Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2009

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 001-09718

The PNC Financial Services Group, Inc.

(Exact name of registrant as specified in its charter)

 

Pennsylvania   25-1435979

(State or other jurisdiction of

incorporation or organization)

  (I.R.S. Employer Identification No.)

One PNC Plaza, 249 Fifth Avenue, Pittsburgh, Pennsylvania 15222-2707

(Address of principal executive offices, including zip code)

(412) 762-2000

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x     No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  x         Accelerated filer  ¨        Non-accelerated filer  ¨        Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ¨    No  x

As of April 30, 2009, there were 445,278,707 shares of the registrant’s common stock ($5 par value) outstanding.

 

 

 


Table of Contents

The PNC Financial Services Group, Inc.

Cross-Reference Index to First Quarter 2009 Form 10-Q

 

     Pages

PART I – FINANCIAL INFORMATION

  

Item 1.        Financial Statements (Unaudited).

   54-98

Consolidated Income Statement

   54

Consolidated Balance Sheet

   55

Consolidated Statement Of Cash Flows

   56

Notes To Consolidated Financial Statements (Unaudited)

  

Note 1   Accounting Policies

   57

Note 2   National City Acquisition

   60

Note 3   Variable Interest Entities

   62

Note 4   Loans and Commitments To Extend Credit

   64

Note 5   Asset Quality

   64

Note 6   Loans Acquired in a Transfer

   65

Note 7   Investment Securities

   67

Note 8   Fair Value

   71

Note 9   Goodwill and Other Intangible Assets

   79

Note 10 Loan Sales and Securitizations

   81

Note 11 Capital Securities of Subsidiary Trusts

   84

Note 12 Certain Employee Benefit And Stock-Based Compensation Plans

   84

Note 13 Financial Derivatives

   86

Note 14 Earnings Per Share

   90

Note 15 Total Equity And Other Comprehensive Income

   91

Note 16 Summarized Financial Information of BlackRock

   92

Note 17 Legal Proceedings

   92

Note 18 Commitments and Guarantees

   92

Note 19 Segment Reporting

   96

Statistical Information (Unaudited)

  

Average Consolidated Balance Sheet And Net Interest Analysis

   99-100

Item 2.        Management’s Discussion and Analysis of Financial Condition and Results of Operations.

   1-53

Financial Review

  

Consolidated Financial Highlights

   1-2

Executive Summary

   3

Consolidated Income Statement Review

   7

Consolidated Balance Sheet Review

   10

Off-Balance Sheet Arrangements And Variable Interest Entities

   15

Fair Value Measurements And Fair Value Option

   18

Business Segments Review

   24

Critical Accounting Policies And Judgments

   36

Status Of Qualified Defined Benefit Pension Plan

   37

Risk Management

   38

Internal Controls And Disclosure Controls And Procedures

   48

Glossary Of Terms

   48

Cautionary Statement Regarding Forward-Looking Information

   51

Item 3.        Quantitative and Qualitative Disclosures About Market Risk.

   38-47

Item 4.        Controls and Procedures.

   48

PART II – OTHER INFORMATION

  

Item 1.        Legal Proceedings.

   101

Item 1A.    Risk Factors.

   101

Item 2.         Unregistered Sales Of Equity Securities And Use Of Proceeds.

   101

Item 4.        Submission Of Matters To A Vote Of Security Holders

   101

Item 6.        Exhibits.

   102

Exhibit Index.

   102

Signature

   102

Corporate Information

   103


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FINANCIAL REVIEW

CONSOLIDATED FINANCIAL HIGHLIGHTS

THE PNC FINANCIAL SERVICES GROUP, INC.

 

Dollars in millions, except per share data    Three months ended March 31  
Unaudited        2009 (a)              2008      

FINANCIAL PERFORMANCE (b)

       

Revenue

       

Net interest income

   $ 2,305      $ 854  

Noninterest income

     1,566        967  

Total revenue

   $ 3,871      $ 1,821  

Provision for credit losses

   $ 880      $ 151  

Noninterest expense

   $ 2,328      $ 1,035  

Net income

   $ 530      $ 384  

Net income attributable to common shareholders

   $ 460      $ 377  

Diluted earnings per common share

   $ 1.03      $ 1.09  

Cash dividends declared per common share (c)

   $ .66      $ .63  

Cash dividends – TARP Capital Purchase Program preferred stock

   $ 47       

Impact of TARP Capital Purchase Program preferred stock dividends per common share

   $ .11           

SELECTED RATIOS

       

Net interest margin (d)

     3.81 %      3.09 %

Noninterest income to total revenue

     40        53  

Efficiency (e)

     60        57  

Tier 1 risk-based capital ratio at March 31

     10.0        7.7  

Tier 1 common capital ratio at March 31

     4.9        5.7  

Return on:

       

Average common shareholders’ equity

     10.23 %      10.82 %

Average assets

     .77        1.10  

See page 48 for a glossary of certain terms used in this Report.

Certain prior period amounts have been reclassified to conform with the current period presentation, which we believe is more meaningful to readers of our consolidated financial statements.

(a) Results for the three months ended March 31, 2009 include the impact of National City, which we acquired on December 31, 2008.
(b) The Executive Summary and Consolidated Income Statement Review portions of the Financial Review section of this Report provide information regarding items impacting the comparability of the periods presented.
(c) In April 2009, the PNC board of directors declared a quarterly common stock cash dividend of 10 cents per share, reflecting a reduction from 66 cents per share in the first quarter of 2009.
(d) Calculated as annualized taxable-equivalent net interest income divided by average earning assets. The interest income earned on certain earning assets is completely or partially exempt from federal income tax. As such, these tax-exempt instruments typically yield lower returns than taxable investments. To provide more meaningful comparisons of margins for all earning assets, we use net interest income on a taxable-equivalent basis in calculating net interest margin by increasing the interest income earned on tax-exempt assets to make it fully equivalent to interest income earned on taxable investments. This adjustment is not permitted under GAAP in the Consolidated Income Statement. The taxable-equivalent adjustments to net interest income for the three months ended March 31, 2009 and March 31, 2008 were $15 million and $9 million, respectively.
(e) Calculated as noninterest expense divided by total revenue.

 

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CONSOLIDATED FINANCIAL HIGHLIGHTS (CONTINUED) (a)

 

Unaudited    March 31
2009 (b)
    December 31
2008 (b)
       March 31
2008
 

BALANCE SHEET DATA (dollars in millions, except per share data)

           

Assets

   $ 286,422     $ 291,081        $ 139,991  

Loans

     171,373       175,489          70,802  

Allowance for loan and lease losses

     4,299       3,917          865  

Investment securities

     46,253       43,473          28,581  

Loans held for sale

     4,045       4,366          2,516  

Goodwill and other intangible assets

     12,178       11,688          9,349  

Equity investments

     8,215       8,554          6,187  

Deposits

     194,635       192,865          80,410  

Borrowed funds

     48,459       52,240          32,779  

Shareholders’ equity

     26,477       25,422          14,423  

Common shareholders’ equity

     18,546       17,490          14,416  

Accumulated other comprehensive loss

     3,289       3,949          779  

Book value per common share

     41.67       39.44          42.26  

Common shares outstanding (millions)

     445       443          341  

Loans to deposits

     88 %     91 %        88 %
 

ASSETS ADMINISTERED (billions)

           

Managed

   $ 96     $ 103        $ 66  

Nondiscretionary

     120       125          110  
 

FUND ASSETS SERVICED (billions)

           

Accounting/administration net assets

   $ 712     $ 839        $ 1,000  

Custody assets

     361       379          476  
 
CAPITAL RATIOS            

Tier 1 risk-based (c)

     10.0 %     9.7 %        7.7 %

Tier 1 common

     4.9       4.8          5.7  

Total risk-based (c)

     13.6       13.2          11.4  

Leverage (c) (d)

     8.9       17.5          6.8  

Common shareholders’ equity to assets

     6.5       6.0          10.3  
 
ASSET QUALITY RATIOS            

Nonperforming loans to total loans

     1.73 %     .95 %        .81 %

Nonperforming assets to total loans and foreclosed assets

     2.02       1.23          .87  

Nonperforming assets to total assets

     1.21       .74          .44  

Net charge-offs to average loans (for the three months ended)

     1.01       1.09          .57  

Allowance for loan and lease losses to total loans

     2.51       2.23          1.22  

Allowance for loan and lease losses to nonperforming loans

     145       236          151  
(a) The Executive Summary and Consolidated Balance Sheet Review portions of the Financial Review section of this Report provide information regarding items impacting the comparability of the periods presented.
(b) Includes the impact of National City, which we acquired on December 31, 2008.
(c) The regulatory minimums are 4.0% for Tier 1, 8.0% for Total, and 4.0% for Leverage ratios. The well-capitalized levels are 6.0% for Tier 1, 10.0% for Total, and 5.0% for Leverage ratios.
(d) Tier 1 risk-based capital divided by adjusted average total assets. The ratio as of December 31, 2008 did not reflect any impact of National City on PNC’s adjusted average total assets.

 

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FINANCIAL REVIEW

THE PNC FINANCIAL SERVICES GROUP, INC.

This Financial Review should be read together with our unaudited Consolidated Financial Statements and unaudited Statistical Information included elsewhere in this Report and with Items 6, 7, 8 and 9A of our 2008 Annual Report on Form 10-K (2008 Form 10-K). We have reclassified certain prior period amounts to conform with the current period presentation, which we believe is more meaningful to readers of our consolidated financial statements. For information regarding certain business and regulatory risks, see the Risk Management section in this Financial Review and Items 1A and 7 of our 2008 Form 10-K and Item 1A included in Part II of this Report. Also, see the Cautionary Statement Regarding Forward-Looking Information and Critical Accounting Policies And Judgments sections in this Financial Review for certain other factors that could cause actual results or future events to differ, perhaps materially, from historical performance and those anticipated in the forward-looking statements included in this Report. See Note 19 Segment Reporting in the Notes To Consolidated Financial Statements included in Part I, Item 1 of this Report for a reconciliation of total business segment earnings to total PNC consolidated net income as reported on a generally accepted accounting principles (GAAP) basis.

 

EXECUTIVE SUMMARY

THE PNC FINANCIAL SERVICES GROUP, INC.

PNC is one of the largest diversified financial services companies in the United States and is headquartered in Pittsburgh, Pennsylvania.

As further described in Note 2 Acquisitions and Divestitures in our 2008 Form 10-K, on December 31, 2008, PNC acquired National City Corporation (National City). Our consolidated financial statements for the first three months of 2009 reflect the impact of National City.

PNC has businesses engaged in retail banking, corporate and institutional banking, asset management, residential mortgage banking and global investment servicing, providing many of its products and services nationally and others in PNC’s primary geographic markets located in Pennsylvania, New Jersey, Washington, DC, Maryland, Virginia, Ohio, Kentucky, Delaware, Florida, Illinois, Indiana, Michigan, Missouri, and Wisconsin. PNC also provides certain investment servicing internationally and also conducts selected consumer and commercial lending businesses and other financial services on a nationwide basis.

We expect to incur total merger and integration costs of approximately $1.2 billion pretax in connection with the acquisition of National City. This total includes $575 million pretax recognized in the fourth quarter of 2008 and $51 million pretax recognized in the first quarter of 2009. The transaction is expected to result in the reduction of approximately $1.2 billion of combined company annualized noninterest expense through the elimination of operational and administrative redundancies.

We are in the process of integrating the business and operations of National City with those of PNC.

KEY STRATEGIC GOALS

We manage our company for the long term and are focused on returning to a moderate risk profile while maintaining strong capital and liquidity positions, investing in our markets and

products, and embracing our corporate responsibility to the communities where we do business.

Our strategy to enhance shareholder value centers on driving pre-tax, pre-provision earnings that exceed credit costs by achieving growth in revenue from our balance sheet and diverse business mix that exceeds growth in expenses controlled through disciplined cost management. The primary drivers of revenue growth are the acquisition, expansion and retention of customer relationships. We strive to expand our customer base by offering convenient banking options and leading technology solutions, providing a broad range of fee-based and credit products and services, focusing on customer service, and through a significantly enhanced branding initiative. We may also grow revenue through appropriate and targeted acquisitions and, in certain businesses, by expanding into new geographical markets.

We are focused on our strategies for quality growth. We are committed to returning to a moderate risk profile characterized by disciplined credit management and limited exposure to earnings volatility resulting from interest rate fluctuations and the shape of the interest rate yield curve. Our actions have created a well-positioned and strong balance sheet, ample liquidity and investment flexibility to adjust, where appropriate and permissible, to changing interest rates and market conditions.

We also continue to be focused on building capital in the current environment characterized by economic and regulatory uncertainty. See the Funding and Capital Sources section of the Consolidated Balance Sheet Review section and the Liquidity Risk Management section of this Financial Review regarding certain restrictions on dividends and common share repurchases resulting from PNC’s participation on December 31, 2008 in the US Treasury’s Troubled Asset Relief Program (TARP) Capital Purchase Program and other regulatory restrictions on dividend capacity.

On April 2, 2009 the Board declared a quarterly common stock dividend of $.10 per share, a reduction from the prior quarterly dividend of $.66 per share. Our Board recognizes the


 

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importance of the dividend to our shareholders. While our overall capital and liquidity positions are strong, extreme economic and market deterioration and the changing regulatory environment drove this difficult but prudent decision. This proactive measure will help us build capital by approximately $1 billion annually, further strengthen our balance sheet and continue to serve our customers.

SUPERVISORY CAPITAL ASSESSMENT PROGRAM (“STRESS TESTS”)

On May 7, 2009, the Board of Governors of the Federal Reserve System announced the results of the stress tests conducted by banking regulators under the Supervisory Capital Assessment Program with respect to the 19 largest bank holding companies. As a result of this test, the Federal Reserve concluded that PNC is currently well capitalized but that, in order to provide a greater cushion against the risk that economic conditions over the next two years are worse than currently anticipated, PNC needed to augment the composition of its capital by increasing the common shareholders’ equity component of Tier 1 capital by $600 million by November 9, 2009. This amount represents one-quarter of 1% of our risk-weighted assets as of March 31, 2009. PNC intends to satisfy this requirement through a combination of growth in retained earnings and the pursuit of other capital raising alternatives.

RECENT MARKET AND INDUSTRY DEVELOPMENTS

Since the middle of 2007 and with a heightened level of activity during the second half of 2008 and into 2009, there has been unprecedented turmoil, volatility and illiquidity in worldwide financial markets, accompanied by uncertain prospects for the overall national economy, which is currently in the midst of a severe recession. In addition, there have been dramatic changes in the competitive landscape of the financial services industry during this time.

Recent efforts by the Federal government, including the US Department of the Treasury, the Federal Reserve, the FDIC, and the Securities and Exchange Commission, to stabilize and restore confidence in the financial services industry have impacted and will likely continue to impact PNC and our stakeholders. These efforts, which will continue to evolve, include the Emergency Economic Stabilization Act of 2008, the American Recovery and Reinvestment Act of 2009, and other legislative, administrative and regulatory initiatives, including the US Treasury’s TARP and TARP Capital Purchase Program, the FDIC’s Temporary Liquidity Guarantee Program (TLGP) and the Federal Reserve’s Commercial Paper Funding Facility (CPFF).

These programs, some of which are further described in Item 7 of our 2008 Form 10-K, include the following:

TARP Capital Purchase Program – On December 31, 2008, PNC issued to the US Treasury $7.6 billion of preferred stock together with a related warrant to purchase shares of common

stock of PNC, in accordance with the terms of the TARP Capital Purchase Program. Funds from this sale count as Tier 1 capital. Holders of this preferred stock are entitled to a cumulative cash dividend at the annual rate per share of 5% of the liquidation preference per year for the first five years after its issuance. After December 31, 2013, if these shares are still outstanding, the annual dividend rate will increase to 9% per year. We plan to redeem the US Treasury’s investment as soon as appropriate, subject to approval by our primary banking regulators. We do not contemplate exchanging any of the shares of preferred stock issued to the US Treasury under the TARP Capital Purchase Program for shares of mandatorily convertible preferred stock.

Further information on these securities is included in Note 19 Shareholders’ Equity included in our Notes to Consolidated Financial Statements within Item 8 of the 2008 Form 10-K.

FDIC Temporary Liquidity Guarantee Program (TLGP) – In December 2008, PNC Funding Corp issued fixed and floating rate senior notes totaling $2.9 billion under the FDIC’s TLGP-Debt Guarantee Program. In March 2009, PNC Funding Corp issued floating rate senior notes totaling $1.0 billion under this program. Each of these series of senior notes is guaranteed by the FDIC and is backed by the full faith and credit of the United States through June 30, 2012.

Since October 14, 2008, both PNC Bank, National Association (PNC Bank, N.A.) and National City Bank have participated in the TLGP-Transaction Account Guarantee Program. Under this program, through December 31, 2009, all non-interest bearing transaction accounts are fully guaranteed by the FDIC for the entire amount in the account. Coverage under this program is in addition to, and separate from, the coverage available under the FDIC’s general deposit insurance rules.

Commercial Paper Funding Facility – Effective October 28, 2008, Market Street Funding LLC (Market Street) was approved to participate in the Federal Reserve’s CPFF. The CPFF commitment to purchase up to $5.4 billion of three-month Market Street commercial paper expires on October 30, 2009. Market Street had no borrowings under this facility at March 31, 2009.

Public-Private Investment Programs – On March 23, 2009, the US Treasury and the FDIC announced that they will establish the Legacy Loans Program (LLP) to remove troubled loans and other assets from banks. The FDIC will provide oversight for the formation, funding, and operation of new public-private investment funds (PPIFs) that will purchase loans and other assets from depository institutions. The LLP will attract private capital through an FDIC debt guarantee and Treasury equity co-investment. All FDIC-insured depository institutions will be eligible to participate in the program.


