet, so shrinking if [QE], we are concerned about deposit flows generically across the industry. So, if fed shrinks its balance sheet, it’s going to pull deposits out of the industry. I think offsetting that somewhat is I think that the banking industry will take advantage of some of the changes in the money fund industry and actually retain balances that historically would have mode both from corporates and from individuals. The dynamics between all that are pretty complex. We spend a lot of time thinking about it. We have strategies in place to make sure that we remain core funded in our deposit profile. I think we will be able to do that, but at the same time I would tell you this will be different this time. We’re going into an environment of potentially rising rates as they drain liquidity in a way that hasn’t been attempted before.

Eric Wasserstrom - SunTrust Robinson Humphrey

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

Bill Demchak

We have been wrong on our provision guidance for four quarters running. I think it reflects the fact that we continue to look at where we are and just kind of say it can’t be this good.

Rob Reilly

Yes. I think that’s right. And the only thing that I would add to that is we did have a release this quarter assuming everything, the economic conditions stay the same, we would have -- expect that further releases although not necessarily at these levels.

Eric Wasserstrom - SunTrust Robinson Humphrey

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

Bill Demchak

I don’t know that we have a bias.

Rob Reilly

Yes, we don’t have a bias, we are in day one here.

Eric Wasserstrom - SunTrust Robinson Humphrey

Right. Okay. Alright, thanks very much.

Bill Demchak

Thank you.

Bill Callihan

Next question please?

Operator

Our next question comes from the line of Ken Usdin with Jefferies. Please proceed with your question.

Bill Demchak

Hi Ken. Hello? Hello Ken?

Ken Usdin - Jefferies

Guys can you hear me?

Bill Demchak

Yes, we can.

Rob Reilly

Yes.

Ken Usdin - Jefferies

Sorry about that. On the expense side, can you guys detail a little bit more about the automation costs that you are expecting in the third quarter, whether that's a new run rate, kind of how that's been funded by the continuous improvement expenses? And then a bigger question for next year just how much of this automation expense can we see as an acceleration to costs going forward?

Bill Demchak

Why don't I just before we get on the third quarter, one of the things that we're doing here as you think about our technology and operations streamlining agenda. We're basically using technology which eventually will give rise to greater depreciation cost. To simplify what we do and lower manual costs right people. And that will play up through time.

The third quarter comment kind of relates to some stuff that we need to do near term just on increasing demands and expectations as it relates to CCAR data requirements from Fed, we just want to stay on the top of our gain as it relates to requirements of the new regulatory regeme.

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

Ken Usdin - Jefferies

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

Bill Demchak

Yes. That is the plan. I mean that the whole idea here is that we will not only have that offset but then build into our core technology and operations the ability to scale this company with positive operating leverage. One of the challenges we had was we were losing our ability to do that because of the manual intervention it took to grow things, we’re putting everything back in the expense line. Through automation, we got to be able to scale it.

Rob Reilly

Hey and just to add to that just in terms of the expenses, just overall in terms of where we are. I do want to emphasize that expenses remain a focus point for us. We’ve got to good first half of the year as you can see, by the first and second quarter. We’ve got a couple of expenses specifically that Bill just talked about in the third quarter but it’s a focus point. And as I said in my opening remarks we continue to believe we’ll finish down year-over-year even with those investments.

Ken Usdin - Jefferies

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

Bill Demchak

Yes. But let distinguish between a couple things, Rob can maybe give you some examples. But one issue is just that the spread on what is otherwise a good loan, right so that’s a pricing issue and we’re seeing competition pretty aggressive inside of the middle market space. And by the way we could be accused of that as well, we’ll protect our existing clients where we have a lot of cross-sell by being aggressive on loan pricing. The other issue out there that concerns me more is on structure and we're seeing in small business and smaller commercial tenders extending collateral values deteriorating a lot of things going into those structures where we would just choose not to compete independent or what the price was. Consumer side we're seeing, you'll see our growth in auto has slowed, we expect that kind of continue as tenders and LTVs on car loans have worsen. So pricing we can deal with, the good loan is a good loan you don't earn as much today, but you do tomorrow to the relationship structure raises.

