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Executives

William H. Callihan - Senior Vice President and Director of Investor Relations

Richard J. Johnson - Chief Financial Officer and Executive Vice President

James E. Rohr - Chairman of the Board, Chief Executive Officer, Member of Executive Committee and Member of Risk Committee

Analysts

Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division

Matthew O'Connor - Deutsche Bank AG, Research Division

John E. McDonald - Sanford C. Bernstein & Co., LLC., Research Division

Leanne Erika Penala - BofA Merrill Lynch, Research Division

Christopher Gamaitoni - Compass Point Research & Trading, LLC

David A. George - Robert W. Baird & Co. Incorporated, Research Division

Paul J. Miller - FBR Capital Markets & Co., Research Division

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

Betsy Graseck - Morgan Stanley, Research Division

Brian Foran - Nomura Securities Co. Ltd., Research Division

Todd L. Hagerman - Sterne Agee & Leach Inc., Research Division

Ed Najarian - ISI Group Inc., Research Division

PNC Financial Services Group (PNC) Q3 2011 Earnings Call October 19, 2011 10:00 AM ET

Operator

Good morning. My name is Brian, and I'll be your conference operator today. At this time, I would like to welcome everyone to the PNC Financial Services Group Earnings Conference Call. [Operator Instructions] As a reminder, this call is being recorded. I would now like to turn the call over to Director of Investor Relations, Mr. Bill Callihan. Please go ahead, sir.

William H. Callihan

Thank you, and good morning. Welcome to our conference call today for the PNC Financial Services Group. Participating on this call are PNC's Chairman and Chief Executive Officer, Jim Rohr; and Rick Johnson, Executive Vice President and Chief Financial Officer.

Today's presentation contains forward-looking information. Actual results and future events could differ possibly materially from those anticipated in our statements and from historical performance due to a variety of risks and other factors. Information about such factors, as well as GAAP reconciliation and other information or non-GAAP financial measures we discussed is included in today's conference call, earnings release, related presentation materials and in our 10-K and 10-Q and various other SEC filings and investor materials. These are all available on our corporate website at pnc.com under the Investor Relations section. These statements speak only as of October 19, 2011, and PNC undertakes no obligation to update them.

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

James E. Rohr

Thank you, Bill. Good morning, everyone, and thank you for joining us. First of all, I'd just like to say that we're pleased with the quarter. We believe it's a very good quarter in an environment where we have very slow economic growth and clearly, interest rates continue to be a challenge. We saw good loan growth, good customer growth and we saw credit quality trends that continue to go in the right direction. So we're very pleased with the quarter.

In the presentation today, I'll talk about PNC's third quarter financial accomplishments, and I think we believe that given the trends that we've seen, we believe that PNC is well positioned to deliver short- as well as long-term value.

Last month, I outlined strategic priorities in this current environment, which we know what kind of environment is very well. And we are focused on 4 things. One, growing customers, managing risk, managing expenses and managing our capital. And I think our strong third quarter performance demonstrates progress in all of these areas.

We earned $834 million in net income or $1.55 per diluted common share. Second, due to our innovative product offerings and our strong cross-selling ability, we grew the number of customers we serve at record levels. In fact, our retail checking relationships and corporate business clients are growing faster than we have ever expected, and we continue to deepen our relationships with them.

Thirdly, due to our success in adding new clients and improved utilization from existing ones, we saw a strong commercial loan growth of $3.7 billion in the quarter. And consumer loans grew an additional $500 million during the quarter. Our overall credit metrics showed significant improvement on a year-over-year basis. Our balance sheet remained highly liquid and core funded with an 82% loan-to-deposit ratio, and our expenses were well managed, reflecting our focus on continuous improvement while continuing to invest in our businesses.

Our strong Tier 1 common ratio is estimated to be 10.5%, which held steady from the second quarter. The third quarter benefited from retained earnings. That benefit was offset by higher risk-weighted assets, primarily from loan growth. Overall, our Tier 1 common ratio remains very strong, and we believe we are well positioned for the Basel capital requirements.

And last but not least in the quarter, we issued $1 billion in preferred stock in July, which enhanced our Tier 1 ratio, and we also issued $1.25 billion in debt in the third quarter, further improving our liquidity. Overall, we produced excellent results during the first 3 quarters, and we believe this will be another strong year for PNC.

So let's turn to the business segments. Our business segments reported strong third quarter results as well. Let's begin with Retail Banking. Now we recognize that customer banking trends are changing as check-writing continues to decline and technology, including tablets and smartphones, becomes more popular. Our Virtual Wallet meets those needs and is helping to drive our customer growth.

In the third quarter, we added an average of 10,000 new Virtual Wallet customers per week, a significant increase from the second quarter average of 6,000 per week. In some weeks, a number of the new accounts reached as high as 14,000 due to new student accounts. Our Virtual Wallet website was also ranked as the best bank website for user experience in 2011 when compared to 14 other major competitors.

We also, on the retail side, we launched a new suite of checking and credit card products in late March. And we're seeing stronger acceptance by new and existing customers. In fact, an average of nearly 70% of new checking accounts that were opened in August and September were relationship accounts, and only 30% of the new customers opted for free checking. That's exactly the mix we hope to achieve as relationship to customers, in general, produced 2x to 3x more revenue than free checking account customers. We are reaching that goal much sooner than we had expected.

The winning strategy has helped to drive customer growth. In fact, we added 95,000 organic checking account customers in the third quarter, giving us a year-to-date growth of 225,000 customers, which is 3.5x greater than the same period last year. On an annualized basis, our checking relationships through September 30 saw organic gains of nearly 5.5%, far exceeding the average population growth in our Retail Banking markets.