 

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On March 23, 2009, the US Treasury also announced the establishment of the Legacy Securities PPIFs, which are designed to address issues raised by troubled assets. These Legacy Securities PPIFs are specifically focused on legacy securities and are part of a plan that directs both equity capital and debt financing into the market for legacy assets. This program is designed to draw in private capital to these markets by providing matching equity capital from the US Treasury and debt financing from the Federal Reserve via the TALF and the US Treasury.

PNC is in the process of determining to what extent, if any, it will participate in these programs.

****

It is also possible that the US Congress and federal banking agencies, as part of their efforts to provide economic stimulus and financial market stability, to enhance the liquidity and solvency of financial institutions and markets, and to enhance the regulation of financial institutions and markets, will announce additional legislation, regulations or programs. These additional actions may include changes in or additions to the statutes or regulations related to existing programs, including those described above. It is not possible at this time to predict the ultimate impact of these actions on PNC’s business plans and strategies.

KEY FACTORS AFFECTING FINANCIAL PERFORMANCE

Our financial performance is substantially affected by several external factors outside of our control including the following, some of which may be affected by legislative, regulatory and administrative initiatives of the Federal government such as those outlined above:

   

General economic conditions, including the length and severity of the current recession,

   

The level of, and direction, timing and magnitude of movement in, interest rates and the shape of the interest rate yield curve,

   

The functioning and other performance of, and availability of liquidity in, the capital and other financial markets,

   

Loan demand, utilization of credit commitments and standby letters of credit, and asset quality,

   

Customer demand for other products and services,

   

Changes in the competitive landscape and in counterparty creditworthiness and performance as the financial services industry restructures in the current environment, and

   

The impact of market credit spreads on asset valuations.

In addition, our success will depend, among other things, upon:

   

Further success in the acquisition, growth and retention of customers,

   

Progress toward integrating the National City acquisition,

   

Continued development of the geographic markets related to our recent acquisitions, including full deployment of our product offerings,

   

Revenue growth,

   

A sustained focus on expense management, including achieving our cost savings targets associated with our National City integration, and creating positive pre-tax, pre-provision earnings,

   

Managing the distressed assets portfolio and other impaired assets,

   

Maintaining solid overall asset quality,

   

Continuing to maintain our deposit base,

   

Prudent risk and capital management leading to a return to our desired moderate risk profile, and

   

Actions we take within the capital and other financial markets.

SUMMARY FINANCIAL RESULTS

 

    Three months ended March 31  
         2009             2008      

Net income, in millions

  $ 530     $ 384  

Diluted earnings per common share

  $ 1.03     $ 1.09  

Return on

     

Average common

    10.23 %     10.82 %

Average assets

    .77 %     1.10 %

Highlights of the first quarter of 2009 included the following:

   

Net income for the first quarter of 2009 reflected the diversification of our businesses. Total revenue was $3.9 billion for the quarter. Net interest income was strong and noninterest income benefited from robust residential mortgage banking activity driven by refinancing volumes and income from servicing rights. Pretax, pre-provision earnings exceeded credit costs by over $650 million in the first quarter of 2009.

   

Our Tier 1 risk-based capital ratio increased by 30 basis points during the quarter to 10.0% and the Tier 1 common capital ratio increased to 4.9% at March 31, 2009. The reduction in our quarterly common stock dividend beginning in April 2009 is expected to add $1 billion annually to PNC’s common equity and cash positions, resulting in annual improvement in capital ratios of approximately 40 basis points.

   

We strengthened our liquidity position and we remain core funded with a loan to deposit ratio of 88% at March 31, 2009 compared with 91% at December 31, 2008. We continued to generate new deposits while allowing high rate acquired certificate of deposit balances to decline consistent with our focus on relationship-based deposits.

   

We are committed to responsible lending, essential to economic recovery. Loans and commitments of approximately $26 billion were originated and renewed during the first quarter of 2009 as we


 

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continued to make credit available to qualified borrowers.

   

Credit quality deterioration continued during the first quarter of 2009 as expected, reflecting further economic weakening and resulting in net additions to loan loss reserves. Nonperforming assets increased during the quarter and were 2.02% of total loans and foreclosed assets at March 31, 2009 compared with 1.23% at December 31, 2008. The ratio of allowance for loan and lease losses to total loans increased to 2.51% at March 31, 2009 from 2.23% at December 31, 2008.

   

Investment securities were $46 billion at March 31, 2009, or 16% of total assets. Approximately 92% of the portfolio was comprised of agency or investment grade equivalent securities.

   

The acquisition of National City is currently exceeding our expectations.

   

The transaction was accretive to first quarter 2009 earnings and is expected to be accretive for full year 2009.

   

The combined company was focused on clients and business growth, implementing centralized loan and deposit pricing.

   

Cost savings of approximately $400 million annualized were realized in the first quarter of 2009, progressing toward the two-year goal of reducing combined company annualized noninterest expense by $1.2 billion.

   

Agreements were reached in April 2009 to divest 61 branches in the third quarter of 2009.

   

The first wave of client conversions is planned for the fourth quarter of 2009.

Our Consolidated Income Statement Review section of this Financial Review describes in greater detail the various items that impacted our results for the first quarters of 2009 and 2008.

AVERAGE CONSOLIDATED BALANCE SHEET HIGHLIGHTS

Various seasonal and other factors impact our period-end balances whereas average balances are generally more indicative of underlying business trends apart from the impact of recent acquisitions.

Our Average Consolidated Balance Sheet for the first quarter of 2009 included the impact of National City, which was the primary driver of increases compared with the first quarter of 2008. The Consolidated Balance Sheet Review section of this Financial Review provides information on changes in selected Consolidated Balance Sheet categories at March 31, 2009 compared with December 31, 2008.

Total average assets were $280.9 billion for the first three months of 2009 compared with $140.6 billion for the first three months of 2008. Total average assets for the first three months of 2009 included $134.9 billion related to National City.

 

Average interest-earning assets were $244.2 billion for the first quarter of 2009, including $123.5 billion related to National City, compared with $111.3 billion in the first quarter of 2008. An increase of $104.5 billion in loans, including $98.2 billion related to National City, and a $16.2 billion increase in securities available for sale, including $13.1 billion related to National City, were reflected in the increase in average interest-earning assets. In addition, securities held to maturity, including those transferred by PNC in the fourth quarter of 2008 from the available for sale portfolio, averaged $3.4 billion in the first quarter of 2009.

Average noninterest-earning assets totaled $36.6 billion in the first quarter of 2009 compared with $29.2 billion in the prior year quarter.

The increase in average total loans, which includes the impact of National City as indicated above, reflected growth in commercial loans of $37.7 billion, consumer loans of $33.7 billion, commercial real estate loans of $16.6 billion and residential mortgage loans of $12.5 billion. Loans represented 71% of average interest-earning assets for the first three months of 2009 and 62% for the first three months of 2008.

Average residential mortgage-backed securities increased $15.7 billion compared with the first quarter of 2008. Average US Treasury and government agencies securities increased $1.1 billion and average state and municipal securities increased $.9 billion in the comparison. These increases were largely as a result of the National City acquisition and were partially offset by declines of $1.3 billion in average commercial mortgage-backed securities and $.8 billion in average asset-backed securities compared with the prior year quarter. Investment securities comprised 20% of average interest-earning assets for the first three months of 2009 and 27% for the first three months of 2008.

Average total deposits were $192.2 billion for the first three months of 2009, including $104.0 billion related to National City, compared with $81.6 billion for the first three months of 2008. Average deposits grew from the prior year period primarily as a result of increases in money market balances, retail certificates of deposit, and demand and other noninterest-bearing deposits. Average total deposits represented 68% of average total assets for the first three months of 2009 and 58% for the first three months of 2008.

Average transaction deposits were $113.5 billion for the first three months of 2009, including $49.6 billion related to National City, compared with $52.5 billion for the first three months of 2008.

Average borrowed funds were $47.9 billion for the first quarter of 2009, including $21.1 billion related to National City, compared with $32.1 billion for the first quarter of 2008.


 

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BUSINESS SEGMENT HIGHLIGHTS

In the first quarter of 2009, we made changes to our business organization structure and management reporting in conjunction with the acquisition of National City. As a result, we now have seven reportable business segments which include:

   

Retail Banking

   

Corporate & Institutional Banking

   

Asset Management Group

   

Residential Mortgage Banking

   

BlackRock

   

Global Investment Servicing

   

Distressed Assets Portfolio

Business segment results for the first quarter of 2008 have been reclassified to present prior periods on the same basis.

Total business segment earnings were $750 million for the first three months of 2009 and $289 million for the first three months of 2008. Highlights of results for the first quarters of 2009 and 2008 are included below. The Business Segments Review section of this Financial Review includes further analysis of our business segment results over these periods.

We provide a reconciliation of total business segment earnings to total PNC consolidated net income as reported on a GAAP basis in Note 19 Segment Reporting.

Retail Banking

Retail Banking earned $56 million for the first quarter of 2009. Results for the quarter were challenged in this environment by ongoing credit deterioration, a lower value assigned to deposits in a declining rate environment, reduced consumer spending and increased FDIC insurance costs. Retail Banking continues to maintain its focus on customer growth, employee and customer satisfaction, investing in the business for future growth, as well as disciplined expense management during this period of market and economic uncertainty.

Corporate & Institutional Banking

Corporate & Institutional Banking earned $374 million in the first quarter of 2009. Total revenue of $1.3 billion was strong given the current environment, driven primarily by net interest income. Noninterest expense was tightly managed, and earnings were impacted by the provision for credit losses, indicative of deteriorating credit quality occurring throughout the economy.

Asset Management Group

Earnings from the Asset Management Group totaled $38 million in the first quarter of 2009 compared with $37 million in the prior year first quarter. The current period earnings reflects new business obtained from National City offset by lower noninterest income and higher provision for credit losses stemming from the depressed equity markets and continued economic challenges. This business segment was formed in the first quarter of 2009.

 

Residential Mortgage Banking

Residential Mortgage Banking earned $226 million for the first quarter of 2009 driven by strong loan origination activity and income from servicing rights. This business segment was formed in the first quarter of 2009 and consists primarily of activities acquired with National City.

BlackRock

Our BlackRock business segment earned $23 million for the first quarter of 2009 compared with $60 million for the first quarter of 2008. Lower equity markets in the first quarter of 2009 impacted BlackRock’s results.

Global Investment Servicing

Global Investment Servicing earned $10 million for the first quarter of 2009 compared with $30 million for the same period of 2008. Results for 2009 were negatively impacted by continued declines in asset values and fund redemptions as a result of the deterioration of the financial markets that began in the fourth quarter of 2008 and the establishment of a legal contingency reserve.

Distressed Assets Portfolio

This business segment was formed in the first quarter of 2009 and consists primarily of assets acquired with National City. The Distressed Assets Portfolio had earnings of $23 million for the first quarter of 2009. Earnings were mainly driven by net interest income of $364 million. Further deterioration of credit quality occurred on the loans in this segment during the quarter.

Other

“Other” reported a net loss of $220 million for the first quarter of 2009 compared with earnings of $95 million for the first quarter of 2008. The loss for the first quarter of 2009 included the after-tax impact of other-than-temporary impairment charges and alternative investment writedowns, equity management losses and integration costs. These items were somewhat offset by a gain related to PNC’s BlackRock LTIP shares obligation and net gains on sales of securities. Earnings for the first quarter of 2008 reflected net securities gains and the partial reversal of the Visa indemnification liability, partially offset by trading losses.

CONSOLIDATED INCOME STATEMENT REVIEW

Our Consolidated Income Statement is presented in Part I, Item 1 of this Report. Net income for the first three months of 2009 was $530 million and for the first three months of 2008 was $384 million. Our Consolidated Income Statement for the first quarter of 2009 includes operating results of National City. As a result, the substantial increase in all income statement comparisons to the first quarter of 2008, except as noted, are primarily due to the operating results of National City.

NET INTEREST INCOME AND NET INTEREST MARGIN

 

    Three months ended March 31  
Dollars in millions       2009             2008      

Net interest income

  $ 2,305     $ 854  

Net interest margin

    3.81 %     3.09 %

 

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In addition to the first quarter 2009 impact of National City, changes in net interest income and margin result from the interaction of the volume and composition of interest-earning assets and related yields, interest-bearing liabilities and related rates paid, and noninterest-bearing sources of funding. See the Statistical Information – Average Consolidated Balance Sheet And Net Interest Analysis section of this Report for additional information.

The increase in net interest income for the first three months of 2009 compared with the first three months of 2008 reflected the increase in average interest-earning assets due to National City and the improvement in the net interest margin described below.

We expect net interest income and net interest margin for the remainder of 2009 to be flat to down compared with the first quarter of 2009 as the maturity of higher-yielding assets will be partially offset by interest-bearing deposit re-pricing, assuming our current expectations for interest rates and economic conditions. We include our current economic assumptions underlying our forward-looking statements in the Cautionary Statement Regarding Forward-Looking Information section of this Financial Review.

The net interest margin was 3.81% for the first three months of 2009 and 3.09% for the first three months of 2008. The following factors impacted the comparison:

   

A decrease in the rate paid on interest-bearing liabilities of 126 basis points. The rate paid on interest-bearing deposits, the largest component, decreased 138 basis points.

   

These factors were partially offset by a 45 basis point decrease in the yield on interest-earning assets. The yield on loans, which represented a larger portion of our earning assets in the first quarter of 2009, decreased 46 basis points.

   

In addition, the impact of noninterest-bearing sources of funding decreased 9 basis points due to lower interest rates and a lower proportion of noninterest-bearing sources of funding to interest-earning assets.

For comparing to the broader market, during the first three months of 2009 the average federal funds rate was .19% compared with 3.17% for the first three months of 2008.

NONINTEREST INCOME

Summary

Noninterest income totaled $1.566 billion for the first three months of 2009 compared with $967 million for the first three months of 2008. Noninterest income for the first quarter of 2009 included $945 million of noninterest income related to National City.

First quarter 2009 noninterest income included the following:

   

Gains on hedges of residential mortgage servicing rights of $202 million,

   

Gains of $103 million related to our BlackRock LTIP shares adjustment,

   

Net credit-related other-than-temporary impairments on debt and equity securities of $149 million,

   

Net losses on private equity and alternative investments of $122 million, and

   

Net gains on sales of securities of $56 million.

Noninterest income for the first three months of 2008 included the impact of the following:

   

Losses related to our commercial mortgage loans held for sale, net of hedges, of $166 million,

   

Income from Hilliard Lyons totaling $164 million, including the gain of $114 million from the sale of this business,

   

A gain of $95 million related to the redemption of a portion of our Visa Class B common shares related to Visa’s March 2008 initial public offering,

   

Trading losses of $76 million,

   

Net gains on sales of securities of $41 million, and

   

Gains of $40 million related to our BlackRock LTIP shares adjustment.

Additional Analysis

Fund servicing fees totaled $199 million in the first three months of 2009 compared with $228 million in the first three months of 2008. Asset management revenue was $189 million in the first three months of 2009 compared with $212 million in the first three months of 2008. Fund servicing fees and asset management revenue were negatively impacted by declines in asset values associated with the lower equity markets during the first three months of 2009. We believe that the equity markets may rebound in 2009 in advance of an economic recovery resulting in improvement to these components of our fee-based income.

Assets managed at March 31, 2009 totaled $96 billion, including National City assets under management, compared with $66 billion at March 31, 2008.

Global Investment Servicing provided fund accounting/ administration services for $712 billion of net fund investment assets and provided custody services for $361 billion of fund investment assets at March 31, 2009, compared with $1.0 trillion and $476 billion, respectively, at March 31, 2008. The decrease in assets serviced in the comparison was due to declines in asset values and fund outflows resulting from market conditions.

For the first quarter of 2009, consumer services fees totaled $316 million, including $180 million related to National City, compared with $170 million in the first quarter of 2008. Consumer service fees in the 2009 period reflected higher card-related revenue more than offset by reduced consumer transaction volumes related to the economy.

Corporate services revenue totaled $245 million in the first three months of 2009, including $73 million related to


 

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National City, and $164 million in the first quarter of 2008. Corporate services fees include treasury management fees, which continued to be a strong contributor to revenue.

Residential mortgage revenue totaled $431 million in the first quarter of 2009. Substantially all of this revenue is associated with National City’s business. Strong mortgage refinancing volumes and $202 million of net hedging gains of mortgage servicing rights occurred in the first quarter of 2009. It is unlikely that we will repeat this strong performance in future periods, particularly the servicing rights hedging gains.

Service charges on deposits totaled $224 million for the first three months of 2009, including $137 million related to National City, and $82 million for the first three months of 2008. Service charges on deposits increased despite declining customer transaction amounts and volumes.

Net gains on sales of securities totaled $56 million for the first quarter of 2009 and $41 million for the first quarter of 2008.

The net credit component of other-than-temporary impairments of securities recognized in earnings was a loss of $149 million in the first three months of 2009. The non-credit component of the fair value mark on these securities of $537 million, which related to market factors, was included in accumulated other comprehensive loss in shareholders’ equity at March 31, 2009. There were no other-than-temporary impairments recognized in the first three months of 2008.

Other noninterest income totaled $55 million for the first quarter of 2009 compared with $70 million for the first quarter of 2008. Other noninterest income for 2009 included gains of $103 million related to our equity investment in BlackRock and net losses on private equity and alternative investments of $122 million as referred to above.

Other noninterest income for 2008 included the $114 million gain from the sale of Hilliard Lyons, the $95 million gain from the redemption of a portion of our investment in Visa related to its March 2008 initial public offering, and gains of $40 million related to our equity investment in BlackRock as described above. The impact of these items was more than offset by losses related to our commercial mortgage loans held for sale, net of hedges, of $166 million, and trading losses of $76 million.