Rob Reilly

Guys what I would add to that, I would just focus on sort of the core compression, spread compression which has been around three basis points. So that excludes the reclassification and all system purchase accounting around the yield. So I just feel right at that 3% which has been largely consistent with what we've been experiencing for the better part of the year under this, I'm sorry, three basis points which has been largely consistent with what we have been experiencing, actually a basis point lower, it's kind of around four to five.

Ken Usdin - Jefferies

Okay. Thanks guys.

Bill Callihan

Sure. Next question please.

Operator

Thank you. (Operator Instructions). Our next question comes from the line of Paul Miller with FBR. Please proceed with your question.

Paul Miller - FBR

Yes. Thank you very much. And can you talk a little bit about I would have to jump it all around, I don't know exactly everything you said. But on your re-performing loan sales, do you say -- I know there is a lot of people feel that there is a great opportunity be selling re-performing loans into the market. Do you foresee selling more loans going forward?

Rob Reilly

Yes. They are different things obviously to project or forecast. We have had loan sales during the last couple of quarters. What I wanted to point out was that the second quarter rather in our judgment had elevated levels around that.

Bill Demchak

And it’s not -- and they are fair value assets out there.

Rob Reilly

Yes.

Bill Demchak

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

Paul Miller - FBR

And then on you might have talked about this already but utilization rates. We have heard from a couple of institution that they are up. I don’t think you have really disclosed it in your documents, can you talk little bit about are you seeing increase in utilization rates?

Bill Demchak

No we did talk about it. They are up from the first quarter which was elevated from the end of the year pretty much overall categories they are not it’s not necessarily anything to write home about they are up half a percent across different categories. Still well below their potential relative to past cycles, but the trend is good. And that increase in utilization is part of what gave rise to the loan growth this quarter.

Paul Miller - FBR

Okay, guys thank you very much.

Bill Demchak

Yes.

Bill Callihan

Next question please.

Operator

Our next question comes from the line of Gerard Cassidy with RBC. Please proceed with your questions.

Gerard Cassidy - RBC

Thank you. Good morning guys.

Bill Demchak

Hey Gerard.

Gerard Cassidy - RBC

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

Bill Demchak

We have that and let Callihan kind of…

Bill Callihan

It’s 2% in the first year.

Bill Demchak

The challenge with that measure that we disclosed in the Q assumes that we don’t actually increase our investment profile alone to 2%. So 2% and in fact saying that we would just replace what we hold today as opposed to increasing what we hold which is in fact what we would do.

Gerard Cassidy - RBC

Right.

Bill Demchak

It's a material number. Front end helps us in many ways near term more than the back end.

Gerard Cassidy - RBC

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

Rob Reilly

Yes.

Gerard Cassidy - RBC

And on the fair value marks, I think Bill you said it was because of the scratch and dent loans in that, is that what helps you guys on the fair value marks on the mortgage side?

Bill Demchak

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

Gerard Cassidy - RBC

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

Rob Reilly

That's exactly right, Gerard. Yes, that's exactly right.

Gerard Cassidy - RBC

Okay. When you guys take a look at -- you gave us some guidance, I just wonder I can get a clarification here on the fee revenue that’s going to be stable in the third quarter. You indicated that the Visa gains were not included in the third quarter assumptions. Is it also we should back them out of the second quarter number spend when you stable would be apples to apples?

Rob Reilly

Yes, that's right, that's right. The distinction as it's between fee income and then total other non-interest income or a total non-interest income which includes other; Visa is in the part of the other.

Gerard Cassidy - RBC

Great. And then finally, obviously your Tier I common ratio is very strong at 10%. Bill, is it safe for us to assume you mentioned that you are growing capital faster than you could redeploy it that the total [ask] in next year’s CCAR should be closer to a 100% than where we are today, which I think is around 65%?

Bill Demchak

I don't know. You shouldn't assume anything in the middle of July without any instructions coming out of the fed or any expectations coming out of the fed as it relates to the ‘14 CCAR.

Rob Reilly

And argue for the industry.

Bill Demchak

Yes. I mean look, we’re running at levels right now beyond what we would say is our need. So, I’ll leave that as a statement and we’ll see what plays out in the environment and where the fed comes back with next year’s process.