Our Corporate & Institutional Bank also had a good quarter. We saw average loans increase in the third quarter compared to linked quarter with growth predominantly in middle market and corporate finance sectors. This included quarter-over-quarter increases in asset-based lending, in public finance and health care customers. We are adding new primary clients in our corporate bank at a record pace. In the third quarter, new primary client growth through 9 months was 869, an increase of 25% from a year ago and on pace to well exceed the 1,000 new primary client target that we had in 2011. If we cross hold to these new clients equal to our existing book, it would represent approximately $200 million in additional annual revenue.

Directory [ph] management revenue was up linked quarter and is on track to have another successful year and we continue to see excellent sales activity across all of our markets. Capital markets had a strong third quarter due in part to the performance of Harris Williams, one of the nation's largest M&A advisory firms, for middle market customers. Harris Williams saw higher third quarter revenue as a number of transactions closed during the period.

And our Asset Management Group reported solid third quarter earnings despite the challenging markets. Assets under administration as of September 30 were approximately $202 billion, slightly lower than the second quarter due to weaker equity market. However, in the third quarter, the business delivered its highest level of sales year-to-date as a result of significant increases in new primary clients and referrals from our Retail Banking and corporate and institutional banking businesses.

PNC remains one of the largest wealth managers in the country. And in the quarter, we launched PNC Wealth Insight late last month. This tool allows our high net worth customers to aggregate and view all of their investments regardless of which firm is managing them. Some 12,000 clients now have access to it, and we've been averaging about 250 additional clients every week since we offered the tool. And we believe this will give us a competitive advantage in the marketplace that we can leverage.

Residential mortgage had a good quarter. Mortgage loan originations were $2.6 billion in the third quarter, which was consistent with the second quarter results and slightly lower than a year ago. The applications increased 28% on a linked-quarter basis, primarily due to refinancing activity, and this creates a solid pipeline as we head into the end of the year. BlackRock reported earnings this morning and had another good quarter. At the end of the third quarter, we held a 21% economic interest in BlackRock.

So let's turn briefly to loan momentum. Now we're starting to see the real revenue benefits and our efforts from growing clients in the C&I business, especially in the area of increased credit. Taking a closer look at commercial loans on Slide 6, we're seeing gains due to continued growth in new commercial customers and improved utilization from existing customers.

On a linked quarter basis, we're seeing a 4% increase in loan commitments, including a 3% increase in loans. Since the fourth quarter of last year, loan commitments increased by 7%, and loans were up 8%. In addition to increased loans, the growth in unfunded commitments generates fee activities, as you know, and we have opportunities to cross sell our fee-based products to our credit customers. We are seeing these increases in spite of the type of economy due to the quality of product offerings and our client relationships. Of course, we remain focused on making loans that meet our risk criteria.

Now Rick will provide you with some more detail about the third quarter results. Rick?

Richard J. Johnson

Thank you, Jim, and good morning, everyone. Our third quarter net income of $834 million or $1.55 per diluted common share is a strong performance and reflects our ability to deliver quality results to our shareholders. In my remarks today, I will focus on the following: the growth of our high-quality balance sheet; key drivers of our strong earnings and returns; our capital adequacy and strong liquidity; and our positive outlook for the remainder of 2011.

Let me begin with our balance sheet as shown on Slide 8, starting with assets. Loans increased by $4 billion or 3% linked quarter as we saw increases in core commercial and consumer lending activities. In commercial lending, we saw gains in virtually every industry sector and market. Consumer loans increased, primarily due to higher indirect auto and education lending. We believe commercial real estate may have reached an inflection point as runoff is slowing and commercial mortgage originations grew linked quarter.

Our distressed loan portfolio continues to decline but at a slower pace than in the past. Looking at our loan book, we see strong origination trends and a solid pipeline of business. Given our improved credit metrics, we believe this will lead to further loan growth.

Turning to liabilities. Transaction deposits were up by approximately $6 billion or 4% linked quarter. We saw a strong deposit inflow to non-interest-bearing demand deposits this quarter as customers are looking for quality during these times. And higher cost retail CDs were lower by $2 billion as we continued to lower our cost of funds. Shareholders' equity increased by $2 billion in the quarter due to retained earnings and our preferred stock offering.

As you can see on Slide 9, we had another strong quarter in terms of our asset quality as our overall credit metrics continue to improve. Third quarter net charge-offs of $365 million were down $49 million or 12% on a linked quarter basis, primarily driven by declines in commercial real estate and residential real estate loans. And given the overall improvement in our credit metrics, our provision for the quarter decreased to $261 million from $280 million last quarter.

Now let's turn to net interest income on Slide 10. This table shows the linked quarter and year-to-date comparisons of core net interest income, purchase accounting accretion and total net interest income. It also shows our provision and our net interest income adjusted for our provisioning for loan losses.

Net interest income of $2.2 billion increased by $25 million linked quarter, and net interest margin of 3.89% was in line with second quarter results. Core net interest income increased $23 million compared to linked quarter results due to loan growth and reduced funding costs, while purchase accounting accretion remains stable due to better-than-expected cash recoveries on commercial impaired loans. Provision-adjusted net interest income was also up linked quarter by $44 million and up 11% on a year-to-date basis compared with last year. The year-to-date improvement was due to significantly lower provisioning, which more than offsets the expected decline in purchase accounting accretion.

Looking ahead, we have about $6 billion in CDs scheduled to mature in the fourth quarter of 2011. This book has a weighted average rate of about 2%. Given the non-relationship nature of many of these accounts, we only expect to retain about half of the maturing CDs, and we expect those to reprice on average to approximately 30 basis points.

As a result, we expect fourth quarter net interest income to remain stable as core net interest income should continue to grow to offset the expected decline in purchase accounting accretion. And we also expect the provision to remain stable with the current quarter performance. Of course, this assumes a stable economy.

Now as you can see on Slide 11, we reported $1.4 billion non-interest income, which decreased $83 million linked quarter while our client fee income of $1.1 billion was essentially flat. Asset management fees remain stable despite lower equity values. Consumer service fees were consistent with the previous quarter as higher credit card fees were offset by lower brokerage activity. Corporate service fees decreased $41 million linked quarter due to reductions in the value of commercial mortgage servicing rights.