Other noninterest income typically fluctuates from period to period depending on the nature and magnitude of transactions completed. Further details regarding our trading activities are included in the Market Risk Management – Trading Risk portion of the Risk Management section of this Financial Review, further details regarding private equity and alternative investments are included in the Market Risk Management-Equity and Other Investment Risk section and further details regarding gains or losses related to our equity investment in BlackRock are included in the Business Segments Review section.

 

PRODUCT REVENUE

In addition to credit and deposit products for commercial customers, Corporate & Institutional Banking offers other services, including treasury management and capital markets-related products and services and commercial mortgage banking activities, that are marketed by several businesses to commercial and retail customers across PNC.

Treasury management revenue, which includes fees as well as net interest income from customer deposit balances, doubled in the first quarter of 2009, to $275 million, compared with $137 million in the first quarter of 2008. In addition to the impact of National City, these increases were primarily related to deposit growth and continued growth in legacy offerings such as lockbox, purchasing cards and services provided to the federal government.

Revenue from capital markets-related products and services totaled $43 million in the first three months of 2009 compared with $76 million in the first three months of 2008. The revenue decline was driven by reduced merger and acquisition revenues reflecting the difficult financing environment along with lower customer trading revenues impacted by reduced derivative activity levels and the impact of counterparty credit on valuations of customer positions. These revenue declines were partially offset by National City-related revenues in 2009.

Commercial mortgage banking activities include revenue derived from commercial mortgage servicing (including net interest income and noninterest income from loan servicing and ancillary services), and revenue derived from commercial mortgage loans intended for sale and related hedges (including loan origination fees, net interest income, valuation adjustments and gains or losses on sales).

Commercial mortgage banking activities resulted in revenue of $94 million in the first quarter of 2009 compared with a $94 million loss for the first quarter of 2008. The loss for the first three months of 2008 reflected losses of $166 million on commercial mortgage loans held for sale, net of hedges, due to the impact of an illiquid market in 2008.

PROVISION FOR CREDIT LOSSES

The provision for credit losses totaled $880 million for the first three months of 2009 compared with $151 million for the first three months of 2008. The provision for credit losses for the first quarter of 2009 was in excess of net charge-offs of $431 million for the period due to a required increase to our allowance for loan and lease losses reflecting continued deterioration in the credit markets and the resulting increase in nonperforming loans.

The Credit Risk Management portion of the Risk Management section of this Financial Review includes additional information regarding factors impacting the provision for credit losses.


 

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NONINTEREST EXPENSE

Noninterest expense for the first quarter of 2009 was $2.3 billion compared with $1.0 billion in the prior year first quarter, with the increase substantially related to National City. Acquisition cost savings of approximately $400 million annualized were realized in the first quarter of 2009, on plan to reach our goal of annualized cost savings of $1.2 billion at the end of two years.

Integration costs totaled $52 million in the first quarter of 2009 compared with $14 million in the first quarter of 2008.

We expect that the FDIC will enact a special deposit insurance assessment in 2009 that will significantly increase our FDIC deposit insurance costs for the year.

EFFECTIVE TAX RATE

Our effective tax rate was 20.1% for the first three months of 2009 and 39.5% for the first three months of 2008. A favorable agreement to settle with taxing authorities in the first quarter of 2009 contributed to the lower effective tax rate in that period and higher taxes related to the gain on sale of Hilliard Lyons in the first quarter of 2008 contributed to the higher effective tax rate in that period.

CONSOLIDATED BALANCE SHEET REVIEW

SUMMARIZED BALANCE SHEET DATA

 

In millions   

March 31

2009

  

Dec. 31

2008

Assets

       

Loans

   $ 171,373    $ 175,489

Investment securities

     46,253      43,473

Cash and short-term investments

     21,807      23,936

Loans held for sale

     4,045      4,366

Equity investments

     8,215      8,554

Goodwill

     8,855      8,868

Other intangible assets

     3,323      2,820

Other

     22,551      23,575

Total assets

   $ 286,422    $ 291,081

Liabilities

       

Deposits

     194,635    $ 192,865

Borrowed funds

     48,459      52,240

Other

     14,672      18,328

Total liabilities

     257,766      263,433

Total shareholders’ equity

     26,477      25,422

Noncontrolling interests

     2,179      2,226

Total equity

     28,656      27,648

Total liabilities and equity

   $ 286,422    $ 291,081

The summarized balance sheet data above is based upon our Consolidated Balance Sheet in Part I, Item 1 of this Report.

An analysis of changes in selected balance sheet categories follows.

 

LOANS

A summary of the major categories of loans outstanding follows. Outstanding loan balances reflect unearned income, unamortized discount and premium, and purchase discounts and premiums totaling $3.5 billion at March 31, 2009 and $4.1 billion at December 31, 2008, respectively.

Loans decreased $4.1 billion, or 2%, as of March 31, 2009 compared with December 31, 2008. Total loans represented 60% of total assets at both March 31, 2009 and December 31, 2008.

Commercial lending represented 57% of the loan portfolio and consumer lending represented 43% at March 31, 2009. Commercial lending declined 4% at March 31, 2009 compared with December 31, 2008. Commercial loans, which comprised 67% of total commercial lending, declined due to lower utilization levels and paydowns. Consumer lending increased slightly at March 31, 2009 from December 31, 2008. Increases in education and residential mortgage loans were somewhat offset by a decline in home equity installment loans.

Details Of Loans

 

In millions    March 31
2009
  

Dec. 31

2008

Commercial

       

Retail/wholesale

   $ 11,226    $ 11,482

Manufacturing

     12,796      13,263

Other service providers

     8,674      9,038

Real estate related (a)

     8,926      9,107

Financial services

     5,050      5,194

Health care

     3,079      3,201

Other

     15,446      17,935

Total commercial

     65,197      69,220

Commercial real estate

       

Real estate projects

     16,830      17,176

Commercial mortgage

     8,590      8,560

Total commercial real estate

     25,420      25,736

Equipment lease financing

     6,300      6,461

TOTAL COMMERCIAL LENDING

     96,917      101,417

Consumer

       

Home equity

       

Lines of credit

     24,112      24,024

Installment

     12,934      14,252

Education

     5,127      4,211

Automobile

     1,737      1,667

Credit card and other unsecured lines of credit

     3,148      3,163

Other

     4,910      5,172

Total consumer

     51,968      52,489

Residential real estate

       

Residential mortgage

     19,661      18,783

Residential construction

     2,827      2,800

Total residential real estate

     22,488      21,583

TOTAL CONSUMER LENDING

     74,456      74,072

Total loans

   $ 171,373    $ 175,489
(a) Includes loans to customers in the real estate and construction industries.

 

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Our loan portfolio continued to be diversified among numerous industries and types of businesses. The loans that we hold are also concentrated in, and diversified across, our principal geographic markets.

Our home equity lines and loans outstanding totaled $37.0 billion at March 31, 2009 and $38.3 billion at December 31, 2008. In this portfolio, we consider the higher risk loans to be those with a recent FICO credit score of less than or equal to 660 and a loan-to-value ratio greater than or equal to 90%. We had $1.2 billion or approximately 3% of the total portfolio in this grouping at March 31, 2009 and December 31, 2008.

In our $19.7 billion residential mortgage portfolio, loans with a recent FICO credit score of less than or equal to 660 and a loan-to-value ratio greater than 90% totaled $3.3 billion and comprised approximately 17% of this portfolio at March 31, 2009. The comparable amounts related to the $18.8 billion residential mortgage portfolio as of December 31, 2008 were $2.5 billion and 14%, respectively.

Commercial lending outstandings are the largest category and are the most sensitive to changes in assumptions and judgments underlying the determination of the allowance for loan and lease losses. We have allocated $2.8 billion, or 65%, of the total allowance for loan and lease losses at March 31, 2009 to these loans. We allocated $1.5 billion, or 35%, of the remaining allowance at that date to consumer lending outstandings. This allocation also considers other relevant factors such as:

   

Actual versus estimated losses,

   

Regional and national economic conditions,

   

Business segment and portfolio concentrations,

   

Industry conditions,

   

The impact of government regulations, and

   

Risk of potential estimation or judgmental errors, including the accuracy of risk ratings.

Net unfunded credit commitments are comprised of the following:

Net Unfunded Credit Commitments

 

In millions    March 31
2009
  

Dec 31

2008

Commercial and commercial real estate

   $ 58,771    $ 60,020

Home equity lines of credit

     22,416      23,195

Consumer credit card lines

     19,291      19,028

Other

     2,343      2,645

Total

   $ 102,821    $ 104,888

Unfunded commitments are concentrated in our primary geographic markets. Commitments to extend credit represent arrangements to lend funds or provide liquidity subject to specified contractual conditions. Commercial commitments

are reported net of participations, assignments and syndications, primarily to financial institutions, totaling $8.7 billion at March 31, 2009 and $8.6 billion at December 31, 2008.

Unfunded liquidity facility commitments and standby bond purchase agreements totaled $6.7 billion at March 31, 2009 and $7.0 billion at December 31, 2008 and are included in the preceding table primarily within the “Commercial and commercial real estate” category.

In addition to credit commitments, our net outstanding standby letters of credit totaled $10.3 billion at March 31, 2009 and December 31, 2008. Standby letters of credit commit us to make payments on behalf of our customers if specified future events occur.

INVESTMENT SECURITIES

Details Of Investment Securities

 

In millions    Amortized
Cost
   Fair
Value

March 31, 2009

       

SECURITIES AVAILABLE FOR SALE

       

Debt securities

       

US Treasury and government agencies

   $ 2,597    $ 2,624

Residential mortgage-backed

       

Agency

     22,860      23,427

Nonagency

     12,900      9,281

Commercial mortgage-backed

     4,248      3,428

Asset-backed

     2,005      1,489

State and municipal

     1,382      1,337

Other debt

     786      774

Corporate stocks and other

     281      280

Total securities available for sale

   $ 47,059    $ 42,640

SECURITIES HELD TO MATURITY

       

Debt securities

       

Commercial mortgage-backed

   $ 2,002    $ 1,969

Asset-backed

     1,602      1,623

Other debt

     9      10

Total securities held to maturity

   $ 3,613    $ 3,602

December 31, 2008

       

SECURITIES AVAILABLE FOR SALE

       

Debt securities

       

US Treasury and government agencies

   $ 738    $ 739

Residential mortgage-backed

       

Agency

     22,744      23,106

Nonagency

     13,205      8,831

Commercial mortgage-backed

     4,305      3,446

Asset-backed

     2,069      1,627

State and municipal

     1,326      1,263

Other debt

     563      559

Corporate stocks and other

     575      571

Total securities available for sale

   $ 45,525    $ 40,142

SECURITIES HELD TO MATURITY

       

Debt securities

       

Commercial mortgage-backed

   $ 1,945    $ 1,896

Asset-backed

     1,376      1,358

Other debt

     10      10

Total securities held to maturity

   $ 3,331    $ 3,264

 

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Investment securities totaled $46.3 billion at March 31, 2009 and $43.5 billion at December 31, 2008. The increase in securities of $2.8 billion since year-end reflected the purchase of US Treasury and government agency securities, somewhat offset by maturities and prepayments. Securities represented 16% of total assets at March 31, 2009 and 15% of total assets at December 31, 2008.

We evaluate our portfolio of investment securities in light of changing market conditions and other factors and, where appropriate, take steps intended to improve our overall positioning.

At March 31, 2009, the investment securities balance included a net unrealized loss of $4.4 billion, which represented the difference between fair value and amortized cost. The comparable amount at December 31, 2008 was a net unrealized loss of $5.4 billion. The fair value of investment securities is impacted by interest rates, credit spreads, and market volatility and illiquidity. The improvement in the unrealized pretax loss from year-end was the result of improving fair values in both agency and nonagency securities. The net unrealized losses at March 31, 2009 did not reflect credit quality concerns of any significance with the underlying assets, which represented an overall well-diversified, high quality portfolio. US government agency residential mortgage-backed securities and US Treasury and government agencies securities collectively represented 56% of the investment securities portfolio at March 31, 2009.

FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments,” was issued in April 2009 and amended other-than-temporary impairment (OTTI) guidance for debt securities regarding recognition and disclosure. The major change in the guidance was the requirement to recognize only the credit portion of OTTI charges in current earnings for those debt securities where there is no intent to sell or it is more likely than not the entity would not be required to sell the security prior to expected recovery. The remaining portion of OTTI charges is included in accumulated other comprehensive loss.

As permitted, PNC adopted this guidance effective January 1, 2009. As a result, we recognized total OTTI in the first quarter of 2009 of $686 million, comprised of $537 million in accumulated other comprehensive loss on the Consolidated Balance Sheet at March 31, 2009, and $149 million recognized as a reduction of noninterest income in our Consolidated Income Statement. Note 7 Investment Securities in the Notes To Consolidated Financial Statements of this Report provides further information regarding the credit portion of OTTI recognized in the first quarter of 2009.

As required under the new FASB guidance, we also recorded a cumulative effect adjustment of $110 million to retained earnings at January 1, 2009 to reclassify the noncredit component of OTTI recognized in 2008 from retained earnings to accumulated other comprehensive loss.

 

We also early adopted FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly,” during the first quarter of 2009. The Fair Value Measurements and Fair Value Option section of this Financial Review has additional information related to FSP FAS 157-4.

At least quarterly we conduct a comprehensive security-level impairment assessment. Our process and methods have evolved as market conditions have deteriorated and as more research and other analyses have become available. We expect that our process and methods will continue to evolve. Our assessment considers the security structure, recent security collateral performance metrics, our judgment and expectations of future performance, and relevant industry research and analysis. We also consider the magnitude of the impairment and the amount of time that the security has been impaired in our assessment. Results of the periodic assessment are reviewed by a cross-functional senior management team representing Asset & Liability Management, Finance, and Balance Sheet Risk Management. The senior management team considers the results of the assessments, as well as other factors, in determining whether the impairment is other-than-temporary. The Fair Value Measurements And Fair Value Option section of this Financial Review provides further detail on the composition of our securities portfolio, including vintage, credit rating, and FICO score, where applicable. Note 7 Investment Securities in the Notes To Consolidated Financial Statements of this Report includes a further discussion of our process for assessing OTTI and the results of the most recent assessment.

If the current issues affecting the US housing market were to continue for the foreseeable future or worsen, if market volatility and illiquidity were to continue or worsen, or if market interest rates were to increase appreciably, the valuation of our available for sale securities portfolio could continue to be adversely affected and we could incur additional OTTI charges that would impact our Consolidated Income Statement.

Net unrealized gains and losses in the securities available for sale portfolio are included in shareholders’ equity as accumulated other comprehensive income or loss, net of tax. The fair value of investment securities generally decreases when interest rates increase and vice versa. In addition, the fair value generally decreases when credit spreads widen and vice versa.

The expected weighted-average life of investment securities (excluding corporate stocks and other) was 3 years and 5 months at March 31, 2009 and 3 years and 1 month at December 31, 2008.


 

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We estimate that at March 31, 2009 the effective duration of investment securities was 2.3 years for an immediate 50 basis points parallel increase in interest rates and 1.9 years for an immediate 50 basis points parallel decrease in interest rates. Comparable amounts at December 31, 2008 were 3.7 years and 3.1 years, respectively.

LOANS HELD FOR SALE

 

In millions   

March 31

2009

  

Dec. 31

2008

Commercial mortgages at fair value (a)

   $ 1,245    $ 1,401

Commercial mortgages at lower of cost or market

     403      747

Total commercial mortgages

     1,648      2,148

Residential mortgages at fair value (a)

     2,226      1,824

Residential mortgages at lower of cost or market

     18      138

Total residential mortgages

     2,244      1,962

Other

     153      256

Total

   $ 4,045    $ 4,366
(a) Balance at December 31, 2008 includes loans held for sale which were acquired from National City and recorded at fair value at the date of acquisition.

Under SFAS 159, we account for certain commercial and residential mortgage loans held for sale at fair value.

We stopped originating certain commercial mortgage loans held for sale at fair value during the first quarter of 2008 and intend to continue pursuing opportunities to reduce these positions at appropriate prices. We sold $.1 billion of commercial mortgage loans held for sale carried at fair value in the first quarter of 2009 and recognized losses of $1 million on these loans, net of hedges. Losses of $166 million on commercial mortgage loans held for sale carried at fair value, net of hedges, were recognized in the first quarter of 2008.

Strong origination volumes partially offset sales to government agencies of $1.6 billion of commercial mortgages held for sale at lower of cost or market during the first quarter of 2009.

Residential mortgage loans held for sale increased during the first quarter of 2009 due to strong refinancing volumes. Loan origination volume was $6.9 billion. Substantially all such loans were originated to agency standards. We sold $6.3 billion of this production, recognizing revenue of $175 million, during the first quarter of 2009. Net interest income on residential mortgage loans held for sale was $87 million for the first quarter of 2009.

 

FUNDING AND CAPITAL SOURCES

Details Of Funding Sources

 

In millions    March 31
2009
   Dec. 31
2008

Deposits

       

Money market

   $ 74,389    $ 67,678

Demand

     44,473      43,212

Retail certificates of deposit

     57,785      58,315

Savings

     6,570      6,056

Other time

     7,619      13,620

Time deposits in foreign offices

     3,799      3,984

Total deposits

     194,635      192,865

Borrowed funds

       

Federal funds purchased and repurchase agreements

     4,789      5,153

Federal Home Loan Bank borrowings

     16,985      18,126

Bank notes and senior debt

     13,828      13,664

Subordinated debt

     10,694      11,208

Other

     2,163      4,089

Total borrowed funds

     48,459      52,240

Total

   $ 243,094    $ 245,105

Total funding sources decreased $2.0 billion at March 31, 2009 compared with the balance at December 31, 2008 as an increase in total deposits was more than offset by a decline in total borrowed funds.

Total deposits increased $1.8 billion at March 31, 2009 compared with December 31, 2008 as growth in money market deposits was partially offset by the decline of higher rate non-relationship certificates of deposit. Interest-bearing deposits represented 79% of total deposits at March 31, 2009 compared with 81% of total deposits at December 31, 2008.