Gerard Cassidy - RBC

Great. Thank you guys.

Bill Demchak

Yes. Thanks Gerard.

Bill Callihan

Next question please?

Operator

Thank you. Our next question comes from the line of Moshe Orenbuch with Crédit Suisse. Please proceed with your question.

Moshe Orenbuch - Crédit Suisse

Great, thanks. And most of my questions have actually been asked and answered but just kind of a follow-up on the net interest income. As I look back to what you said three months ago, you talked about that purchase accounting accretion that really didn’t change and you talked about some of the other things. I am not sure that you’ve talked so much about the general kind of spread compression. I mean, did your kind of view on that kind of soften during this quarter or is that a change or is that not, am I just reading too much into it?

Bill Demchak

We’ve been rolling three or four basis points a quarter.

Rob Reilly

For the last year and half. Just…

Moshe Orenbuch - Crédit Suisse

Okay. So your view is that it hasn’t really changed that it’s just pretty much...

Bill Demchak

Yes, that’s right.

Moshe Orenbuch - Crédit Suisse

Okay. Alright. Thanks very much.

Bill Demchak

Yes. Thanks very much.

Bill Callihan

Next question please?

Operator

Thank you. Our next question comes from line of Betsy Graseck with Morgan Stanley. Please proceed with your question.

Betsy Graseck - Morgan Stanley

Hi, thanks. Just on the expenses and I know we talked a lot about that already today. You are obviously indicating that 2014 expenses anticipated come below 2013. You’re two thirds the way through the CIP program, not as much of this quarter CIP fell to the bottom-line because of things like (inaudible) I am just wondering based on what I am hearing that expectation is that more of your CIP program will likely fall to the bottom-line in 3Q and 4Q that's my read between the line, is that accurate?

Rob Reilly

Yes, I think that's accurate. Yes, It's an annual program. We continue to do, continue to go after expense savings part of that program and even beyond that. So we would expect to get savings in the third quarter from our continuous improvement programs.

Betsy Graseck - Morgan Stanley

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

Bill Demchak

Danger with the continuous improvement program is because while we save the money that the better guidance is the direct guidance on what we expect expenses to do in totality in a quarter. And the comments going from second to third was we continued slight jump on the back of this automation and regulatory stuff and some seasonality we’re having in employee (inaudible).

Betsy Graseck - Morgan Stanley

Got it.

Bill Demchak

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

Betsy Graseck - Morgan Stanley

Okay. And then obviously continuous is important and the continuous improvement from NIM, so the fact that your two-thirds away through this year, I don't think we should take to mean that your original end game for this year is setting stone, I mean that could increase?

Rob Reilly

That's possible. That is what occurred last year.

Bill Demchak

Yes. Look, we never give up.

Rob Reilly

That's right. We never give up. That's right.

Betsy Graseck - Morgan Stanley

Okay. Thanks.

Bill Callihan

Next question please?

Operator

Thank you. Our next question comes from the line of Mike Mayo with CLSA. Please proceed with your question.

Mike Mayo - CLSA

Hi.

Bill Demchak

Hi Mike.

Rob Reilly

Hi Mike.

Mike Mayo - CLSA

My first question is a high level one. One of your main strategic initiatives is to improve the performance of the new markets, the Southeast and the Midwest up to the level of the Northeast. You have indicated in some presentations cross-sell rates and things like that but can you just give us a comparison of new markets versus legacy markets on efficiency, ROA or some other metrics like that?

Bill Demchak

Just trying to think back to we used some of this in one of the presentations.

Rob Reilly

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

Bill Demchak

I mean it’s today the region as a whole contributes to the bottom line in a healthy way but it’s materially below its potential relative to what we see elsewhere if that’s what you are kind of driving at. At the same time it’s growing at a pace across every line of business that is faster than the legacy businesses. So if you are looking for longer term potential, it’s a material number to the company with a high degree of difficulty and a lot of years to play out.

Mike Mayo - CLSA

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

Bill Demchak

Yes, we have that out in some public records, why don’t you get that from Bill?

Bill Callihan

Mike, we can talk offline, I have got couple of things out there from a presentation we can go through.