Last quarter, the CMSR valuation decrease totaled $69 million. In the third quarter, the valuation decrease totaled $105 million, reflecting the low interest rate environment. This more than offset the gains from Harris Williams, which had a number of transactions closed in the quarter.

Residential mortgage fees increased 21% due to an increase in loan sales and hedging gains on mortgage servicing rights. Positive service charges were higher by 7% due to seasonally higher customer activity. Other fees decreased $72 million, primarily due to lower asset values, including hedges on deferred compensation obligations. Year-to-date non-interest income adjusted for regulatory changes increased 4% over the prior year. Overall, we see this as a strong performance in the current regulatory environment. As we look to the fourth quarter, we do expect an additional $75 million or $0.09 per share reduction in consumer service fees related to debit card regulatory changes.

Despite these headwinds, we believe non-interest income in the fourth quarter should be flat to up compared to the third quarter. The diversity of our revenue streams enabled us to achieve a solid performance in an environment that will continue to be affected by regulatory reform headwinds and implementation challenges. At the same time, we see opportunities for growth in our fee-based revenues as a result of our larger franchise, our ability to cross sell our products and services to existing clients and our excellent progress in adding new clients.

Turning to Slide 12. Our culture of continuous improvement is reflected in our well-managed costs, which are down $36 million or 2% linked quarter as most categories were lower. Marketing expenses increased in the quarter due to advertising cost associated with new product and new market launches. Our year-to-date non-interest expenses increased 2% due to legal contingencies and higher foreclosure-related costs of approximately $46 million.

In the fourth quarter, we do expect a noncash charge of approximately $198 million or $0.24 per share associated with calling $750 million of our trust-preferred securities, which we announced last week. While this represents a noncash cost for accelerating the discount on this debt, it provides us with an opportunity to reduce our funding costs going forward by at least $30 million annually. Considering this is very long paper, we see substantial future benefits. Excluding the impact of the noncash charge and any legal and regulatory contingencies, we expect fourth quarter expenses to be relatively consistent with third quarter expenses.

As shown on Slide 13, our Tier 1 common ratio at the end of the third quarter is estimated to be 10.5%. This was unchanged linked quarter as our strong asset growth offset the benefit from retained earnings. Since September 30, 2010, our Tier 1 common ratio has increased by 90 basis points. Our Tier 1 common ratio is estimated to be 13.1% at the end of the third quarter, an increase of 30 basis points linked quarter, primarily due to the issuance of $1 billion in preferred stock during the quarter.

Now with regard to Basel III, using reasonable assumptions, we believe we will be in a pro forma range of 8% to 8.5% for our Tier 1 common equity ratio by the end of 2012, which will put us above the 2019 requirements. This includes conservative assumptions as to the incremental capital requirements for sub-investment grade securities. The pro forma range also assumes no common stock issuance in connection with the pending RBC Bank acquisition. We expect to hear from our regulators sometime this quarter regarding the capital plan we submitted related to our RBC Bank acquisition application.

This was another strong quarter for PNC, and we are expecting the fourth quarter to be in the same -- to deliver similar results subject to the trust-preferred security goal.

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

James E. Rohr

Thank you, Rick. Rick spoke quite a bit about our expectations for the fourth quarter. So I'll turn my comments to the outlook for 2012, and we believe that we're well positioned to deliver quality growth, assuming modest economic expansion.

Slide 14 provides a summary of our current expectations. Now let me begin with PNC excluding the impact of the RBC Bank acquisition. We expect NII will be stable in 2012 assuming low rates and no loan growth. However, we're currently seeing loan growth. And if that were to continue, we would see upside benefits to this forecast.

We believe our provision will continue to decline in 2012 versus 2011. And with our customer growth trends, non-interest income should increase in 2012 despite further regulatory impacts on debit card fees. And finally, full-year expenses are currently expected to remain relatively flat in 2012 versus 2011. Of course, this is apart from any legal and regulatory related contingencies, as well as the integration and operating cost related to RBC and Flagstar.

And regarding RBC Bank, we expect the acquisition to be accretive in 2012 assuming that we do not issue common equity related to the transaction. So all in all, we have positive expectations for earnings in 2012.

In summary, this was another strong quarter for PNC. And given the guidance we just shared, we believe PNC will report strong results for all of 2011 and 2012. A stronger economy or higher interest rates could make those results even better. Since the current economic downturn began in the mid-2007, it's clear that PNC's management team has navigated in this environment and delivered real value to the shareholders.

As you can see on Slide 14, our tangible book value per share has more than doubled during the period, and our pretax pre-provision earnings per share have increased more than 60%. When we compare both of these metrics to our peers, you can see that we dramatically outperformed them during this period. While economic and regulatory uncertainty remain, at PNC, we remain focused on managing our business by one, growing our customers; two, managing expenses; three, managing risk; and four, managing our capital effectively.

We believe our third quarter results reflect our ability to produce excellent earnings in this kind of challenging environment. We're looking forward to a good fourth quarter in 2012.

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

William H. Callihan

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Betsy Graseck with Morgan Stanley.

Betsy Graseck - Morgan Stanley, Research Division

A couple of questions. One, on the NII outlook. Rick, you mentioned about the CD rollover that you're expecting, that you expect to retain about half of the $6 billion that's coming due and repricing from 2% to 30 bps. Is that because you're anticipating that's going to roll over into a different type of liability category or are you offering new CDs at 30 bps?

Richard J. Johnson

No, we're actually offering -- right now, our CDs are at 30 basis points and we figure that about 50% of those are customers who will want to stay with that product with us, and we're figuring the other 50% will be non-customers. So would just roll-off, and we'll see whether they go into other deposit products or we reduce asset balances if we don't have that liquidity.

Betsy Graseck - Morgan Stanley, Research Division

Okay. And that's a 1-year duration?