Borrowed funds totaled $48.5 billion at March 31, 2009 compared with $52.2 billion at December 31, 2008. The $3.7 billion decline primarily resulted from repayments of Federal Home Loan Bank and other borrowings. PNC issued $1.0 billion of senior notes guaranteed by the FDIC under the Temporary Liquidity Guarantee Program in the first quarter of 2009. The Liquidity Risk Management section of this Financial Review contains further details regarding actions we have taken which impacted our borrowed funds balances in 2009.

Capital

We manage our capital position by making adjustments to our balance sheet size and composition, issuing debt, equity or hybrid instruments, executing treasury stock transactions, managing dividend policies and retaining earnings. The reduction in our quarterly common stock dividend beginning in April 2009 is expected to add $1 billion annually to PNC’s common equity and cash positions, resulting in annual improvement in capital ratios of approximately 40 basis points.


 

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Total shareholders’ equity increased $1.1 billion, to $26.5 billion, at March 31, 2009 compared with December 31, 2008 primarily due to a $.7 billion decline in accumulated other comprehensive loss and an increase of $.3 billion in retained earnings. The Investment Securities section has further information regarding the accumulated other comprehensive loss.

Common shares outstanding were 445 million at March 31, 2009 and 443 million at December 31, 2008.

Our current common stock repurchase program permits us to purchase up to 25 million shares of PNC common stock on the open market or in privately negotiated transactions. This program will remain in effect until fully utilized or until modified, superseded or terminated. The extent and timing of share repurchases under this program will depend on a number of factors including, among others, market and general economic conditions, economic and regulatory capital considerations, alternative uses of capital, regulatory and contractual limitations, and the potential impact on our credit ratings. We did not purchase any shares during the first quarter of 2009 under this program and, as described below, are restricted from doing so under the TARP Capital Purchase Program.

Under the TARP Capital Purchase Program, there are restrictions on dividends and common share repurchases associated with the preferred stock that we issued to the US Treasury in accordance with that program. As is typical with cumulative preferred stock, dividend payments for this preferred stock must be current before dividends can be paid on junior shares, including our common stock, or junior shares can be repurchased or redeemed. Also, under the TARP Capital Purchase Program agreements, the US Treasury’s consent will be required for any increase in common dividends per share above $.66 per share quarterly until the third anniversary of the preferred stock issuance as long as the US Treasury continues to hold any of the preferred stock. Further, during that same period, the US Treasury’s consent will be required, unless the preferred stock is no longer held by the US Treasury, for any share repurchases with limited exceptions, most significantly purchases of common shares in connection with any benefit plan in the ordinary course of business consistent with past practice. Any increase in our dividends while we remain subject to these restrictions would depend on the status of our efforts to put ourselves into position to redeem the US Treasury’s investment in PNC.

 

Risk-Based Capital

 

Dollars in millions    March 31
2009
    Dec. 31
2008
 

Capital components

      

Shareholders’ equity

      

Common

   $ 18,546     $ 17,490  

Preferred

     7,932       7,932  

Trust preferred capital securities

     2,981       2,898  

Noncontrolling interest

     1,512       1,506  

Goodwill and other intangible assets

     (10,239 )     (9,800 )

Eligible deferred income taxes on goodwill and other intangible assets

     791       594  

Pension, other postretirement benefit plan adjustments

     631       666  

Net unrealized securities losses, after-tax

     2,994       3,618  

Net unrealized losses (gains) on cash flow hedge derivatives, after-tax

     (378 )     (374 )

Other

     (248 )     (243 )

Tier 1 risk-based capital

     24,522       24,287  

Subordinated debt

     5,596       5,676  

Eligible allowance for credit losses

     3,078       3,153  

Total risk-based capital

   $ 33,196     $ 33,116  

Tier 1 common capital

      

Tier 1 risk-based capital

   $ 24,522     $ 24,287  

Preferred equity

     (7,932 )     (7,932 )

Trust preferred capital securities

     (2,981 )     (2,898 )

Noncontrolling interest

     (1,512 )     (1,506 )

Tier 1 common capital

   $ 12,097     $ 11,951  

Assets

      

Risk-weighted assets, including off- balance sheet instruments and market risk equivalent assets

   $ 244,746     $ 251,106  

Adjusted average total assets

     276,422       138,689  

Capital ratios

      

Tier 1 risk-based

     10.0 %     9.7 %

Tier 1 common

     4.9       4.8  

Total risk-based

     13.6       13.2  

Leverage

     8.9       17.5  

Capital levels were strengthened during the first quarter of 2009. Higher capital levels were net of dividend payments, including $47 million paid to the US Department of the Treasury during the first quarter of 2009 on $7.6 billion of preferred stock. We plan to redeem the Treasury Department’s investment as soon as appropriate, subject to approval by our primary banking regulators.

As described in the Executive Summary section of this Financial Review, as a result of the Supervisory Capital Assessment Program, we will be required to increase our Tier 1 common capital by $600 million by November 9, 2009. We intend to do so through a combination of growth in retained earnings and other capital raising alternatives. We do not contemplate exchanging any of the shares of preferred stock issued to the US Treasury under the TARP Capital Purchase Program for shares of mandatorily convertible preferred stock.


 

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PNC’s Tier 1 risk-based capital ratio increased by 30 basis points to 10.0% at March 31, 2009 from 9.7% at December 31, 2008. The increase in the ratio was due to higher risk-based capital primarily from retained earnings coupled with a decline in risk-weighted assets. Our Tier 1 common capital ratio was 4.9% at March 31, 2009.

The leverage ratio at December 31, 2008 reflected the favorable impact on Tier 1 risk-based capital from the issuance of securities under TARP and the issuance of PNC common stock in connection with the National City acquisition, both of which occurred on December 31, 2008. In addition, the ratio as of that date did not reflect any impact of National City on PNC’s adjusted average total assets.

The access to, and cost of, funding new business initiatives including acquisitions, the ability to engage in expanded business activities, the ability to pay dividends, the level of deposit insurance costs, and the level and nature of regulatory oversight depend, in part, on a financial institution's capital strength. At March 31, 2009 and December 31, 2008, each of our domestic bank subsidiaries was considered “well capitalized” based on US regulatory capital ratio requirements, which are indicated on page 2 of this Report. We believe our bank subsidiaries will continue to meet these requirements during the remainder of 2009.

OFF-BALANCE SHEET ARRANGEMENTS AND VARIABLE INTEREST ENTITIES

We engage in a variety of activities that involve unconsolidated entities or that are otherwise not reflected in our Consolidated Balance Sheet that are generally referred to as “off-balance sheet arrangements.” The following sections of this Report provide further information on these types of activities:

   

Commitments, including contractual obligations and other commitments, included within the Risk Management section of this Financial Review, and

   

Note 10 Loan Sales and Securitizations and Note 18 Commitments and Guarantees in the Notes To Consolidated Financial Statements included in Part I, Item 1 of this Report.

   

At March 31, 2009, $2.3 billion of loans were securitized by PNC. The comparable amount was $2.4 billion at December 31, 2008. These securitized loans are not included on our Consolidated Balance Sheet.

The following provides a summary of variable interest entities (VIEs), including those that we have consolidated and those in which we hold a significant variable interest but have not consolidated into our financial statements as of March 31, 2009 and December 31, 2008.

 

Consolidated VIEs – PNC Is Primary Beneficiary

 

In millions   

Aggregate

Assets

  

Aggregate

Liabilities

 

Partnership interests in low income housing projects

       

March 31, 2009

   $ 1,452    $ 803  

December 31, 2008

   $ 1,499    $ 863 (a)

Credit Risk Transfer Transaction

       

March 31, 2009

   $ 1,012    $ 1,012  

December 31, 2008

   $ 1,070    $ 1,070  
(a) We have revised this amount due to PNC’s adoption of SFAS 160 as noncontrolling interests are no longer classified as aggregate liabilities.

Non-Consolidated VIEs – Significant Variable Interests

 

In millions   

Aggregate

Assets

  Aggregate
Liabilities
  PNC Risk
of Loss
 

March 31, 2009

        

Market Street

   $ 4,618   $ 4,744   $ 6,653 (a)

Partnership interests in tax credit investments (b) (c)

     1,117     649     860  

Collateralized debt obligations

     17           2  

Total

   $ 5,752   $ 5,393   $ 7,515  

December 31, 2008

        

Market Street

   $ 4,916   $ 5,010   $ 6,965 (a)

Partnership interests in tax credit investments (b) (c)

     1,095     652     920  

Collateralized debt obligations

     20           2  

Total

   $ 6,031   $ 5,662   $ 7,887  
(a) PNC’s risk of loss consists of off-balance sheet liquidity commitments to Market Street of $6.1 billion and other credit enhancements of $.6 billion at March 31, 2009. The comparable amounts were $6.4 billion and $.6 billion at December 31, 2008. These liquidity commitments are included in the Net Unfunded Credit Commitments table in the Consolidated Balance Sheet Review section of this Report.
(b) Amounts reported primarily represent low income housing projects.
(c) Aggregate assets and aggregate liabilities represent approximate balances due to limited availability of financial information associated with the acquired National City partnerships that we did not sponsor.

Market Street

Market Street Funding LLC (Market Street) is a multi-seller asset-backed commercial paper conduit that is owned by an independent third party. Market Street’s activities primarily involve purchasing assets or making loans secured by interests in pools of receivables from US corporations that desire access to the commercial paper market. Market Street funds the purchases of assets or loans by issuing commercial paper which has been rated A1/P1 by Standard & Poor’s and Moody’s, respectively, and is supported by pool-specific credit enhancements, liquidity facilities and program-level credit enhancement. Generally, Market Street mitigates its potential interest rate risk by entering into agreements with its borrowers that reflect interest rates based upon its weighted average commercial paper cost of funds. During 2008 and the first quarter of 2009, Market Street met all of its funding needs through the issuance of commercial paper.

Market Street commercial paper outstanding was $4.1 billion at March 31, 2009 and $4.4 billion at December 31, 2008. The


 

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weighted average maturity of the commercial paper was 27 days at March 31, 2009 compared with 24 days at December 31, 2008.

Effective October 28, 2008, Market Street was approved to participate in the Federal Reserve’s CPFF authorized under Section 13(3) of the Federal Reserve Act. The CPFF commitment to purchase up to $5.4 billion of three-month Market Street commercial paper expires on October 30, 2009. As of March 31, 2009, Market Street did not have any outstandings in the CPFF.

During the first quarter of 2009, PNC Capital Markets, acting as a placement agent for Market Street, held a maximum daily position in Market Street commercial paper of $8 million with an average of $5 million. This compares with a maximum daily position of $75 million with an average of $12 million for the year ended December 31, 2008. PNC Capital Markets owned $8 million of Market Street commercial paper at March 31, 2009 and none at December 31, 2008. PNC Bank, N.A. made no purchases of Market Street commercial paper during the first quarter of 2009.

PNC Bank, N.A. provides certain administrative services, the program-level credit enhancement and 99% of liquidity facilities to Market Street in exchange for fees negotiated based on market rates. Program administrator fees and commitment fees related to PNC’s portion of the liquidity facilities for the first quarters of 2009 and 2008 were insignificant.

The commercial paper obligations at March 31, 2009 and December 31, 2008 were effectively collateralized by Market Street’s assets. While PNC may be obligated to fund under the $6.1 billion of liquidity facilities for events such as commercial paper market disruptions, borrower bankruptcies, collateral deficiencies or covenant violations, our credit risk under the liquidity facilities is secondary to the risk of first loss provided by the borrower or another third party in the form of deal-specific credit enhancement, such as by the over collateralization of the assets. Deal-specific credit enhancement that supports the commercial paper issued by Market Street is generally structured to cover a multiple of expected losses for the pool of assets and is sized to generally meet rating agency standards for comparably structured transactions. In addition, PNC would be required to fund $1.0 billion of the liquidity facilities if the underlying assets are in default. See Note 18 Commitments And Guarantees included in the Notes To Consolidated Financial Statements of this Report for additional information.

PNC provides program-level credit enhancement to cover net losses in the amount of 10% of commitments, excluding explicitly rated AAA/Aaa facilities. PNC provides 100% of the enhancement in the form of a cash collateral account funded by a loan facility. This facility expires in March 2013.

 

Market Street has entered into a Subordinated Note Purchase Agreement (Note) with an unrelated third party. The Note provides first loss coverage whereby the investor absorbs losses up to the amount of the Note, which was $8.0 million as of March 31, 2009. Proceeds from the issuance of the Note are held by Market Street in a first loss reserve account that will be used to reimburse any losses incurred by Market Street, PNC Bank, N.A. or other providers under the liquidity facilities and the credit enhancement arrangements.

Assets of Market Street Funding LLC (a)

 

In millions    Outstanding    Commitments    Weighted
Average
Remaining
Maturity
In Years

March 31, 2009

          

Trade receivables

   $ 1,491    $ 3,389    2.21

Automobile financing

     904      937    3.58

Collateralized loan obligations

     280      305    1.22

Credit cards

     300      300    .44

Residential mortgage

     14      14    26.75

Other

     1,151      1,315    1.87

Cash and miscellaneous receivables

     478            

Total

   $ 4,618    $ 6,260    2.27

December 31, 2008

          

Trade receivables

   $ 1,516    $ 3,370    2.34

Automobile financing

     992      992    3.94

Collateralized loan obligations

     306      405    1.58

Credit cards

     400      400    .19

Residential mortgage

     14      14    27.00

Other

     1,168      1,325    1.76

Cash and miscellaneous receivables

     520            

Total

   $ 4,916    $ 6,506    2.34
(a) Market Street did not recognize an asset impairment charge or experience any material rating downgrades during 2008 or the first quarter of 2009.

Market Street Commitments by Credit Rating (a)

 

      March 31,
2009
    December 31,
2008
 

AAA/Aaa

   22 %   19 %

AA/Aa

   10     6  

A/A

   62     72  

BBB/Baa

   6     3  

Total

   100 %   100 %
(a) The majority of our facilities are not explicitly rated by the rating agencies. All facilities are structured to meet rating agency standards for applicable rating levels.

We evaluated the design of Market Street, its capital structure, the Note, and relationships among the variable interest holders under the provisions of FASB Interpretation No. 46, (Revised 2003) “Consolidation of Variable Interest Entities” (FIN 46R). Based on this analysis, we are not the primary beneficiary as defined by FIN 46R and therefore the assets and liabilities of Market Street are not reflected in our Consolidated Balance Sheet.


 

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We would consider changes to the variable interest holders (such as new expected loss note investors and changes to program-level credit enhancement providers), terms of expected loss notes, and new types of risks related to Market Street as reconsideration events. We review the activities of Market Street on at least a quarterly basis to determine if a reconsideration event has occurred.

Based on current accounting guidance, we are not required to consolidate Market Street into our consolidated financial statements. However, if PNC would be determined to be the primary beneficiary under FIN 46R, we would consolidate the commercial paper conduit at that time. Based on current accounting guidance, to the extent that the par value of the assets in Market Street exceeded the fair value of the assets upon consolidation, the difference would be recognized by PNC as a loss in our Consolidated Income Statement in that period. Based on the fair value of the assets held by Market Street at March 31, 2009, this loss would not be material. In addition, the consolidation of Market Street would have minimal to no impact on our risk-weighted assets, risk-based capital ratios or debt covenants.

Credit Risk Transfer Transaction

PNC’s subsidiary, National City Bank (NCB), sponsored a special purpose entity (SPE) trust and concurrently entered into a credit risk transfer agreement with an independent third-party to mitigate credit losses on a pool of nonconforming mortgage loans originated by its former First Franklin business unit. The SPE was formed with a small contribution from NCB and was structured as a bankruptcy-remote entity so that its creditors have no recourse to NCB. In exchange for a perfected security interest in the cash flows of the nonconforming mortgage loans, the SPE issued to NCB asset-backed securities in the form of senior, mezzanine, and subordinated equity notes. NCB has incurred credit losses equal to the subordinated equity notes and currently holds the right to put certain tranches of the mezzanine notes to the independent third-party at par. NCB holds the senior notes and will be responsible for credit losses in excess of the mezzanine securities.

The SPE was deemed to be a VIE as its equity was not sufficient to finance its activities. NCB was determined to be the primary beneficiary of the SPE as it would absorb the majority of the expected losses of the SPE through its holding of certain of the asset-backed securities. Accordingly, this SPE was consolidated and all of the entity’s assets, liabilities, and equity associated with the note tranches held by NCB are intercompany balances and are eliminated in consolidation. Nonconforming mortgage loans, including foreclosed properties, pledged as collateral to the SPE remain on the balance sheet and totaled $661 million at March 31, 2009.

At March 31, 2009, the carrying value of the mezzanine notes held by NCB was $153 million. During the first quarter of 2009, cumulative credit losses in the mortgage loan pool

surpassed the principal balance of subordinated equity notes, giving NCB the right to put the first mezzanine note to the third party in accordance with the credit risk transfer agreement. As a result, NCB exercised its put option and received $16 million for this mezzanine note. In April 2009, NCB entered into negotiations with the third party to terminate a portion of each party’s rights and obligations under the credit risk transfer agreement. In exchange for a $105 million payment received from the third party, NCB agreed to terminate its contractual right to put the two senior mezzanine note tranches to the third party. A pretax gain of $8 million was recognized in connection with this transaction.

Management assessed what impact the reconsideration events above would have on determining whether NCB would remain the primary beneficiary of the SPE. Management concluded that NCB would remain the primary beneficiary and accordingly should continue to consolidate the SPE.

Perpetual Trust Securities

We issue certain hybrid capital vehicles that qualify as capital for regulatory and rating agency purposes.