Mike Mayo - CLSA

Sure. No, I look at that. If in the future you are able to quantify even more with more specifics, it might be helpful to communicate that, that’s fine. Separately, your efficiency ratio, it has gone the wrong direction from 59% to 61% in the past year second quarter versus second quarter and I guess in the third quarter it will still get a little bit worse since expenses will be up for per your guidance and revenues would be down a little bit per guidance and this is the same time you have gotten most of the savings from CIP. I guess is that just further prior quest you are just reinvesting the benefit or it's just a tough environment and you are making a best of that situation. How should we think of that?

Bill Demchak

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

I can, we can control expenses, which we are doing and we can run our company. The end result of that because of the cyclical factors is our expectation and we put that up here in our guidance, it’s going to get a little worse in the third quarter.

I can offset that and choose to do things that don't make long-term economic sense to us. We could grow our securities book, we could start balance sheet in mortgages, we could make that number anything you want it in the near term. I just don't think that's the right way to run a company.

Mike Mayo - CLSA

And as a follow up to that, without using a word convexity, can you explain again why it makes sense for PNC to be an anomaly when it comes to shrinking the securities book? And with -- I do remember, yes, you were in a call before the financial crisis and you highlighted that correctly. So, maybe it's here an anomaly more people should pay attention, I'm serious?

Bill Demchak

Well all we're saying in the securities book. So, the disclosure around these books is not always terrific, you basically have a notional amount, you kind of have categories and then we put out an average maturity or average duration. What is missing is the convexity associated with it.

So, the duration, the current duration of the current coupon mortgage is pretty short, because of prepay rates. If rates go up, it extends massively that's negative convexity. So, I could have the same notional securities book with the same average life at somebody else. And we think we have a much better risk profile, because our book is not extend in a rising rate environment of this rolled out and occur and then disappear on a low average life for others people who will extent. Same way it will appear at balance sheet in mortgages as opposed to putting up through to the agencies.

That’s all we’re seeing. It’s an opportunity cuts. We could choose to take that risk. I just think that the risk return of the benefit for the probably of lower rates and being able to write down this curve versus extending in higher rates, yes, I think there is more downside than upside.

Mike Mayo - CLSA

How much is that opportunity cost in your view? I mean if you did what some others do or what you could do how much of it revenue pick up could that be?

Bill Demchak

Couple of hundred million, pretty easy.

Mike Mayo - CLSA

That’s per year?

Bill Demchak

Yes. Pretty easy, yes.

Mike Mayo - CLSA

So that’s in a way, and insurance policy against a negative impact from higher interest rates when they occur?

Bill Demchak

Yes, I mean we’re just, I would rather have the upside leverage in a higher rate environment, rather than rates go up and you’re basically bound because your assets have extended and you can’t deploy into the new higher rates, at the same time as your funding costs go up. All right?

Mike Mayo - CLSA

All right. Yes, no, that I get it. And the last question, as far as the purchase accounting accretion, you said that should hurt $300 million this year. How much has that hurt already?

Rob Reilly

It’s right about there about 150. It isn’t the exact number but it’s right on schedule.

Bill Demchak

It hurts every day.

Rob Reilly

Yes, it hurts every day. I think it’s an exact number but generally it’s right at the half level.

Mike Mayo - CLSA

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

Rob Reilly

There’ll be more.

Bill Demchak

It trends the level, I mean it's going to trend, it's such a small percentage that it ought to be dwarfed by other thing.

Rob Reilly

And those two NIMs will converge.

Mike Mayo - CLSA

Is that more National City or RBC?

Bill Demchak

It's more National City.

Bill Demchak

It's more the impaired books, Mike.

Rob Reilly

Yes.

Mike Mayo - CLSA

Okay, great, alright. Thank you.

Bill Callihan

Next question please?

Operator

Our next question comes from the line of Matt Burnell from Wells Fargo Securities. Please proceed with your question.

Matt Burnell - Wells Fargo Securities

Good morning, guys. Just one additional question on margin compressions for Rob I guess. Rob, if you characterize your positioning relative to LCR, and I realize the rules are not finals.

Rob Reilly

Yes.