Richard J. Johnson

Are those 1-year duration? Yes, that's correct...

Betsy Graseck - Morgan Stanley, Research Division

Yes, okay. And then on the yields side, there was other earning asset yield, which went up during the quarter. Could you just go through what that was all about?

Richard J. Johnson

Yes, we lowered our average balances on deposit with the Fed during the course of the quarter. And so as you would imagine, if we have less on deposit with the Fed and the rest of the balances go up.

Betsy Graseck - Morgan Stanley, Research Division

Okay. And then how are you thinking about the trajectory for the securities yield?

Richard J. Johnson

Well, that's where it's going to -- clearly, we cannot replace the current yield we have on the securities book. So that will continue to come down as time passes. But that's where we have the advantages on this liability side where we have substantial repricing in both near term and long term. As Jim said, of 2012 we're very comfortable that the liability side's going to keep pace, if maybe, not even outpace the asset side.

Betsy Graseck - Morgan Stanley, Research Division

Okay. And what's the duration of the securities portfolio right now?

Richard J. Johnson

Probably 3.5 years.

Betsy Graseck - Morgan Stanley, Research Division

And would you think about extending that at all or just switching around the asset classes or...

Richard J. Johnson

Not right now, Betsy. I think we'll be very careful with that. What might happen when rates rise and the capital of impact that might occur there.

Betsy Graseck - Morgan Stanley, Research Division

Okay. And then, Jim, just one for you on the comments around RBC Bank. Obviously, the deal would be accretive if there is no capital issuance. When do you think you get that clarification or certainty?

James E. Rohr

Well, sometime in the fourth quarter. I mean, we've submitted the stress results on -- the application implication went in a few weeks ago. The forecast went in about 2 weeks ago, and we would expect to hear back probably late November or early December. That would be our expectation.

Betsy Graseck - Morgan Stanley, Research Division

You don't have to wait for the CCAR to have that answer?

James E. Rohr

No, this is separate from the CCAR.

Betsy Graseck - Morgan Stanley, Research Division

Okay. So we should potentially hear by the end of the quarter?

James E. Rohr

Yes.

Operator

Next question comes from Erika Penala from Bank of America Merrill Lynch.

Leanne Erika Penala - BofA Merrill Lynch, Research Division

My first question is a follow-up to Betsy's. It seems as if because of the RBC transaction, unlike other large banks, you are potentially having 2 formalized conversations with the regulators with regards to capital adequacy or capital floors. I guess do you suspect that the regulators have their act together enough that the marker that you're going to get in November is going to be the same marker that you're going to get on the CCAR next year?

James E. Rohr

I think the regulators have their act together to be honest, but I can't speak on behalf of them. But they're very consistent about wanting us to meet capital requirements. And I think that's why we're optimistic that we won't have to issue any common because they're really focused on the longer-term capital adequacy of the company and the risk profile that we have, and I think they do have their act together. So that's why we think we'll hear on the RBC transaction before the end of the quarter, and then we'll take a look at our income projections for next year and talk to it about or making submission about dividends.

Leanne Erika Penala - BofA Merrill Lynch, Research Division

Okay. And on the margin, could you give us a sense of how commercial loan yields trended this quarter versus last? And given what you're seeing with regards to origination spreads today, how you expect that to trend over the next few quarters?

Richard J. Johnson

Well, the commercial loan yields held up very well on the quarter, maybe 2 or 3 basis points decline, not much. Most of that is very short dated. So reprices in most of the focus has been repricing to the lower rate environment. In fact, you might even see a lift in that given that some of the short-dated rates have actually increased as we go into [ph].

Leanne Erika Penala - BofA Merrill Lynch, Research Division

Okay. And just one last question. I know you haven't closed the transaction yet, but as far as thinking about how much RBC could potentially contribute in terms of purchase accounting accretion, I guess is a good starting point for us to add back the interest rate or liquidity mark that you told us you took when you announced the deal?

James E. Rohr

We haven't given any guidance really with regards to the accretion level of the company. We believe that we'll be able to take the marks, the credit marks that are required at closing. There's really no liquidity risk in the company. Balance sheet will be mark-to-market. We'll be able to take out what we expect $150 million worth of expenses from that next year. As you know, the whole conversion takes place the first weekend that we close. So while those cost saves, we're front-end loaded. And so we think it'll be nicely accretive assuming we don't have to issue any common, and I don't think we've given any guidance yet as to what level that might be.

Operator

Next question, John McDonald from Sanford Bernstein.

John E. McDonald - Sanford C. Bernstein & Co., LLC., Research Division

Rick, any color on reasonable assumptions you're using for BlackRock and the sub-investment grade debt in your pro forma Basel III? And then somewhat related for Jim, how long do you expect the buybacks to be on hold? Do you have to close the deal first, do you have to wait for it to see how the Fed decides how you fund it? And then on M&A, are you on hold for now or would you still be open to other RBC-type deals?

Richard J. Johnson

John, in our assumptions we put in about a 1.4% mark related to the capital ratio for sub-investment grade securities. And in our discussions so far with the regulators, it is clear that they recognize that the dollar-per-dollar capital on those securities is more than is necessary for senior tranches. I think where they're still working through is trying to figure out how to come up with a way to do the calculation, which reflects the inherent risk in the securities. And we'll just have to wait and be patient for that answer.

So I expect that 1.4% impact that we showed to come down hopefully, pretty dramatically, once we understand the true risk content and we have a model that works with both us and the regulators. As far as BlackRock goes, we only had to add -- I think, it's like 20 basis points, 30 basis points more deduction from our capital ratio. But that gives us about $1.5 billion economic capital, $1.5 billion regulatory capital. And we make over $300 million a year from BlackRock. So that's a 20% return on any capital calculation I do. And that looks like a pretty good return.