In February 2008, PNC Preferred Funding LLC (the LLC), one of our indirect subsidiaries, sold $375 million of 8.700% Fixed-to-Floating Rate Non-Cumulative Exchangeable Perpetual Trust Securities of PNC Preferred Funding Trust III (Trust III) to third parties in a private placement. In connection with the private placement, Trust III acquired $375 million of Fixed-to-Floating Rate Non-Cumulative Perpetual Preferred Securities of the LLC (the LLC Preferred Securities). The sale was similar to the March 2007 private placement by the LLC of $500 million of 6.113% Fixed-to-Floating Rate Non-Cumulative Exchangeable Trust Securities (the Trust II Securities) of PNC Preferred Funding Trust II (Trust II) in which Trust II acquired $500 million of LLC Preferred Securities and to the December 2006 private placement by PNC REIT Corp. of $500 million of 6.517% Fixed-to-Floating Rate Non-Cumulative Exchangeable Perpetual Trust Securities (the Trust I Securities) of PNC Preferred Funding Trust I (Trust I) in which Trust I acquired $500 million of LLC Preferred Securities.

Each Trust III Security is automatically exchangeable into a share of Series J Non-Cumulative Perpetual Preferred Stock of PNC, each Trust II Security is automatically exchangeable into a share of Series I Non-Cumulative Perpetual Preferred Stock of PNC (Series I Preferred Stock), and each Trust I Security is automatically exchangeable into a share of Series F Non-Cumulative Perpetual Preferred Stock of PNC Bank, N.A. (PNC Bank Preferred Stock), in each case under certain conditions relating to the capitalization or the financial condition of PNC Bank, N.A. and upon the direction of the Office of the Comptroller of the Currency.

Our 2008 Form 10-K includes additional information regarding the Trust I and Trust II Securities, including descriptions of replacement capital covenants.


 

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PNC has contractually committed to Trust II and Trust III that if full dividends are not paid in a dividend period on the Trust II Securities or the Trust III Securities, as applicable, or the LLC Preferred Securities held by Trust II or Trust III, as applicable, PNC will not declare or pay dividends with respect to, or redeem, purchase or acquire, any of its equity capital securities during the next succeeding dividend period, other than: (i) purchases, redemptions or other acquisitions of shares of capital stock of PNC in connection with any employment contract, benefit plan or other similar arrangement with or for the benefit of employees, officers, directors or consultants, (ii) purchases of shares of common stock of PNC pursuant to a contractually binding requirement to buy stock existing prior to the commencement of the extension period, including under a contractually binding stock repurchase plan, (iii) any dividend in connection with the implementation of a shareholders’ rights plan, or the redemption or repurchase of any rights under any such plan, (iv) as a result of an exchange or conversion of any class or series of PNC’s capital stock for any other class or series of PNC’s capital stock, (v) the purchase of fractional interests in shares of PNC capital stock pursuant to the conversion or exchange provisions of such stock or the security being converted or exchanged or (vi) any stock dividends paid by PNC where the dividend stock is the same stock as that on which the dividend is being paid.

PNC Bank, N.A. has contractually committed to Trust I that if full dividends are not paid in a dividend period on the Trust I Securities, LLC Preferred Securities or any other parity equity securities issued by the LLC, neither PNC Bank, N.A. nor its subsidiaries will declare or pay dividends or other distributions with respect to, or redeem, purchase or acquire or make a liquidation payment with respect to, any of its equity capital securities during the next succeeding period (other than to holders of the LLC Preferred Securities and any parity equity securities issued by the LLC) except: (i) in the case of dividends payable to subsidiaries of PNC Bank, N.A., to PNC Bank, N.A. or another wholly-owned subsidiary of PNC Bank, N.A. or (ii) in the case of dividends payable to persons that are not subsidiaries of PNC Bank, N.A., to such persons only if, (A) in the case of a cash dividend, PNC has first irrevocably committed to contribute amounts at least equal to such cash dividend or (B) in the case of in-kind dividends payable by PNC REIT Corp., PNC has committed to purchase such in-kind dividend from the applicable PNC REIT Corp. holders in exchange for a cash payment representing the market value of such in-kind dividend, and PNC has committed to contribute such in-kind dividend to PNC Bank, N.A.

PNC Capital Trust E Trust Preferred Securities

In February 2008, PNC Capital Trust E issued $450 million of 7.75% Trust Preferred Securities due March 15, 2068 (the Trust E Securities). PNC Capital Trust E’s only assets are $450 million of 7.75% Junior Subordinated Notes due March 15, 2068 and issued by PNC (the JSNs). The Trust E Securities are fully and unconditionally guaranteed by PNC.

We may, at our option, redeem the JSNs at 100% of their principal amount on or after March 15, 2013.

In connection with the closing of the Trust E Securities sale, we agreed that, if we have given notice of our election to defer interest payments on the JSNs or a related deferral period is continuing, then PNC would be subject during such period to restrictions on dividends and other provisions protecting the status of the JSN debenture holder similar to or in some ways more restrictive than those potentially imposed under the Exchange Agreements with Trust II and Trust III, as described above. PNC Capital Trusts C and D have similar protective provisions with respect to $500 million in principal amount of junior subordinated debentures. Also, in connection with the closing of the Trust E Securities sale, we entered into a replacement capital covenant as described more fully in our 2008 Form 10-K.

Acquired Entity Trust Preferred Securities

As a result of the National City acquisition, we assumed obligations with respect to $2.4 billion in principal amount of junior subordinated debentures issued by the acquired entity. Under the terms of these debentures and $158 million in principal amount of similar debentures assumed as a result of prior acquisitions, if there is an event of default under the debentures or PNC exercises its right to defer payments on the related trust preferred securities issued by the statutory trusts or there is a default under PNC’s guarantee of such payment obligations, PNC would be subject during the period of such default or deferral to restrictions on dividends and other provisions protecting the status of the debenture holders similar to or in some ways more restrictive than those potentially imposed under the Exchange Agreements with Trust II and Trust III, as described above.

As more fully described in our 2008 Form 10-K, we are subject to replacement capital covenants with respect to four tranches of junior subordinated debentures inherited from National City as well as a replacement capital covenant with respect to our Series L Preferred Stock.

FAIR VALUE MEASUREMENTS AND FAIR VALUE OPTION

SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. See Note 8 Fair Value in the Notes To Consolidated Financial Statements under Part 1, Item 1 of this Report for further information. FSP FAS 157-4 was issued in April 2009 and provides additional guidance for estimating fair values when the volume and level of activity for the asset or liability have significantly decreased. It also provides guidance on identifying circumstances that indicate a transaction is not orderly. As permitted, PNC adopted this guidance effective January 1, 2009.


 

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Assets and liabilities measured at fair value on a recurring basis, including instruments for which PNC has elected the fair value option, are summarized below. As prescribed by SFAS 157, the assets and liabilities acquired from National City on December 31, 2008 are excluded from our SFAS 157 and SFAS 159 disclosures as of that date, but are included as of and for the three months ended March 31, 2009.

 

At March 31, 2009, assets recorded at fair value represented 20% of total assets and fair value liabilities represented 2% of total liabilities compared with 13% of total assets and 2% of total liabilities as of December 31, 2008.


 

Fair Value Measurements – Summary

 

     March 31, 2009    December 31, 2008 (j)
In millions    Level 1    Level 2    Level 3    Total Fair
Value
   Level 1    Level 2    Level 3    Total Fair
Value

Assets

                           

Securities available for sale

   $ 2,758    $ 25,453    $ 14,429    $ 42,640    $ 347    $ 21,633    $ 4,837    $ 26,817

Financial derivatives (a)

     6      6,845      175      7,026      16      5,582      125      5,723

Trading securities (b)

     174      801      112      1,087      89      529      73      691

Commercial mortgage loans held for sale (c)

           1,245      1,245            1,400      1,400

Residential mortgage loans held for sale (c)

        2,226         2,226              

Loans (d)

        53         53              

Customer resale agreements (e)

        1,064         1,064         1,072         1,072

Equity investments

           1,135      1,135            571      571

Residential mortgage servicing rights (f)

           1,052      1,052            6      6

Other assets (g)

            155      310      465             144             144

Total assets

   $ 2,938    $ 36,597    $ 18,458    $ 57,993    $ 452    $ 28,960    $ 7,012    $ 36,424

Liabilities

                           

Financial derivatives (h)

   $ 1    $ 5,020    $ 101    $ 5,122    $ 2    $ 4,387    $ 22    $ 4,411

Trading securities sold short (i)

     349      45         394      182      207         389

Other liabilities

            21             21             9             9

Total liabilities

   $ 350    $ 5,086    $ 101    $ 5,537    $ 184    $ 4,603    $ 22    $ 4,809
(a) Included in other assets on the Consolidated Balance Sheet.
(b) Included in trading securities on the Consolidated Balance Sheet. Fair value includes net unrealized gains of $8.7 million at March 31, 2009 compared with net unrealized losses of $27.5 million at December 31, 2008.
(c) Included in loans held for sale on the Consolidated Balance Sheet. PNC elected the fair value option under SFAS 159 for certain commercial and residential mortgage loans held for sale.
(d) Included in loans on the Consolidated Balance Sheet. PNC elected the fair value option under SFAS 159 for residential mortgage loans originated for sale. Certain of these loans have been subsequently reclassified into portfolio loans.
(e) Included in federal funds sold and resale agreements on the Consolidated Balance Sheet. PNC elected the fair value option under SFAS 159 for this item.
(f) Included in other intangible assets on the Consolidated Balance Sheet.
(g) Includes BlackRock Preferred Series C Stock.
(h) Included in other liabilities on the Consolidated Balance Sheet.
(i) Included in other borrowed funds on the Consolidated Balance Sheet. These are all debt securities.
(j) Excludes assets and liabilities associated with National City.

Valuation Hierarchy

The following is an outline of the valuation methodologies used for measuring fair value under SFAS 157 for the major items above. SFAS 157 focuses on the exit price in the principal or most advantageous market for the asset or liability in an orderly transaction between willing market participants and establishes a reporting hierarchy to maximize the use of observable inputs. The fair value hierarchy (i.e., Level 1, Level 2, and Level 3) is described in detail in Note 8 Fair Value in the Notes To Consolidated Financial Statements under Part I, Item 1 of this Report.

We characterize active markets as those where transaction volumes are sufficient to provide objective pricing information, with reasonably narrow bid/ask spreads and where dealer quotes received do not vary widely and are based on current information. Inactive markets are typically

characterized by low transaction volumes, price quotations which vary substantially among market participants or are not based on current information, wide bid/ask spreads, a significant increase in implied liquidity risk premiums, yields, or performance indicators for observed transactions or quoted prices compared to historical periods, a significant decline or absence of a market for new issuance, or any combination of the above factors. We also consider nonperformance risks including credit risk as part of our valuation methodology for all assets and liabilities measured at fair value. Any models used to determine fair values or to validate dealer quotes based on the descriptions below are subject to review and independent testing as part of our model validation and internal control testing processes. Our Model Validation Committee tests significant models on at least an annual basis. In addition, we have teams, independent of the traders, verify marks and assumptions used for valuations at each period end.


 

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Securities

Securities include both the available for sale and trading portfolios. We use prices sourced from pricing services, dealer quotes or recent trades to determine the fair value of securities. Approximately 60% of our positions are valued using prices obtained from pricing services provided by the Barclay’s Capital Index, formerly known as the Lehman Index, and Interactive Data Corp. (IDC) and for approximately 30% more of our positions, we use prices obtained from the pricing services as an input into the valuation process. Barclay’s Capital Index prices are set with reference to market activity for highly liquid assets such as agency mortgage-backed securities, and matrix priced for other assets, such as CMBS and asset-backed securities. IDC primarily uses pricing models considering adjustments for ratings, spreads, matrix pricing and prepayments for the instruments we value using this service, such as non-agency residential mortgage-backed securities, agency adjustable rate mortgage securities, agency CMOs and municipal bonds. Dealer quotes received are typically non-binding and corroborated with other dealers’ quotes, by reviewing valuations of comparable instruments, or by comparison to internal valuations. In circumstances where relevant market prices are limited or unavailable, valuations may require significant management judgments or adjustments to determine fair value. In these cases, the securities are classified as Level 3.

The valuation techniques used for securities classified as Level 3 include identifying a proxy security, market transaction or index along with, in certain instances, using a discounted cash flow approach. The proxy selected generally has similar credit, tenor, duration, pricing and structuring attributes to the PNC position. The price, market spread, or yield on the proxy is then used to calculate an indicative market price for the security. Depending on the nature of the PNC position and its attributes relative to the proxy, management may make additional adjustments to account for market conditions, liquidity, and nonperformance risk, based on various inputs including recent trades of similar securities, single dealer quotes, and/or other observable and unobservable inputs. For certain security types, primarily non-agency residential and commercial mortgage-backed securities, the fair value methodology incorporates values obtained from a discounted cash flow model. The modeling process incorporates assumptions management believes willing market participants would use to value the security under current market conditions. The assumptions used include prepayment projections, credit loss assumptions, and discount rates, which include a risk premium due to liquidity and uncertainty, that are based on both observable and unobservable inputs. We use the discounted cash flow analysis, in conjunction with other relevant pricing information obtained from either pricing services or broker quotes to establish the fair value that management believes is representative under current market conditions. Management has applied this approach to an increasing number of positions over the past several quarters as the level of market activity for these assets has significantly decreased. For purposes of determining fair value at March 31, 2009, the relevant pricing information was the predominant input.

 

    March 31, 2009 (a)  
    Agency     Non-Agency  
Dollars in millions   Residential
Mortgage-
Backed
Securities
    Residential
Mortgage-
Backed
Securities
    Commercial
Mortgage-
Backed
Securities
    Other
Asset-
Backed
Securities
 

Fair Value – Available for Sale

  $ 23,427     $ 9,281     $ 3,428     $ 1,489  

Fair Value – Trading

    214       9       17          

Total Fair Value

  $ 23,641     $ 9,290     $ 3,445     $ 1,489  

% of Fair Value:

           

By Vintage

           

2009

    5 %        

2008

    39 %         2 %

2007

    15 %     16 %     10 %     16 %

2006

    14 %     22 %     30 %     31 %

2005 and earlier

    22 %     62 %     60 %     50 %

Not available

    5 %                     1 %

Total

    100 %     100 %     100 %     100 %

By Credit rating

           

Agency

    100 %        

AAA

        58 %     98 %     37 %

AA

        5 %     1 %     4 %

A

        4 %       3 %

BBB

        7 %       9 %

BB

        7 %       16 %

B

        11 %       7 %

Lower than B

        8 %       20 %

No rating

                    1 %     4 %

Total

    100 %     100 %     100 %     100 %

By FICO Score

           

³720

        70 %       7 %

<720 or ³660

        26 %       49 %

<660

            7 %

No FICO score

    N/A       4 %     N/A       37 %

Total

            100 %             100 %

 

    December 31, 2008 (a)  
    Agency     Non-Agency  
Dollars in millions   Residential
Mortgage-
Backed
Securities
    Residential
Mortgage-
Backed
Securities
    Commercial
Mortgage-
Backed
Securities
    Other
Asset-
Backed
Securities
 

Fair Value – Available for Sale

  $ 12,544     $ 7,420     $ 3,391     $ 1,492  

Fair Value – Trading

    198               28          

Total Fair Value

  $ 12,742     $ 7,420     $ 3,419     $ 1,492  

% of Fair Value:

           

By Vintage

           

2008

    36 %     1 %      

2007

    24 %     15 %     10 %     15 %

2006

    23 %     23 %     31 %     30 %

2005

    5 %     35 %     12 %     31 %

2004 and earlier

    12 %     26 %     47 %     24 %

Total

    100 %     100 %     100 %     100 %

By Credit rating

           

Agency

    100 %     1 %      

AAA

        82 %     98 %     71 %

AA

        4 %     1 %     7 %

A

        5 %       2 %

BBB

        2 %       8 %

BB

        3 %       6 %

B

        1 %       2 %

Lower than B

        2 %       4 %

No rating

                    1 %        

Total

    100 %     100 %     100 %     100 %

By FICO Score

           

>720

        68 %       13 %

<720 or >660

        30 %       47 %

<660

            1 %

No FICO score

    N/A       2 %     N/A       39 %

Total

            100 %             100 %
(a) As prescribed by SFAS 157, the assets and liabilities acquired from National City on December 31, 2008 are excluded from our SFAS 157 and SFAS 159 disclosures as of that date, but are included as of and for the three months ended March 31, 2009.

 

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The following table provides additional information on fair values and net unrealized losses for certain of our available for sale securities. Note 7 Investment Securities in the Notes To Consolidated Financial Statements of this Report includes further discussion of our process for assessing OTTI and the results of the most recent assessment.

 

     March 31, 2009  
     Available for Sale Non-Agency  
In millions    Residential
Mortgage-
Backed
Securities
  Residential
Mortgage-
Backed
Securities
    Other
Asset-
Backed
Securities
  Other
Asset-
Backed
Securities
 
     Fair
Value
  Net
Unrealized
Loss
    Fair
Value
  Net
Unrealized
Loss
 

By Credit Rating

          

AAA

   $ 5,406   ($ 1,388 )   $ 552   ($ 85 )

Other Investment Grade

     1,442     (559 )     239     (48 )

Total Investment Grade

     6,848     (1,947 )     791     (133 )

BB

     692     (365 )     235     (145 )

B

     974     (749 )     101     (57 )

Lower than B

     764     (558 )     303     (160 )

No Rating

     3             59     (21 )

Total Sub-Investment Grade

     2,433     (1,672 )     698     (383 )

Total

   $ 9,281   ($ 3,619 )   $ 1,489   ($ 516 )

Remaining Fair Value of Securities Rated Sub-Investment Grade:

          

OTTI has been recognized

   $ 727     $ 175    

No OTTI recognized to date

     1,706             523        
     $ 2,433           $ 698        

Residential Mortgage-Backed Securities

At March 31, 2009, our residential mortgage-backed securities portfolio was comprised of $23.6 billion fair value of US government agency-backed securities compared with $12.7 billion fair value at December 31, 2008 and $9.3 billion fair value of private-issuer securities compared with $7.4 billion fair value at December 31, 2008. The agency securities are generally collateralized by 1-4 family, conforming, fixed-rate residential mortgages. The private-issuer securities are also generally collateralized by 1-4 family residential mortgages. The mortgage loans underlying the private-issuer securities are generally non-conforming (i.e., original balances in excess of the amount qualifying for agency securities) and predominately have interest rates that are fixed for a period of time, after which the rate adjusts to a floating rate based upon

a contractual spread that is indexed to a market rate (i.e., a “hybrid ARM”), or interest rates that are fixed for the term of the loan.