Matt Burnell - Wells Fargo Securities

If you have three basis points of compression this quarter from LCR, at what point do you think that might go down to no effects on margin quarter-over-quarter from your activity to prepare for LCR?

Rob Reilly

Sure. Of course that's hard to answer definitively, because the final rules aren’t established. But what I said in previous earnings calls and I’ll say here is we believe the majority of the work is behind us and the majority of the NIM compression is behind us and you can see that late fourth quarter, I think it was something like 7 basis points of compression and then it was four and now it’s three. So we’re close here and the majority of the work is behind us.

Matt Burnell - Wells Fargo Securities

Okay. And then I guess a bigger picture question, I mean if you look at your average consumer loan balances, they’ve been pretty flattish year-over-year, not growing as much as the commercial side of things and I suspect some of that’s demand rather than your underwriting. But if the employment situation continues to improve net worth -- household net worth has improved fairly materially over the last couple of years. How you’re thinking about potentially tweaking your lending standards on the consumer side to potentially grow that book at yields that are presumably a bit better than you are getting on the consumer side, sorry, on the commercial side?

Bill Demchak

Yes, first off, inside of our consumer balance sheet as it were, we have sort of mechanical run off in our education lending book which hits us every quarter, so that’s the old government guaranteed program that no longer exist and that just rolls down. We had environmental as a function of rate declines or flat balances inside of home equity. We have offset those with growth in credit card and auto. And on the small business side which ought to be a big piece of it, we have been kind of trending flat to down as run off in some of the non-core books from RBC and still National City are offset by new business generation. One thing, we look at risk return on all of our credit products on a relationship basis. So the notion that something yields more to us, why don’t I go chase that it’s kind of be on a loss adjusted basis. We think we have had our credit box pretty much defined and consistent for the last bunch of years and I don’t know that we are inclined to change it.

Matt Burnell - Wells Fargo Securities

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

Bill Demchak

Look, we have seen, whole industry has seen just the back of strength within auto which is kind of got back to pre-crisis levels. We have seen growth in auto lending, we have seen partly as a function of our opportunity because we were underpenetrated and we have seen growth in card balances well beyond what you would expect in a normal environment. Look, and Chairman spoke about it yesterday, there is still a constraint on consumer wages notwithstanding on improved employment picture. And until that changes and consumer spending changes materially which will drive the whole account, I don't expect to see a big lift in consumer credit.

Matt Burnell - Wells Fargo Securities

Okay. Thank you very much.

Bill Callihan

Next question please?

Operator

Thank you. Our next question comes from the line of Terry McEvoy with Stern Agee. Please proceed with your question.

Terry McEvoy - Stern Agee

Hi, thanks. Good morning. Just a question Bill, in your prepared remarks you said that the first half of ‘14 was largely in line with plans. And I'm just wondering where you are not tracking within in plans, is that just a function of issues out of your control, we talked about spread compression et cetera or is anything connected to execution on expense cutting, growing in certain markets et cetera that you had assumed would have fallen in place in the first half of the year?

Bill Demchak

I would tell you, it's a great question and thank you for asking. Look, we are -- the things within our control that we can execute on in our strategic priorities, we feel really good about from the Southeast to the change in what we're doing in mortgage to wealth growth to the focus on cross-sell inside of C&I and importantly on our technology agenda. So we feel good about that.

The environmental stuff, we would have had in our forecast rates higher today, not front end rates, but we would have the tenure higher which would have lifted the whole curve and that would head our net interest income higher than where we sit. But that I can't do anything about. The stuff that we can execute on, the company and the employees have just done a phenomenal job and I couldn't be happier with them.

Bill Callihan

Thank you very much. And we’re now past probably the time. So, I think Bill that's a great way to close the call or should we have any other comments?

Bill Demchak

No, we’ve been asked this for an hour 11, we’ve talked as much about net interest income as I can think about it. Thank you guys again for your time and your interest and we’ll see again in the third quarter.

Bill Callihan

Operator, close the call.

Operator

This concludes today’s conference call. You may now disconnect.

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Source: The PNC Financial Services Group's (PNC) CEO Bill Demchak On Q2 2014 Results - Earnings Call Transcript

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