James E. Rohr

With regards to capital, John, I think it's a stepwise function. We've got our application in for the RBC transaction. I think -- well, as I said, I think we'll hear about that in the quarter. Then we'll take a look and make an application for what we think might be appropriate capital policies for the following year in CCAR. Hopefully, I think we'll be able to increase the dividend as the payout ratio is still relatively low, and then that will be the #1 priority. And to the extent that share buyback might be available, that will be the #2 priority. With regards to M&A, we really don't see any meaningful transactions on the horizon. I think we might be interested in doing something like the BankAtlantic or Flagstar branch acquisitions if something fit and was priced appropriately.

But I think our work today, as the opportunity for us is to just continuing to make our franchise work. And the pricing in the RBC transaction, I think, works for us in terms of risk-reward and making the RBC transaction work. So that's our focus right now.

John E. McDonald - Sanford C. Bernstein & Co., LLC., Research Division

Okay. And then one follow-up on RBC. How much investment do you need to make into this franchise in order to get the revenues and the ROA of that franchise up to par? And does your accretive immediately for '12 including investments you'll be making next year and then does that investment pickup in '13 that you need to put into this franchise that you bought?

James E. Rohr

The interesting part about the RBC transaction is that from an infrastructure point of view, we have to make almost no investment. The technology that we have available to us is certainly scalable and we'll be converting their entire franchise to our platform that weekend. So that'll be the good news. On the other hand, they really don't have the staffing to sell a lot of the products that we have. And so the investment will be mostly in people, and I think we'll be that the accretive number, it does have us investing in those people right away. As a matter of fact, we're hiring some people as we speak.

And then thirdly, we'll be building branches, I think. We spoke -- there was a question asked of us, what about Atlanta? And RBC thought that they might need 100 branches in Atlanta, for example. Well, with -- if they're in the right places, with RBC, we get 55 plus 27 and Flagstar gives 82, we'll close 5 or 6 and build 20. It will be done. And so we'll be adding branches in various markets. But we'll be taking other branches out of the system as well so at the same time. So I think the investment is not a huge investment nor to really take full advantage of it.

Operator

Next question, David George from Baird.

David A. George - Robert W. Baird & Co. Incorporated, Research Division

Question on your 2012 commentary, namely the provision. You guys have recaptured, I don't have the exact math between $300 million and $400 million of reserves so far this year. So is your lower credit cost guidance a function of the provision going down relative to 2011 or credit losses coming down? Just trying to gauge the sustainability of reserve releases for you guys going forward.

Richard J. Johnson

I would say it's from the beginning of 2011 till the end of 2011, both credit costs and the provision have been coming down. And so just on that basis alone, you would expect even if we maintain the level of credit costs and provisioning through all of 2012, we'll be down. And under our modest recovery here, we expect that would be the case. The assumptions about further decrease.

Operator

Next question from Todd Hagerman with Sterne Agee.

Todd L. Hagerman - Sterne Agee & Leach Inc., Research Division

A couple of questions. Jim, if you could maybe just give us an update. I don't think you mentioned it in your prepared remarks in terms of your continuous improvement program and some of the cost savings you're thinking about next year, you guided to towards kind of towards flattish expenses. Just wondering if you could kind of give us an update in terms of how you're thinking about things today as we continue to hear the word uncertainty thrown around by a number of your competitors. How are you thinking about that continuous improvement going into next year? And any thoughts surrounding that?

James E. Rohr

Well, we have a lot of thoughts about continuous improvement. This is the busy -- this is the beginning of the budget cycle. So we're working on it hard. As you know, and we made the announcement at Barclays that we had over 1,000 suggestions, and we're implementing about 750 of them to take out $400 million worth of expense. And I think that's a number that we're working hard at, and I'm pretty confident we're going to get it. Sp the statement that we're seeing is that our expenses will be relatively flat next year, and that's what we're driving right now in the budget process. And the ideas that came from the employees are certainly going to help us get there.

Todd L. Hagerman - Sterne Agee & Leach Inc., Research Division

So again, just to be clear the $400 million is factored into the outlook for the full year 2012?

James E. Rohr

That's correct.

Todd L. Hagerman - Sterne Agee & Leach Inc., Research Division

Okay. And then, Rick, just again just kind of following up on the funding side. You mentioned the trust redemption. I think, again, at a previous conference, you talked about potential funding cost reductions upwards of $450 million to $500 million for 2012. Could you just kind of elaborate on those figures in terms of just reminding us where that's coming from?

Richard J. Johnson

Sure, I'd be happy to. A couple of things. One is I mentioned the fourth quarter this year, we're going to have about $6 billion of into popped CDs that will reprice from about 2% down to 30 basis points, so we'll retain about 50% of those. Now we also have approximately $11 billion that are going to reprice in the first half of next year, and they're coming down from an average rate of 2.6%, and we don't have high expectations to how much of that is going to reprice. These are sort of the 3-year CDs and that CD put off for liquidity. We're not sure -- we'll maybe run a lot of those balances down. So there's a lot of funding benefit coming out of that.

All that CD repricing is about $250 million to $300 million between 2011, 2012, but the annual running rate of that is about $400 million to $450 million going forward. So you can see a big wave of benefit going beyond 2012. The others, I mentioned the trust-preferred securities. We've got about $2.2 billion of those maturing between now and the end of 2012. We think that'll have a year-over-year impact of about $60 million and an annualized impact of over $100 million. And we have about $5 billion of debt maturing between now and the end of next year, again, for about a $75 million to $100 million impact this year and next.

And then you have the overall repricing in the deposit base, lowering rates giving us extremely low rate environment and that's going to run into about $50 million to $70 million on a going forward basis. So all of those together are going to benefit our funding cost year-over-year by about $450 million to $500 million and on an annualized basis about $700 million. So you see the benefit we get in 2012 and even further benefits in 2013.

Operator

Next question from Matt O'Connor with Deutsche Bank.

Matthew O'Connor - Deutsche Bank AG, Research Division

Two unrelated questions. First on the RBC deal, can you remind us what the repricing flexibility is there? Obviously, macro conditions have deteriorated a bit, maybe not so much on the credit side, but the rate outlook and obviously, stocks are down. But just remind us of the flexibility that you have and when the final price will be determined?