Substantially all of the securities are senior tranches in the subordination structure and have credit protection in the form of credit enhancement, over-collateralization and/or excess spread accounts. At March 31, 2009, $2.4 billion, or 26%, of private-issuer securities were rated below “BBB” by at least one national rating agency or not rated. At December 31, 2008, $419 million, or 6%, of private-issuer securities were rated below “BBB” by at least one national rating agency or not rated.

For 39 non-agency residential mortgage-backed securities, we recorded OTTI charges of $118 million in the first quarter of 2009. Seven of these securities, with remaining fair value of $117 million, were rated investment grade (three AAA, three AA, and one BBB). Of the remaining securities for which we recorded OTTI, two were rated BB-equivalent (remaining fair value of $19 million), seven were rated B-equivalent (remaining fair value of $101 million), and 23 were rated lower than B-equivalent (remaining fair value $417 million). Prior to the first quarter of 2009, we recorded OTTI charges for eight securities. At March 31, 2009, one of these securities was rated B-equivalent (remaining fair value of $35 million) and seven of these securities were rated lower than B-equivalent (remaining fair value $155 million).

For the sub-investment grade securities for which we have not recorded an OTTI through March 31, 2009, the remaining fair value was $1.7 billion. The results of our security-level assessments indicate that we will recover the entire cost basis of these securities. Refer to Note 7 Investment Securities in the Notes To Consolidated Financial Statements of this Report for a further discussion of our process for assessing OTTI and the results of the most recent assessment.

Commercial Mortgage-Backed Securities

The commercial mortgage-backed securities portfolio was $3.4 billion fair value at March 31, 2009 and December 31, 2008 and consisted of fixed-rate, private-issuer securities collateralized by non-residential properties, primarily retail properties, office buildings, and multi-family housing. Substantially all of the securities are the most senior tranches in the subordination structure.

At March 31, 2009 $15 million, or 1%, of the commercial mortgage-backed securities were not rated. At December 31, 2008, $18 million, or 1%, of the commercial mortgage-backed securities were not rated.

For three commercial mortgage-backed securities, we recorded OTTI charges of $5 million in the first quarter of 2009. All of these securities were rated B-equivalent or lower. The remaining fair value of these securities approximates zero. We recorded no OTTI charges prior to the first quarter of 2009 for commercial mortgage-backed securities.


 

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Table of Contents

Other Asset-Backed Securities

The asset-backed securities portfolio was $1.5 billion fair value at March 31, 2009 and December 31, 2008, and consisted of fixed-rate and floating-rate, private-issuer securities collateralized primarily by various consumer credit products, including second-lien residential mortgage loans, credit cards, and automobile loans. Substantially all of the securities are senior tranches in the subordination structure and have credit protection in the form of credit enhancement, over-collateralization and/or excess spread accounts.

At March 31, 2009, $698 million, or 47%, of the asset-backed securities were rated below “BBB” by at least one national rating agency or not rated. At December 31, 2008, $184 million, or 12%, of the asset-backed securities were rated below “BBB” by at least one national rating agency or not rated.

For four asset-backed securities collateralized by residential mortgage loans, we recorded OTTI charges of $18 million in the first quarter of 2009. Three of these securities, with a remaining fair value of $69 million, were rated lower than B-equivalent and one, with a remaining fair value of $22 million, was rated A-equivalent. Prior to the first quarter of 2009, we recorded OTTI charges for seven securities. The remaining fair value of these securities, substantially all of which are currently rated lower than B-equivalent, totaled $106 million.

For the sub-investment grade securities for which we have not recorded an OTTI charge through March 31, 2009, the remaining fair value was $523 million. The results of our security-level assessments indicate that we will recover the entire cost basis of these securities. Refer to Note 7 Investment Securities in the Notes To Consolidated Financial Statements of this Report for a further discussion of our process for assessing OTTI and the results of the most recent assessment.

Financial Derivatives

Exchange-traded derivatives are valued using quoted market prices and are classified as Level 1. However, the majority of derivatives that we enter into are executed over-the-counter and are valued using internal techniques. Readily observable market inputs to these models can be validated to external sources, including industry pricing services, or corroborated through recent trades, dealer quotes, yield curves, implied volatility or other market-related data. Certain derivatives, such as total rate of return swaps, are corroborated to the CMBX index. These derivatives are classified as Level 2. Derivatives priced using significant management judgment or assumptions are classified as Level 3. The fair values of our derivatives are adjusted for nonperformance risk including credit risk as appropriate. Our nonperformance risk adjustment is computed using new loan pricing and considers externally available bond spreads, in conjunction with internal historical recovery observations. The credit risk adjustment is not currently material to the overall derivatives valuation.

 

Commercial Mortgage Loans Held for Sale

We account for certain commercial mortgage loans held for sale at fair value under SFAS 159. The election of the fair value option aligns the accounting for the commercial mortgages with the related hedges. It also eliminates the requirements of hedge accounting under SFAS 133. At origination, these loans were intended for securitization. As such, a synthetic securitization methodology was used historically to value the loans and the related unfunded commitments on an aggregate basis based upon current commercial mortgage-backed securities (CMBS) market structures and conditions. Due to inactivity in the CMBS securitization market in 2008 and 2009, we now determine the fair value of commercial mortgage loans held for sale under SFAS 159 by using a whole loan methodology. Fair value is determined using assumptions that management believes a market participant would use in pricing the loans. When available, valuation assumptions included observable inputs based on whole loan sales in the quarter. Adjustments are made to these assumptions to account when uncertainties exist, including market conditions, and liquidity. Based on the significance of unobservable inputs, we classified this portfolio as Level 3.

Customer Resale Agreements

We account for structured resale agreements at fair value, which are economically hedged using free-standing financial derivatives. The fair value for structured resale agreements is determined using a model which includes observable market data as inputs such as interest rates. Readily observable market inputs to this model can be validated to external sources, including yield curves, implied volatility or other market-related data.

BlackRock Series C Preferred Stock

Effective February 27, 2009, we elected to account for the approximately 2.9 million shares of the BlackRock Series C Preferred Stock received in a stock exchange with BlackRock at fair value. The Series C Preferred Stock will economically hedge the BlackRock LTIP liability that is accounted for as a derivative. The fair value of the Series C Preferred Stock is determined using a third-party modeling approach, which includes both observable and unobservable inputs. This approach considers expectations of a default/liquidation event and the use of liquidity discounts based on our inability to sell the security at a fair, open market price in a timely manner. Due to the significance of unobservable inputs, this security is classified as Level 3.

Residential Mortgage Loans Held for Sale

We account for residential mortgage loans originated for sale at fair value on a recurring basis under SFAS 159. Residential mortgage loans are valued based on quoted market prices, where available, prices for other traded mortgage loans with similar characteristics, and purchase commitments and bid information received from market participants. These loans are regularly traded in active markets and observable pricing


 

22


Table of Contents

information is available from market participants. The prices are adjusted as necessary to include the embedded servicing value in the loans and to take into consideration the specific characteristics of certain loans that are priced based on the pricing of similar loans. These adjustments represent unobservable inputs to the valuation but are not considered significant to the fair value of the loans. Accordingly, residential mortgage loans held for sale are classified as Level 2.

Equity Investments

The valuation of direct and indirect private equity investments requires significant management judgment due to the absence of quoted market prices, inherent lack of liquidity and the long-term nature of such investments. The carrying values of direct and affiliated partnership interests reflect the expected exit price and are based on various techniques including publicly traded price, multiples of adjusted earnings of the entity, independent appraisals, anticipated financing and sale transactions with third parties, or the pricing used to value the entity in a recent financing transaction. Indirect investments in private equity funds are valued based on the financial statements that we receive from their managers. Due to the time lag in our receipt of the financial information and based on a review of investments and valuation techniques applied, adjustments to the manager provided value are made when available recent portfolio company information or market information indicates a significant change in value from that provided by the manager of the fund. These investments are classified as Level 3.

Residential mortgage servicing rights

Residential mortgage servicing rights (MSRs) are carried at fair value on a recurring basis. These residential MSRs do not trade in an active open market with readily observable prices. Although sales of servicing assets do occur, the precise terms and conditions typically would not be available. Accordingly, management determines the fair value of its residential MSRs using a discounted cash flow model incorporating assumptions about loan prepayment rates, discount rates, servicing costs, and other economic factors. Management compares its fair value estimates to third-party valuations on a quarterly basis to assess the reasonableness of the fair values calculated by its internal valuation models. Due to the nature of the valuation inputs, residential MSRs are classified as Level 3.

 

Level 3 Assets and Liabilities

Under SFAS 157, financial instruments are considered Level 3 when their values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable. At March 31, 2009, Level 3 fair value assets of $18.5 billion represented 32% of total assets at fair value and 6% of total assets. At December 31, 2008, Level 3 fair value assets of $7.0 billion represented 19% of total assets at fair value and 2% of total assets. Level 3 fair value liabilities of $101 million at March 31, 2009 represented 2% of total liabilities at fair value and less than 1% of total liabilities at that date. Level 3 fair value liabilities of $22 million at December 31, 2008 represented less than 1% of total liabilities at fair value and less than 1% of total liabilities at that date.

During the first quarter of 2009, securities transferred into Level 3 from Level 2 exceeded securities transferred out by $8.2 billion. These primarily related to non-agency residential and commercial mortgaged-backed securities where management determined that the volume and level of activity for these assets had significantly decreased. The lack of relevant market activity for these securities resulted in management modifying its valuation methodology for the instruments transferred in the first quarter of 2009. Other Level 3 assets include commercial mortgage loans held for sale, certain equity securities, private equity investments, residential mortgage servicing rights and other assets. Unrealized gains and losses on available for sale securities do not impact liquidity or risk-based capital. However, reductions in the credit ratings of these securities would have an impact on the determination of risk-weighted assets which could reduce our regulatory capital ratios. In addition, the amount representing the credit-related portion of other-than-temporary impairments on available for sale securities would reduce our regulatory capital ratios.

Total securities measured at fair value at March 31, 2009 and December 31, 2008 included securities available for sale and trading securities consisting primarily of residential and commercial mortgage-backed securities and other asset-backed securities. Unrealized gains and losses on available for sale securities do not impact liquidity or risk-based capital. However, reductions in the credit ratings of these securities would have an impact on the determination of risk-weighted assets which could reduce our regulatory capital ratios. In addition, other-than-temporary impairments on available for sale securities would reduce our regulatory capital ratios.


 

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Table of Contents

BUSINESS SEGMENTS REVIEW

In the first quarter of 2009, we made changes to our business organization structure and management reporting in conjunction with the acquisition of National City. As a result, we now have seven reportable business segments which include:

   

Retail Banking

   

Corporate & Institutional Banking

   

Asset Management Group

   

Residential Mortgage Banking

   

BlackRock

   

Global Investment Servicing

   

Distressed Assets Portfolio

Business segment results for the first quarter of 2008 have been reclassified to present prior periods on the same basis.

Business segment results, including inter-segment revenues, and a description of each business are included in Note 19 Segment Reporting included in the Notes To Consolidated Financial Statements under Part I, Item 1 of this Report. Certain revenue and expense amounts included in this Financial Review differ from the amounts shown in Note 19 primarily due to the presentation in this Financial Review of business net interest revenue on a taxable-equivalent basis and income statement classification differences related to Global Investment Servicing.

Results of individual businesses are presented based on our management accounting practices and management structure. There is no comprehensive, authoritative body of guidance for management accounting equivalent to GAAP; therefore, the financial results of our individual businesses are not necessarily comparable with similar information for any other company. We refine our methodologies from time to time as our management accounting practices are enhanced and our businesses and management structure change. Financial results are presented, to the extent practicable, as if each business operated on a stand-alone basis. As permitted under GAAP, we have aggregated the business results for certain similar operating segments for financial reporting purposes.

Assets receive a funding charge and liabilities and capital receive a funding credit based on a transfer pricing methodology that incorporates product maturities, duration and other factors. Capital is intended to cover unexpected losses and is assigned to the banking and servicing businesses using our risk-based economic capital model. We have assigned capital equal to 6% of funds to Retail Banking to reflect the capital required for well-capitalized domestic banks and to approximate market comparables for this business. The capital assigned for Global Investment Servicing reflects its legal entity shareholder’s equity.

 

We have allocated the allowances for loan and lease losses and unfunded loan commitments and letters of credit based on our assessment of risk inherent in the business segment loan portfolios. Our allocation of the costs incurred by operations and other shared support areas not directly aligned with the businesses is primarily based on the use of services.

Total business segment financial results differ from total consolidated results. The impact of these differences is reflected in the “Other” category. “Other” for purposes of this Business Segments Review and the Business Segment Highlights in the Executive Summary includes residual activities that do not meet the criteria for disclosure as a separate reportable business, such as gains or losses related to BlackRock transactions including LTIP share distributions and obligations, earnings and gains or losses related to Hilliard Lyons for the first quarter of 2008, integration costs, asset and liability management activities including net securities gains or losses and certain trading activities, equity management activities, alternative investments, intercompany eliminations, most corporate overhead, and differences between business segment performance reporting and financial statement reporting (GAAP), including the presentation of net income attributable to noncontrolling interests.

Period-end Employees

 

     

March 31

2009 (a)

  

Dec. 31

2008 (a)

  

March 31

2008

Full-time employees

          

Retail Banking

   22,415    9,304    8,867

Corporate & Institutional Banking

   4,479    2,294    2,218

PNC Asset Management Group

   3,216    1,849    1,777

Residential Mortgage Banking

   3,819        

Global Investment Servicing

   4,732    4,934    4,865

Distressed Assets Portfolio

   124        

Other

          

Operations & Technology

   9,243    4,491    4,394

Staff Services and other

   3,830    2,441    2,371

Total Other

   13,073    6,932    6,765

Total full-time employees

   51,858    25,313    24,492

Retail Banking part-time employees

   5,376    2,347    2,304

Other part-time employees

   1,561    561    539

Total part-time employees

   6,937    2,908    2,843

Total National City legacy employees (a)

        31,374     

Total

   58,795    59,595    27,335
(a) National City’s legacy employees are included in the aggregate at December 31, 2008 but are included in the individual business segments as appropriate at March 31, 2009.

Employee data as reported by each business segment in the table above reflects staff directly employed by the respective businesses and excludes operations, technology and staff services employees reported in the Other segment. Global Investment Servicing employees are stated on a legal entity basis.


 

24


Table of Contents

Results Of Businesses – Summary

(Unaudited)

 

     Earnings      Revenue      Average Assets (a)
Three months ended March 31 – in millions    2009     2008    2009     2008    2009    2008

Retail Banking (b)

   $ 56     $ 137    $ 1,445     $ 741    $ 66,358    $ 32,604

Corporate & Institutional Banking

     374       25      1,314       315      93,048      45,020

Asset Management Group

     38       37      255       145      7,405      2,795

Residential Mortgage Banking

     226          527          7,208     

BlackRock

     23       60      26       81      4,295      4,357

Global Investment Servicing (c)

     10       30      190       228      2,479      2,699

Distressed Assets Portfolio

     23              377              23,019       

Total business segments

     750       289      4,134       1,510      203,812      87,475

Other (b) (d) (e)

     (220 )     95      (263 )     311      77,040      53,080

Total consolidated

   $ 530     $ 384    $ 3,871     $ 1,821    $ 280,852    $ 140,555
(a) Period-end balances for BlackRock and Global Investment Servicing.
(b) Amounts for 2008 reflect the reclassification of the results of Hilliard Lyons, which we sold on March 31, 2008, and the related gain on sale, from Retail Banking to “Other.”
(c) Global Investment Servicing revenue represents the sum of servicing revenue and nonoperating income (expense) less debt financing costs.
(d) For our segment reporting presentation in this Financial Review, “Other” for the first three months of 2009 includes $52 million of pretax integration costs primarily related to National City while “Other” for the first three months of 2008 includes $14 million of pretax integration costs attributable to other acquisitions.
(e) “Other” average assets include securities available for sale associated with asset and liability management activities.