James E. Rohr

The price is $112 million below book value.

Richard J. Johnson

Tangible book.

James E. Rohr

Tangible book. So whatever happens to their P&L between now and then, we don't have to pay for it.

Matthew O'Connor - Deutsche Bank AG, Research Division

Okay. So that's that, okay. And then separately, I think we're seeing on the side a number of banks where there's been just such a sharp improvement in credit quality the last several quarters. We're starting to kind of bump up around the bottom, and I just wanted to ask specifically on the home equity past dues, which picked up a little bit off of somewhat low levels.

But any color that you could provide there and thoughts on kind of how home equity in general plays out right, because the minimum payment each month is pretty low. Eventually these stuff starts to amortize. Eventually, you've got to pay it back. You've got a lot of reserves and have written down some of the riskier stuff. But just thoughts on how this plays out over time will be helpful.

Richard J. Johnson

That's a great point, because I believe that is the area the credit that we all are watching very carefully. It's both the home equity, as well as the residential mortgage. We've been seeing substantial improvements in delinquencies and now performing to those space. But clearly, more recently, they've flattened out a bit, and in some cases, have backed up a little bit. And that's why we've been cautious about releasing reserves against the consumer portfolios. So we're watching that very carefully and want to make sure that we're not overly aggressive in releasing reserves until we see a sustained improvement in those metrics.

Matthew O'Connor - Deutsche Bank AG, Research Division

Okay. Can you remind us when some of the amortization kicks in, right? Because the vast majority of it is, I think, is interest only for 5, 7, 10 years, something like that.

James E. Rohr

I don't know, we're amortizing now. Most of those grace periods are over.

Richard J. Johnson

We can get back to a little bit more specifics, Matt. But, yes, most of the grace periods are gone.

Operator

Next question Ed Najarian, ISI Group.

Ed Najarian - ISI Group Inc., Research Division

So most of my questions have been answered, but 2 specific ones. You went through a lot of the CD repricing, which obviously will be very helpful to lowering funding cost. I was wondering if you could give some outlook on how quickly over the next several quarters you would expect the accretable yield contribution from the deposit side, which I think was about $90 million this quarter. How quickly you would expect that to come down?

Richard J. Johnson

Well, it'll come down pretty dramatically because we're going to have the most of those CDs repriced by the middle of 2012. And though -- so therefore, you're going to stop seeing the accretable benefits. But you have to keep in mind that, that when we did the marks on those, the ones that are maturing in the first half of next year with a coupon of about 2.6%, we'd actually marked to roughly 2%. So the purchase accounting is a benefit of going from 2.60% to 2%, and then we're picking up a benefit of going from 2% all the way down to 30 or less. So even though that's running off, you're going to get a substantial benefit in core net interest income.

Ed Najarian - ISI Group Inc., Research Division

Okay. That's helpful. And so we should expect that to be pretty much gone by, say, the end of the second quarter of next year?

Richard J. Johnson

Well, there's more. But I would say it's going to have a big run off by then, and it's going to be pretty well done by the end of '12. De minimis amounts that'll go into through '13.

Ed Najarian - ISI Group Inc., Research Division

Okay. And then you talked about getting to 8% to 8.5% on Basel III. You talked about by the end of 2012, you talked about not -- that includes not issuing any common for RBC. I'm assuming that in your plan, you've sort of alluded to this before that you'd be potentially looking for a dividend increase next year in terms of your quest in the CCAR. Any thoughts on what you might be looking for in terms of a stock buyback request or how you're thinking about that from a sort of a ratio of earnings perspective above and beyond dividends next year?

James E. Rohr

Well, I think like I said before, it's a stepwise function. We've got to get the RBC transaction approved and understand the capital requirements, if any, around that. But we hope to issue that we have to run the CCAR, we don't even have the input from the regulators yet on the CCAR. And that will change the problem [ph]. So we have to see what the projections for earnings on that are.

We're comfortable, as you know, Ed, as well as anybody that we're comfortable with that ratio, much higher than we have today. The board's been comfortable in the 40% to 50% range with dividend payout if we don't see any need for the capital. And then we have to take a look and see how Basel looks, and those things are changing as we speak. Rick mentioned a couple of items that, I think, we're taking a particularly conservative view on when we say 8% to 8.5%, if those go the other way, it kind of changes the opportunity.

So we just have to walk through this. There's no reason to be upfront with this right now. I think we've managed the capital very well, and we're going to continue to do that going forward. And to the extent that we have way too much, we'll return it to the shareholder if we can't put it to good use. And you know that in the period of 2004, '05, '06 when loan growth, we didn't want to put it -- we didn't -- the risk return at subprime and stuff like that, we didn't see it was right. We didn't grow the balance sheet and we bought back a fair amount of stock. So it's all part of the appropriate capital management for the time.

Ed Najarian - ISI Group Inc., Research Division

Okay. And then -- that's very helpful. And then just one last question, I'm not trying to put words in your mouth, but as we go through your 2012 guidance, I think that would, if I'm understanding it correctly, would clearly lead us to an EPS estimate for next year that's higher in 2012 and in 2011. Is that your intention?

James E. Rohr

I think we gave you what you could give you in terms of -- we're going through the budget right now, so we don't have any numbers. We just told you what we thought the trends would be for the 4 most important parts of the P&L.

Operator

Next question Ken Usdin with Jefferies.

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

There were a bunch of items this quarter on the fee side that were largely related to mark-to-market type of stuff. It was the commercial services, the other income and I'm just wondering what the outlook is for what needs to happen for some of those to become recoverable or are they just at a new run rate for now?