 

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Table of Contents

RETAIL BANKING

(Unaudited)

 

Three months ended March 31

Dollars in millions

      2009 (a)     2008  

INCOME STATEMENT

     

Net interest income

  $ 928     $ 405  

Noninterest income

     

Service charges on deposits

    219       79  

Brokerage

    61       35  

Consumer services

    208       99  

Other

    29       123  

Total noninterest income

    517       336  

Total revenue

    1,445       741  

Provision for credit losses

    303       94  

Noninterest expense

    1,063       422  

Pretax earnings

    79       225  

Income taxes

    23       88  

Earnings

  $ 56     $ 137  

AVERAGE BALANCE SHEET

     

Loans

     

Consumer

     

Home equity

  $ 27,631     $ 13,056  

Indirect

    4,119       2,026  

Education

    4,882       844  

Credit cards

    2,113       239  

Other consumer

    1,858       446  

Total consumer

    40,603       16,611  

Commercial and commercial real estate

    12,923       5,349  

Floor plan

    1,510       1,017  

Residential mortgage

    2,252       2,132  

Total loans

    57,288       25,109  

Goodwill and other intangible assets

    5,807       4,894  

Other assets

    3,263       2,601  

Total assets

  $ 66,358     $ 32,604  

Deposits

     

Noninterest-bearing demand

  $ 15,819     $ 8,922  

Interest-bearing demand

    17,900       7,800  

Money market

    38,730       15,846  

Total transaction deposits

    72,449       32,568  

Savings

    6,461       2,593  

Certificates of deposit

    56,355       15,832  

Total deposits

    135,265       50,993  

Other liabilities

    1,651       410  

Shareholder’s equity

    8,415       3,213  

Total funds

  $ 145,331     $ 54,616  

PERFORMANCE RATIOS

     

Return on average shareholder’s equity

    3 %     17 %

Noninterest income to total revenue

    36 %     45 %

Efficiency

    74 %     57 %

OTHER INFORMATION (b)

     

Credit-related statistics:

     

Commercial nonperforming assets

  $ 194     $ 94  

Consumer nonperforming assets

    86       37  

Total nonperforming assets (c)

  $ 280     $ 131  

SOP 03-3 impaired loans

  $ 1,322          

Commercial net charge-offs

  $ 83     $ 43  

Consumer net charge-offs

    124       22  

Total net charge-offs

  $ 207     $ 65  

Commercial net charge-off ratio

    2.33 %     2.72 %

Consumer net charge-off ratio

    1.17 %     .47 %

Total net charge-off ratio

    1.47 %     1.04 %

Other statistics:

     

ATMs

    6,402       3,903  

Branches (d)

    2,585       1,089  

 

At March 31

Dollars in millions, except as noted

   2009 (a)     2008  

OTHER INFORMATION (CONTINUED) (b)

 

   

Home equity portfolio credit statistics:

 

   

% of first lien positions (e)

     35 %     38 %

Weighted average loan-to-value ratios (e)

     74 %     72 %

Weighted average FICO scores (f)

     727       724  

Annualized net charge-off ratio

     .34 %     .34 %

Loans 90 days past due

     .65 %     .45 %

Checking-related statistics:

      

Retail Banking checking relationships (g)

     5,134,000       2,274,000  

Brokerage statistics:

      

Financial consultants (h)

     658       387  

Full service brokerage offices

     43       24  

Brokerage account assets (billions)

   $ 26     $ 18  

Managed credit card loans:

      

Loans held in portfolio

   $ 2,104     $ 239  

Loans securitized

     1,824          

Total managed credit card loans

   $ 3,928     $ 239  

Net charge-offs:

      

Securitized credit card loans

   $ 31      

Managed credit card loans

   $ 79     $ 2  

Net charge-offs as a % of average loans (annualized):

      

Securitized credit card loans

     6.89 %    

Managed credit card loans

     8.15 %     3.37 %
(a) Includes the impact of National City, which we acquired on December 31, 2008.
(b) Presented as of March 31 except for net charge-offs and annualized net charge-off ratios, which are for the three months ended.
(c) Includes nonperforming loans of $264 million at March 31, 2009 and $118 million at March 31, 2008.
(d) Excludes certain satellite branches that provide limited products and/or services.
(e) Includes loans from acquired portfolios for which lien position and loan-to-value information was limited.
(f) Represents the most recent FICO scores we have on file.
(g) Amounts as of March 31, 2009 include the impact of National City prior to application system conversions. These amounts may be refined subsequent to system conversions.
(h) Financial consultants provide services in full service brokerage offices and PNC traditional branches.

Retail Banking’s earnings were $56 million for the first quarter of 2009 compared with $137 million for the same period in 2008. The first quarter of 2009 includes revenues and expenses associated with business acquired with National City. These results were challenged in this environment by ongoing credit deterioration, a lower value assigned to our deposits, reduced consumer spending and increased FDIC insurance costs. Retail Banking continues to maintain its focus on customer growth, employee and customer satisfaction, investing in the business for future growth, as well as disciplined expense management during this period of market and economic uncertainty.


 

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Highlights of Retail Banking’s performance during the first quarter of 2009 include the following:

 

The acquisition of National City added approximately $29 billion of loans and $81 billion of deposits to Retail Banking for the quarter. Other salient points related to this acquisition include the following:

   

Added over 1,400 branches, including 61 branches that will be divested in the third quarter of 2009,

   

Expanded our ATMs by over 2,100 locations,

   

Established or significantly increased our branch presence in Ohio, Kentucky, Indiana, Illinois, Pennsylvania, Michigan, Wisconsin, Missouri and Florida – giving PNC one of the largest branch distribution networks among banks in the country,

   

Expanded our customer base with the addition of approximately 2.7 million checking relationships, and

   

Added $12 billion in brokerage account assets.

 

Retail Banking expanded the number of customers it serves and grew checking relationships. Excluding relationships added from acquisitions since the first quarter of 2008, net new consumer and business checking relationships for legacy PNC grew by 18,000 during the first quarter of 2009 compared with 9,000 a year earlier.

 

We continued to invest in the branch network, albeit at a slower pace than in prior years given the current economic conditions. We are optimizing our network by opening new branches in high growth areas, relocating branches to areas of higher market opportunity, and consolidating branches in areas of declining opportunity. We opened 7 traditional branches during the first quarter. We also opened 14 in-store branches and added 170 ATM machines. To continue to optimize our network, we also consolidated 16 branches in this quarter.

 

   The in-store branches and the ATMs were primarily opened under our previously reported exclusive banking services agreement with Giant Food LLC supermarkets. We plan to open approximately 25 additional locations for the remainder of 2009 in connection with our Giant Food LLC arrangement.

Total revenue for the first quarter of 2009 was $1.445 billion compared with $741 million for the same quarter in 2008. Net interest income of $928 million increased $523 million compared with 2008. The increase in net interest income was driven by the National City acquisition and partially offset by declines in legacy net interest income as a result of the negative impact of a lower value assigned to deposits in this low rate environment.

Noninterest income for the first quarter of 2009 was $517 million, an increase of $181 million over the prior year first quarter. The National City acquisition was the major factor for the increase, partially offset in the comparison by a $95 million gain from the redemption of Visa common shares in

the first quarter of 2008. In addition, core growth in consumer related fees has been negatively impacted by current economic conditions and a decline in consumer spending.

The Market Risk Management – Equity and Other Investment Risk section of this Financial Review includes further information regarding Visa.

The provision for credit losses for the first three months of 2009 was $303 million compared with $94 million in the first three months of 2008. Net charge-offs were $207 million for the first quarter of 2009 and $65 million in the same period of 2008. The increases in provision and net charge-offs were primarily a result of a loan portfolio that has increased 128%, including a significantly larger credit card portfolio, and the continued credit deterioration in both the commercial and consumer loan portfolios.

Given the current environment and the acquisition of National City, we believe the provision and nonperforming assets in 2009 will continue to exceed comparable 2008 levels.

Noninterest expense for the first quarter of 2009 totaled $1.063 billion, an increase of $641 million over the same period in 2008. Increases were attributable to the impact of acquisitions, continued investments in the business, and increased FDIC insurance costs.

Growing core checking deposits as a lower-cost funding source and as the cornerstone product to build customer relationships is the primary objective of our deposit strategy. Furthermore, core checking accounts are critical to our strategy of expanding our payments business. In the first quarter of 2009, average total deposits increased $84.3 billion compared with the same period in 2008.

 

Average money market deposits increased $22.9 billion over the first quarter of 2008. This increase was primarily due to the National City acquisition and core money market growth as customers generally prefer more liquid deposits in a low rate environment.

 

In the first quarter of 2009, average certificates of deposit increased $40.5 billion. The increase was due to the National City acquisition, which was partially offset by a decrease in legacy certificates of deposits. The legacy decline is a result of a focus on relationship customers rather than pursuing higher-rate single service customers. The deposit strategy of Retail Banking is to remain disciplined on pricing, target specific products and markets for growth, and focus on the retention and growth of balances for relationship customers.

 

Average demand deposits increased $17.0 billion over the first quarter of 2008. This increase was primarily driven by acquisitions and organic growth.


 

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Currently, we are predominately focused on a relationship-based lending strategy that targets specific customer sectors (homeowners, students, small businesses and auto dealerships) while seeking a moderate risk profile for the loans that we originate.

In the first three months of 2009, average total loans were $57.3 billion, an increase of $32.2 billion over the same period in 2008.

 

Average commercial and commercial real estate loans grew $7.6 billion compared with the first quarter of 2008. The increase was primarily due to the National City acquisition.

 

Average home equity loans grew $14.6 billion over the first quarter of 2008. The majority of the increase is attributable to the National City acquisition. Our home equity loan portfolio is relationship based, with 95% of the portfolio attributable to borrowers in our primary geographic footprint. The nonperforming assets and charge-offs that we have experienced are within our expectations given current market conditions.

 

Average education loans grew $4.0 billion compared with the first quarter of 2008. The increase was due to the National City acquisition and an increase in the core business which was a result of the transfer of approximately $1.8 billion of education loans previously held for sale to the loan portfolio during the first quarter of 2008.

 

Average credit card balances increased $1.9 billion over the prior year first quarter. This increase was primarily the result of the National City acquisition and also reflected legacy growth of 49% over the first quarter of 2008.


 

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CORPORATE & INSTITUTIONAL BANKING

(Unaudited)

 

Three months ended March 31

Dollars in millions except as noted

   2009 (a)    2008  

INCOME STATEMENT

       

Net interest income

   $ 1,040    $ 304  

Noninterest income

       

Corporate service fees

     219      133  

Other

     55      (122 )

Noninterest income

     274      11  

Total revenue

     1,314      315  

Provision for credit losses

     285      56  

Noninterest expense

     454      245  

Pretax earnings

     575      14  

Income taxes

     201      (11 )

Earnings

   $ 374    $ 25  

AVERAGE BALANCE SHEET

       

Loans

       

Corporate (b)

   $ 52,510    $ 20,315  

Commercial real estate

     15,593      5,138  

Commercial – real estate related

     4,267      2,845  

Asset-based lending

     7,025      4,974  

Total loans (b)

     79,395      33,272  

Goodwill and other intangible assets

     3,376      3,061  

Loans held for sale

     1,712      2,418  

Other assets

     8,565      6,269  

Total assets

   $ 93,048    $ 45,020  

Deposits

       

Noninterest-bearing demand

   $ 17,571    $ 8,165  

Money market

     8,118      5,459  

Other

     7,415      2,815  

Total deposits

     33,104      16,439  

Other liabilities

     11,263      5,599  

Capital

     6,169      2,911  

Total funds

   $ 50,536    $ 24,949  

 

Three months ended March 31

Dollars in millions except as noted

   2009 (a)     2008  

PERFORMANCE RATIOS

      

Return on average capital

     25 %     3 %

Noninterest income to total revenue

     21       3  

Efficiency

     35       78  

COMMERCIAL MORTGAGE SERVICING PORTFOLIO (in billions)

      

Beginning of period

   $ 270     $ 243  

Acquisitions/additions

     5       5  

Repayments/transfers

     (6 )     (4 )

End of period

   $ 269     $ 244  

OTHER INFORMATION

      

Consolidated revenue from: (c)

      

Treasury Management

   $ 275     $ 137  

Capital Markets

   $ 43     $ 76  

Commercial mortgage loans held for sale (d)

   $ 22     $ (143 )

Commercial mortgage loan servicing (e)

     72       49  

Total commercial mortgage banking activities

   $ 94     $ (94 )

Total loans (f)

   $ 77,485     $ 24,981  

Total nonperforming assets (f)(g)

   $ 1,812     $ 440  

SOP 03-3 impaired loans (f)

   $ 1,343      

Net charge-offs

   $ 169     $ 32  

Net carrying amount of commercial mortgage servicing rights (f)

   $ 874     $ 678  
(a) Includes the impact of National City, which we acquired on December 31, 2008.
(b) Includes lease financing.
(c) Represents consolidated PNC amounts.
(d) Includes valuations on commercial mortgage loans held for sale and related commitments, derivative valuations, origination fees, gains on sale of loans held for sale and net interest income on loans held for sale.
(e) Includes net interest income and noninterest income from loan servicing and ancillary services.
(f) At March 31.
(g) Includes nonperforming loans of $1.774 billion at March 31, 2009 and $421 million at March 31, 2008.

Corporate & Institutional Banking earned $374 million in the first quarter of 2009. The first quarter of 2009 includes revenues and expenses associated with business acquired with National City. Total revenue of $1.3 billion was strong given the current environment, driven primarily by net interest income. Noninterest expense was tightly managed, and earnings were impacted by the provision for credit losses, indicative of deteriorating credit quality occurring throughout the economy.

Corporate & Institutional Banking overview:

   

Net interest income for the first quarter of 2009 was $1.0 billion, or 79% of total revenue, driven by strong loan spreads.

 

   

Corporate service fees were $219 million in the first quarter of 2009. The major components of corporate service fees were treasury management, corporate finance fees and commercial mortgage servicing revenue. Treasury management fees continued to be a strong contributor to revenue.


 

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Other noninterest income was $55 million for the first quarter of 2009 and primarily consisted of leasing revenues. Other noninterest income for the first quarter of 2008 included losses of $166 million on commercial mortgage loans held for sale, net of hedges.

   

Provision for credit losses was $285 million in the first quarter of 2009 reflecting general credit deterioration, particularly in real estate. Net charge-offs for the first quarter of 2009 were $169 million.

   

Growth in nonperforming assets was driven by continued weakness in our commercial real estate and corporate loan portfolios.

   

Given the current environment and the acquisition of National City, we believe the provision and nonperforming assets will continue to exceed comparable 2008 levels.

   

Noninterest expense of $454 million reflected tight expense discipline for the first quarter of 2009.

   

Average loans were $79 billion for the first quarter of 2009 and were comprised of 66% corporate loans, 25% commercial real estate and related loans, and 9% asset-based lending. During the first quarter of 2009, loan growth slowed across the customer base reflecting reduced originations, lower utilization levels and paydowns.

   

Average deposits were $33 billion for the first quarter, including 53% noninterest bearing demand and 25% money market. During the quarter PNC continued to experience deposit growth due to a flight to quality including the return of deposits from National City customers who had previously moved funds to other institutions.

   

The commercial mortgage servicing portfolio was $269 billion at March 31, 2009 and $270 billion at December 31, 2008. Servicing portfolio additions continued to be modest due to the declining volumes in the commercial mortgage securitization market and were offset by repayments/transfers.

See the additional revenue discussion regarding treasury management, capital markets-related products and services, and commercial mortgage banking activities on page 9.


 

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ASSET MANAGEMENT GROUP

(Unaudited)

 

Three months ended March 31

Dollars in millions except as noted

   2009 (a)     2008 (b)  

INCOME STATEMENT

      

Net interest income

   $ 100     $ 32  

Noninterest income

     155       113  

Total revenue

     255       145  

Provision for credit losses

     17       1  

Noninterest expense

     171       85  

Pretax earnings

     67       59  

Income taxes

     29       22  

Earnings

   $ 38     $ 37  

AVERAGE BALANCE SHEET

      

Loans

      

Consumer

   $ 3,852     $ 1,956  

Commercial and commercial real estate

     1,752       532  

Residential mortgage

     1,151       65  

Total loans

     6,755       2,553  

Goodwill and other intangible assets

     404       42  

Other assets

     246       200  

Total assets

   $ 7,405     $ 2,795  

Deposits

      

Noninterest-bearing demand

   $ 1,261     $ 851  

Interest-bearing demand

     1,543       688  

Money market

     3,327       1,453  

Total transaction deposits

     6,131       2,992  

Certificates of deposit and other

     1,292       468  

Total deposits

     7,423       3,460  

Other liabilities

     173       17  

Capital

     867       208  

Total funds

   $ 8,463     $ 3,685  

PERFORMANCE RATIOS

      

Return on average capital

     18 %     72 %

Noninterest income to total revenue

     61       78  

Efficiency

     67       59  

OTHER INFORMATION

      

Total nonperforming assets (c)

   $ 68     $ 5  

SOP 03-3 impaired loans (c)

   $ 215      

Total net charge-offs

   $ 11     $ 1  
 

ASSETS UNDER ADMINISTRATION (in billions) (c) (d)

      

Assets under management

      

Personal

   $ 59     $ 46  

Institutional

     37       20  

Total

   $ 96     $ 66  

Asset Type

      

Equity

   $ 38     $ 36  

Fixed Income

     32       17  

Liquidity/Other

     26       13  

Total

   $ 96     $ 66  

Nondiscretionary assets under administration

      

Personal

   $ 26     $ 30  

Institutional

     94       80  

Total

   $ 120     $ 110  

Asset Type

      

Equity

   $ 41     $ 46  

Fixed Income

     25       26  

Liquidity/Other

     54       38  

Total

   $ 120     $ 110  
(a) Includes the impact of National City, which we acquired on December 31, 2008.
(b) Includes the legacy PNC wealth management business previously included in Retail Banking.
(c) As of March 31.
(d) Excludes brokerage account assets.

Earnings from the Asset Management Group totaled $38 million in the first quarter of 2009 compared with $37 million in the prior year first quarter. The current period earnings reflects new business obtained from National City offset by lower noninterest income from legacy business and higher provision for credit losses stemming from the depressed equity markets and continued economic challenges.

First quarter results for the Asset Management Group were highlighted by the National City acquisition and reflect the following:

 

Increased assets under management,

 

Expanded number of wealth households in our footprint,

 

Increased number of distribution channels and cross-sell opportunities, and

 

Solid financial results in spite of the adverse economic conditions.

Assets under management of $96 billion at March 31, 2009 increased $30 billion compared with the balances at March 31, 2008. The increased assets under management is attributable to the National City acquisition but is somewhat mitigated by the declining equity market values. Nondiscretionary assets under administration of $120 billion at March 31, 2009 increased $10 billion compared with the balances at March 31, 2008.

Total revenue for the first three months of 2009 was $255 million, compared with $145 million for the first three months of 2008. Net interest income of $100 million reflected strong results from the loan portfolios. Noninterest income of $155 million increased $42 million, compared with the first quarter of 2008. This growth was attributed primarily to the National City acquisition but was somewhat mitigated by the decline in equity market values.