Richard J. Johnson

No, I think on the commercial mortgage servicing rates do not have the negative impact we had this quarter. You just don't -- you need rates not to go any lower and obviously, we wouldn't have the charge. To the extent that rates do backup and they have already this quarter a bit. We could see some recoveries and we have about 150 to 200 of impairment over the last 2 years in this book. Not suggesting that rates are going to go up enough to recover all that, but I think we do have some potential here for rates to improve and for us to be able to get some of that back. The other item that was in there is as you probably know, we have some deferred comp plans where we haven't the obligation on our books, and we hedge our exposure in those comp plans. And so depending on how up and down the rates go in the market or interest rates move, you end up taking a mark-to-market on the non-interest income side on the hedges, but you also take a mark-to-market on the expense side. That number this quarter is about $25 million in terms of a loss in the fee income category, but also was a reduction in expenses by a similar amount. And if market rates should change next quarter, then that will reverse itself.

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

Okay. Great. And then a follow-up just on foreclosure and other real estate expense. It looked like that was up this quarter. Can you just talk a little bit about -- was that due to moving more inventory along? And a more broader question, just, are we kind of at the peak for -- I know it lags the improvement in credit quality, but are we at the kind of peak yet as far as REO cost and environmental flash credit-related costs?

Richard J. Johnson

No. Most of these foreclosure costs were related to penalties that we will incur from the GSEs for delays in getting our foreclosure process complete. Our expectation prior was that the moratoriums put on by the state would be honored by the GSEs and we're coming to find out they won't be. And so therefore, those moratoriums are causing us to fall behind, and so we set up a life-to-date reserve on those costs. I expect we'll have to modify that each quarter, but I don't -- I think this is a very high charge this quarter that we shouldn't expect to see this level of charge repeat itself in the future.

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

Okay. And last quick one, can you just give us the magnitude of the sub-investment grade run off. And if your assumptions have changed and what they are going forward, as far as kind of either monthly or quarterly roll off that you're expecting looking ahead?

Richard J. Johnson

Well, the runoff was about -- the paydown was about $230 million. The only offset to that was the fact that we had further sub-investment grade securities downgraded. So net-net, the actual book value changed by about $50 million to $100 million, not as much as we would have expected, but we're still holding to our assumptions around after the impact on our capital over the next 15 months.

Operator

Next question, Brian Foran with PNC.

Brian Foran - Nomura Securities Co. Ltd., Research Division

It seems like expanding some of the consumer businesses is long-term opportunity, but the card balances were roughly flat this quarter and the mortgage origination volumes were roughly flat this quarter. Can you just talk through both in the short term what drove those things in the quarter, and then the long term just remind us overall appetite for how big you want those businesses to be.

James E. Rohr

Well, we would expect -- we started a marketing campaign in the summer on the credit cards, and the acceptance ratio has been very good. We started -- it's part of our relationship banking on the consumer side and we've had runoff as everyone has in existing balances, but the growth of new cards has been quite good, so we're pleased about that. With regards to mortgage originations going into the fourth quarter, mortgage apps are up 28%. So going in to the quarter, both for credit cards and for mortgages, I think we're very optimistic about how fourth quarter will turn out.

Brian Foran - Nomura Securities Co. Ltd., Research Division

And then just a follow-up question on the guidance. Just as we think, I'm sure some people will model to a operating number where some people will model to a GAAP number. Can you just remind us when we think about merger and integration expenses next year, as well as any potential additional noncash charges from trust preferred, is there a ballpark you're thinking of penciling in, in terms of these nonoperating numbers that we should or a range of nonoperating numbers we could expect next year from those 2 items?

Richard J. Johnson

Well, the total integration charges that we assumed with National City in the original assumptions previously announced is about $300 million. Not all of that will occur next year, but probably a good majority of it will. As far as other factors, I mean, trust preferred when we call those, we have a number of that maturing next year. I mean, we'll have to look at rates at that time and make a decision as to whether or not it's a good decision to call or not, and to the extent there may be a charge for those as well. I can't venture a guess on what other litigation or regulatory tech charges might present with those.

James E. Rohr

If we do -- I mean, we would have reserved for them already.

Operator

Next question comes from Gerard Cassidy, RBC.

Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division

Jim, when you look out after the RBC deal is closed and maybe it's about this time next year and maybe considering other acquisitions, would you guys consider another transformational type of deal like you did with Nat City? Or is it more the regional banks that you can bolt onto the existing franchise that you would have interest in?

James E. Rohr

Gerard, I think the National City transaction was a unique opportunity. At $2 a share, buying the bank that had the highest, at least book capital ratio of the industry, it was a unique opportunity then. In order for that to happen again, we would have to have another financial crisis, and we'd have to have the courage to do it. So -- and I'm not sure we wanted any of those things to happen again. So just as we look forward to a slow-growing economy, which I think is where we're at. I would think that we would just be doing small branch acquisitions to fill out the RBC and the PNC franchise, if it's priced right.

I mean, one of the things we saw and this is a longer, longer answer that you probably wanted. But the trends, we're growing customers at a tremendous pace because branch utilizations are down and the utilization of our technology is way up. And so in many cases, I'm not sure we have to buy all of these customers or the branches. And so we look, for example, in Chicago, I think it's a good example, we wanted to grow in Chicago. We're fourth or fifth in Chicago. We look to the small banks in Chicago and they wanted 2x book and we said that was well, and we built 30 branches.

And I think we can maybe build another 20 branches in Chicago; we'll be done. We'll have all we want. So -- and then we grow up, we sell our electronic products. So I think the acquisition piece is probably a pretty slow process going forward. I don't see it -- to answer your question, I don't see any transformational deals on the horizon.

Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division

Okay. And moving onto, I may have missed it in your prepared remarks, but have you guys come out with your strategy to help offset the revenue loss from the Durbin amendment on the debit card issue?

James E. Rohr

We look at that a little differently than just trying to -- obviously, that cost us a lot of money. The real issue, I think, is the fact that interest rates are so low. We've got $180 billion worth of deposits that basically, we don't really make any money out of in this interest rate environment. And so I know a lot of people want to look at Durbin, but we look at it from the point of view of how do we reprice the consumer relationship in order to get the appropriate return on business. And that's why we still have a free checking product. We've got 3 relationship products, and now we have 70% of our customers buying relationship products. And so someone might say, well, it's because of Durbin. But Durbin's only a part of the revenue expense relationship with the consumer.

So I think the consumer pricing model will -- that'll just evolve over the next few years. I think consumers will either purchase the products they want to purchase for different kinds of fees or balance requirements or not, or they'll change their behavior. And I think you're seeing behavioral change being growing a lot with online banking for us growing at 20%, mobile banking growing at 40%. Branch utilization, which will be down 7.5% this year, down 6% on average for the last 5 years. So the consumer is changing, and I think it's just repricing the new relationship with consumers given the interest rate environment.

Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division

Speaking in this consumer behavior, have you guys been able to look at your recapture of the Regulation E fees that the industry lost? And you guys lost obviously, as you had to change your methodologies. Have you been able to figure out if you've recaptured all of that revenue?

Richard J. Johnson

I think it's the same point that Jim made on the previous, as you got to look at the whole relationship. And what we've been able to do through changing the checking relationship and other factors is to drive a lot of volume of new customer accounts into the company. And if we can drive the volume and increase transaction activities through that, then we can overcome some of the fee factors.

The other we can do is to take a very hard look given the change in consumer behavior on a consolidation of branches, as well as the cost to serving branches and putting the right staffing models in place. And these are things that we're working on today, but you're not going to get all that money back in one year. It's going to take a couple of years to be able to recoup it.

Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division

Sure. And then my final question, maybe talking about branches. Obviously, aside from the new expansion into new territories, as you pointed out in Chicago. With the success of the online banking and mobile banking, do you see over an extended period of time that the branch, your branch network should shrink if delivering more of your customers through these electronic channels?

James E. Rohr

Absolutely. I mean, one of the things that we found in our studies is that 77% of all of our customers and prospects want to have a multi-channel capability. So fewer than 20% will even consider a relationship with somebody who does not have a multi-channel capability. So people want to have branches. But branch utilization is going down significantly, and obviously the utilization of online and remote capabilities are growing.

So I think it's a trend that we're going to follow. And I think we're cross-selling those products very, very successfully. And I think the Virtual Wallet product, which was -- we mentioned was named the #1 player by far. As a matter of fact if we look at the study, is a great success. And those are the kinds of things that are going to drive a lot of growth into the future. This year, we'll open 50 branches. We'll close a little over 80. Next year, we might open as many. We're doing the budget right now, but we'll probably close at least as many as we open. So that rationalization of the branches, I think, is something that we've been doing for a period of time, but that'll just continue.

Operator

Next question comes from Chris Gamaitoni from Compass Point.

Christopher Gamaitoni - Compass Point Research & Trading, LLC

Just some clarity on that $3.3 billion of securities that were shifted to help the maturity. What exactly was that?

Richard J. Johnson

They were primarily agency, mortgage-backed securities and some high-quality commercial mortgage-backed securities that we moved into help ourself, because we have an intent to hold maturity. So very high-quality securities and moved them into hold the maturity [ph].

Christopher Gamaitoni - Compass Point Research & Trading, LLC

Okay. And then are you having any valuation or capital impact from recent volatility in prime MBS markets given the development of Primax [ph]?

Richard J. Johnson

No.

Christopher Gamaitoni - Compass Point Research & Trading, LLC

Or how you value the anonymous investment grade securities?

[Technical Difficulty]

Operator

Last question comes from Paul Miller with FBR Market.

Paul J. Miller - FBR Capital Markets & Co., Research Division

Just to follow up on 2 questions ago about the branch utilization rates. Do you find a difference in branch utilization from the bigger cities like Chicago or D.C. versus the smaller rural towns which you guys like? Is that one of your sweet spots?

James E. Rohr

Well, the answer is yes. They're different everywhere in each market. In Washington, D.C., we have Starbucks in several of our branches. In some parts of small towns in Pennsylvania, our coffee expenses, our own expense and people come and meet there. So it depends on the market you're in, and we manage the branch based on utilization and the customer base that we have on those markets.

So it does vary a lot. I mean, some branches are totally tied to small business. Some branches are totally tied to high network. So you really have to look at each market, and we actually designed the branches. We only build green branches. We have more green buildings than any other company in the world. But we designed those branches based upon the customer mix that comes in.

Paul J. Miller - FBR Capital Markets & Co., Research Division

And then just one question. On your accretable yield versus non-accretable yield, over the last year, it looks like you've switched about $800 million from non-accretable, accretable. And I believe, in the last, and I asked this question a couple of quarters ago, you said mainly it was due to the HELOCs performing much better in footprint from that city versus out of footprint. Is that still going on today or is there some other things going on in there with that change over?

Richard J. Johnson

Well, if you look at from the second quarter to the third quarter, you saw about a $200 million shift. Half of that is due to the commercial book in the cash recoveries and the improvements. We're seeing that the other half is where the consumer book is extending the life of the loans out. And as a result, we're going to be receiving more interest for a longer period of time than our original assumption. So it's a little mix of both.

Paul J. Miller - FBR Capital Markets & Co., Research Division

Are you modifying those loans? Is that why they're extending out?

Richard J. Johnson

Some are modified, yes. But that's not the primary reason for the extension. It's just that our assumptions around the cash flows may have been more conservative than it will be in the future or it is now -- sorry, more conservative previous than it is now.

Operator

I have no further questions.

James E. Rohr

Okay. Thank you very much, everyone, for joining us. As I said in the beginning, I think this is a really solid quarter for us. A relatively clean, cleaning quarter to use your term. And we're very, very pleased with it in this economic environment. We're looking forward to a good fourth quarter in 2012. Thank you for joining us.

Operator

Okay. Thank you. That does conclude the conference today. You may disconnect your phone lines at this time.

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