The provision for credit losses of $17 million increased from $1 million in the first quarter of 2008 reflecting the deteriorating economic environment and larger loan portfolios. Net charge-offs were $11 million for the first quarter of 2009 and $1 million for the first quarter of 2008. The increases in provision and net charge-offs were in the consumer and commercial portfolios, with the losses primarily concentrated in the acquired National City portfolio.

Noninterest expense of $171 million increased $86 million in the first quarter of 2009 compared with the same period of 2008. The increase is attributable to the National City acquisition and rising FDIC insurance costs. Despite these run rate increases, expenses remain well managed as we continued to implement continuous improvement initiatives and began to deliver the cost savings targets resulting from the acquisition.


 

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Balance sheet activity for the first quarter of 2009 reflects both core and acquisition-related growth. Average loans of $6.8 billion increased $4.2 billion compared with 2008. Average total deposits of $7.4 billion increased $4.0 billion compared with the first quarter of 2008. Core deposit growth was driven by a shift in customer focus from riskier equity investments into deposit products given the current economic environment and the return of deposits from National City customers reflecting their confidence in the new combined company.

RESIDENTIAL MORTGAGE BANKING

(Unaudited)

 

Three months ended March 31

Dollars in millions

   2009  

INCOME STATEMENT

    

Net interest income

   $ 87  

Noninterest income

    

Loan servicing revenue

     261  

Loan sales revenue

     175  

Other

     4  

Total noninterest income

     440  

Total revenue

     527  

Provision for (recoveries of) credit losses

     (9 )

Noninterest expense

     173  

Pretax earnings

     363  

Income taxes

     137  

Earnings

   $ 226  

AVERAGE BALANCE SHEET

    

Portfolio loans

   $ 1,429  

Loans held for sale

     2,693  

Mortgage servicing rights

     1,164  

Other assets

     1,922  

Total assets

   $ 7,208  

Deposits and other borrowings

   $ 4,761  

Other liabilities

     1,566  

Capital

     1,492  

Total funds

   $ 7,819  

PERFORMANCE RATIOS

    

Return on average capital

     61 %

Efficiency

     33 %

OTHER INFORMATION

    

Servicing portfolio for others (in billions) (a)

   $ 168  

Fixed rate

     87 %

Adjustable rate/balloon

     13 %

Weighted average interest rate

     5.99 %

MSR capitalized value (in billions)

   $ 1.0  

MSR capitalization value (in basis points)

     62  

Weighted average servicing fee (in basis points)

     30  

Net MSR hedging gains

   $ 202  

Loan origination volume (in billions)

   $ 6.9  

Percentage of originations represented by:

    

Agency and government programs

     97 %

Purchased volume

     17 %

SOP 03-3 impaired loans (a)

   $ 474  
(a) As of March 31.

 

Residential Mortgage Banking earned $226 million for the first quarter of 2009 driven by strong loan origination activity and income from servicing rights. This business was formed in the first quarter of 2009 and consists primarily of activities acquired with National City.

Residential Mortgage Banking overview:

   

Total loan originations were $6.9 billion for the first quarter. The strong volume was consistent with industry trends and was primarily originated under agency (FNMA, FHLMC, FHA/VA) guidelines.

   

Residential mortgage loans serviced for others totaled $168 billion at March 31, 2009 compared to $173 billion at January 1, 2009. The decrease was due to payoffs exceeding new direct production during the quarter.

   

Noninterest income was $440 million in the first quarter of 2009 driven by mortgage servicing rights net hedging gains of $202 million and loan sale revenue of $175 million that resulted from strong loan origination refinance volume. It is unlikely that we will repeat the strong performance in residential mortgage fees that we saw in the first quarter of 2009, particularly the servicing rights hedging gains.

   

Net interest income was $87 million in the first quarter of 2009 resulting from residential mortgage loans held for sale associated with strong origination volumes during the quarter.

   

Noninterest expense of $173 million included the addition of personnel costs associated with strong origination volumes and increased focus on loan underwriting quality and loss mitigation activities.

   

Mortgage servicing rights for others are valued at 62 basis points, with a weighted average servicing fee of 30 basis points, which reflects the fair value of the servicing rights and is based on a number of assumptions including higher prepayment volume.


 

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BLACKROCK

Our BlackRock business segment earned $23 million in the first three months of 2009 and $60 million in the first three months of 2008. These results reflect our approximately 31.5% share of BlackRock’s reported GAAP earnings for the first quarter of 2009 and our approximately 33% share of BlackRock’s reported GAAP earnings for the first quarter of 2008 and the additional income taxes on these earnings incurred by PNC.

PNC’s investment in BlackRock was $4.0 billion at March 31, 2009 and $4.2 billion at December 31, 2008. The book value per common share was $100.11 at March 31, 2009.

BLACKROCK LTIP AND EXCHANGE AGREEMENTS

PNC’s noninterest income for the first quarter of 2009 included a $103 million pretax gain primarily related to our BlackRock LTIP shares obligation. PNC’s noninterest income for the first quarter of 2008 included a pretax gain of $40 million related to our BlackRock LTIP shares adjustment.

As further described in our Current Report on Form 8-K filed December 30, 2008, PNC entered into an Exchange Agreement with BlackRock on December 26, 2008. The transactions that resulted from this agreement restructured PNC’s ownership of BlackRock equity without altering, to any meaningful extent, PNC’s economic interest in BlackRock. PNC continues to be subject to the limitations on its voting rights in its existing agreements with BlackRock. Also on December 26, 2008, BlackRock entered into an Exchange Agreement with Merrill Lynch in anticipation of the consummation of the merger of Bank of America Corporation and Merrill Lynch that occurred on January 1, 2009. The PNC and Merrill Lynch Exchange Agreements restructured PNC’s and Merrill Lynch’s respective ownership of BlackRock common and preferred equity.

 

The exchange contemplated by these agreements was completed on February 27, 2009. On that date, PNC’s obligation to deliver BlackRock common shares was replaced with an obligation to deliver shares of BlackRock’s new Series C Preferred Stock. PNC acquired the 2.9 million shares of Series C Preferred Stock from BlackRock in exchange for common shares on that same date. PNC will account for these preferred shares at fair value as permitted under SFAS 159, which will offset the impact of marking-to-market the obligation to deliver these shares to BlackRock as we aligned the fair value marks on this asset and liability. The fair value amount of the BlackRock Series C Preferred Stock is included on our Consolidated Balance Sheet in the caption Other assets. Additional information regarding the valuation of the BlackRock Series C Preferred Stock is included in Note 8 Fair Value of the Consolidated Financial Statements included in this Report.

PNC continues to account for its remaining investment in BlackRock under the equity method of accounting, with its share of BlackRock’s earnings reduced from approximately 33% to 31.5%, primarily due to the exchange of BlackRock common stock for BlackRock Series C Preferred Stock. The Series C Preferred Stock is not taken into consideration in determining PNC’s share of BlackRock earnings under the equity method. PNC’s percentage ownership of BlackRock common stock has increased from approximately 36.5% to 46.5%. The increase resulted from a substantial exchange of Merrill Lynch’s BlackRock common stock for BlackRock preferred stock. As a result of the BlackRock preferred stock held by Merrill Lynch and the new BlackRock preferred stock issued to Merrill Lynch and PNC under the Exchange Agreements, PNC’s share of BlackRock common stock has been, and will continue to be, higher than its overall share of BlackRock’s equity and earnings.

The transactions related to the Exchange Agreements do not affect our right to receive dividends declared by BlackRock.


 

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GLOBAL INVESTMENT SERVICING

(Unaudited)

 

Three months ended March 31

Dollars in millions except as noted

   2009     2008  

INCOME STATEMENT

      

Servicing revenue

   $ 205     $ 238  

Operating expense

     175       181  

Operating income

     30       57  

Debt financing

     5       11  

Nonoperating income (a)

     (10 )     1  

Pretax earnings

     15       47  

Income taxes

     5       17  

Earnings

   $ 10     $ 30  

PERIOD-END BALANCE SHEET

      

Goodwill and other intangible assets

   $ 1,297     $ 1,311  

Other assets

     1,182       1,388  

Total assets

   $ 2,479     $ 2,699  

Debt financing

   $ 825     $ 986  

Other liabilities

     959       1,070  

Shareholder’s equity

     695       643  

Total funds

   $ 2,479     $ 2,699  

PERFORMANCE RATIOS

      

Return on average equity

     6 %     19 %

Operating margin (b)

     15       24  

SERVICING STATISTICS (at March 31)

      

Accounting/administration net fund assets (in billions) (c)

      

Domestic

   $ 645     $ 875  

Offshore

     67       125  

Total

   $ 712     $ 1,000  

Asset type (in billions)

      

Money market

   $ 345     $ 413  

Equity

     199       358  

Fixed income

     99       128  

Other

     69       101  

Total

   $ 712     $ 1,000  

Custody fund assets (in billions)

   $ 361     $ 476  

Shareholder accounts (in millions)

      

Transfer agency

     13       19  

Subaccounting

     62       57  

Total

     75       76  
(a) Net of nonoperating expense.
(b) Total operating income divided by servicing revenue.
(c) Includes alternative investment net assets serviced.

Global Investment Servicing earned $10 million for the first quarter of 2009 compared with $30 million for the same period of 2008. Results for 2009 were negatively impacted by continued declines in asset values and fund redemptions as a result of the deterioration of the financial markets and the establishment of a legal contingency reserve.

Highlights of Global Investment Servicing’s performance for the first quarter included:

   

Maintaining a positive operating margin in the face of market declines that approached 40% over the past year by proactively managing the cost structure

   

Launching additional capabilities within core processing businesses as well as innovative products resulting from the synergies created by the acquisition of Coates Analytics including:

   

Full service processing capabilities for indexed and actively managed exchange traded funds (ETFs) in the fund administration, custody and transfer agency areas

   

Intelligent Dashboard, a web based Coates Analytics product, to assist accounting and administration clients in fund oversight by organizing and storing essential data and documents from multiple sources to deliver fund critical metrics

   

Increasing subaccounting shareholder accounts by 5 million, or 9%, to 62 million, as existing clients continued to convert additional fund families to this platform. Global Investment Servicing remains a leading provider of subaccounting services and is well positioned to handle the industry trend to subaccount, which allows broker dealers the ability to hold many shareholder accounts within a single omnibus account on an asset manager’s books. This was evidenced by a recently signed deal with a nationally recognized financial services firm to provide both subaccounting and wealth management reporting afforded by the acquisition of Albridge Solutions.

Servicing revenue for 2009 totaled $205 million, a decrease of $33 million, or 14%, from first quarter 2008. This decrease resulted primarily from the lower equity markets, lower interest rate environment, high redemption activity, and account closures and consolidations which have impacted investment income and both asset based and account based fees.

Operating expense decreased by $6 million, or 3%, to $175 million, in the quarter to quarter comparison. Cost containment actions taken by the business beginning in the fourth quarter of 2008 in response to the market conditions, offset partially by investments in technology to support business growth, drove the lower expense level.

Debt financing costs were lower than prior year levels due to the much lower interest rate environment and principal payments of $161 million made during the prior twelve months.

Nonoperating income was impacted by the establishment of a legal contingency reserve.

Total assets serviced by Global Investment Servicing totaled $1.8 trillion at March 31, 2009 compared with $2.6 trillion and $2.0 trillion at March 31, 2008 and December 31, 2008, respectively. The decline in assets serviced was a direct result of global market declines.


 

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DISTRESSED ASSETS PORTFOLIO

(Unaudited)

 

Three months ended March 31

Dollars in millions, except as noted

   2009  

INCOME STATEMENT

    

Net interest income

   $ 364  

Noninterest income

     13  

Total revenue

     377  

Provision for credit losses

     259  

Noninterest expense

     80  

Pretax earnings

     38  

Income taxes

     15  

Earnings

   $ 23  

AVERAGE BALANCE SHEET

    

Commercial lending:

    

Commercial

   $ 197  

Commercial real estate

     3,392  

Equipment lease financing

     858  

Total commercial lending

     4,447  

Consumer lending:

    

Home equity

     7,849  

Residential real estate

     11,012  

Total consumer lending

     18,861  

Total portfolio loans

     23,308  

Other assets

     (289 )

Total assets

   $ 23,019  

Deposits

   $ 45  

Other liabilities

     264  

Capital

     2,592  

Total funds

   $ 2,901  

OTHER INFORMATION

    

Total nonperforming assets (a)

   $ 933  

SOP 03-3 impaired loans (a)

   $ 8,499  

Net charge-offs

   $ 51  

Net charge-offs as a percentage of portfolio loans (annualized)

     .89 %
 

LOANS (in billions) (a)

    

Brokered home equity

   $ 7.1  

Retail mortgages

     6.4  

Residential development

     3.5  

Non-prime mortgages

     2.0  

Construction

     1.5  

Completed construction

     .9  

Cross-border leases

     .8  

Total loans

   $ 22.2  
(a) As of March 31.

 

This business segment was formed in the first quarter of 2009 and consists primarily of assets acquired with National City. The Distressed Assets Portfolio had earnings of $23 million for the first quarter of 2009. Earnings included net interest income of $364 million which was driven by accretion on impaired loans. The provision for credit losses was $259 million, which reflected further deterioration in credit quality during the quarter. Noninterest expense was $80 million for the quarter comprised primarily of costs associated with foreclosed assets and servicing costs.

Distressed Assets Portfolio overview:

   

The loan portfolio included residential real estate development loans, subprime residential mortgage loans, brokered home equity loans and certain other residential real estate loans and cross-border leases. The majority of the distressed loans were associated with acquisitions, including $20 billion related to National City at March 31, 2009.

   

Loans in this business segment require special servicing and management oversight given current market conditions. The business activities of this segment are primarily risk and asset management activities that are focused on maximizing value within a defined risk profile. Business intent drives the categorization of assets in this business segment. Not all impaired loans of PNC are included in this business segment, nor are 100% of the loans included in this business segment considered impaired.

   

As of March 31, 2009, $8.5 billion of loans were deemed impaired and nonperforming assets were $933 million.

   

Total loans were $22 billion at March 31, 2009 compared with $27 billion at January 1, 2009. The decline in loans during the first quarter was primarily due to net transfers to core portfolios and net paydowns.

The fair value marks that we took on a large portion of the assets in this business segment in the first quarter of 2009, along with our experienced team that is managing these assets, put us in a good position to evaluate government-supported programs and other opportunities to manage these assets. Because of our capital and liquidity positions, we have the flexibility to be patient, but would sell these assets if the terms or conditions were appropriate.


 

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CRITICAL ACCOUNTING POLICIES AND JUDGMENTS

Note 1 Accounting Policies in the Notes To Consolidated Financial Statements included in Part I, Item 1 of this Report and in Part II, Item 8 of our 2008 Form 10-K describe the most significant accounting policies that we use. Certain of these policies require us to make estimates and strategic or economic assumptions that may prove to be inaccurate or subject to variations that may significantly affect our reported results and financial position for the period or in future periods.

We must use estimates, assumptions, and judgments when financial assets and liabilities are measured and reported at fair value. Assets and liabilities carried at fair value inherently result in a higher degree of financial statement volatility. Fair values and the information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices and/or other observable inputs provided by independent third-party sources, when available. When such third-party information is not available, we estimate fair value primarily by using cash flow and other financial modeling techniques utilizing assumptions such as credit quality, liquidity, interest rates and other relevant inputs. Changes in underlying factors, assumptions, or estimates in any of these areas could materially impact our future financial condition and results of operations.

We discuss the following critical accounting policies and judgments under this same heading in Item 7 of our 2008 Form 10-K:

   

Fair Value Measurements

   

Allowances For Loan And Lease Losses And Unfunded Loan Commitments And Letters of Credit

   

Estimated Cash Flows on Impaired Loans

   

Goodwill

   

Lease Residuals

   

Revenue Recognition

   

Income Taxes

During the first quarter of 2009, we reassessed our critical accounting policies and judgments and added valuation of residential mortgage servicing rights (MSRs).

Residential Mortgage Servicing Rights – In conjunction with the acquisition of National City, PNC acquired servicing rights for residential real estate loans. We have elected to measure these mortgage servicing rights (MSRs) at fair value. MSRs are established and valued using discounted cash flow modeling techniques which require management to make estimates regarding future net servicing cash flows, taking into consideration actual and expected mortgage loan prepayment rates, discount rates, servicing costs, and numerous other factors.

 

PNC employs a risk management strategy designed to protect the value of MSRs from changes in interest rates. MSR values are hedged with securities and a portfolio of derivatives, primarily interest-rate swaps, options, mortgage-backed forwards, and futures contracts. As interest rates change, these financial instruments are expected to have changes in fair value which are negatively correlated to the change in fair value of the hedged MSR portfolio. The hedge relationships are actively managed in response to changing market conditions over the life of the MSR assets. Selecting appropriate financial instruments to hedge this risk requires significant management judgment to assess how mortgage rates and prepayment speeds could affect the future values of MSRs. Hedging results can frequently be volatile in the short term, but over longer periods of time are expected to protect the economic value of the MSR portfolio.

The fair value of MSRs and significant inputs to the valuation model as of March 31, 2009 are shown in the table below. The expected and actual rates of mortgage loan prepayments are the most significant factors driving the fair value. Management uses an internal proprietary model to estimate future loan prepayments. This model uses empirical data drawn from the historical performance of National City’s managed portfolio, as adjusted for current market conditions. Future interest rates are another important factor in the valuation of MSRs. Management utilizes market implied forward interest rates to estimate the future direction of mortgage and discount rates. The forward rates utilized are derived from the current yield curve for U.S. dollar interest rate swaps and are consistent with pricing of capital markets instruments. Changes in the shape and slope of the forward curve in future periods may result in volatility in the fair value estimate.

 

(Dollars in Millions)    March 31
2009
 

Fair value

   $ 1,052  

Weighted-average life (in years)

     2.50  

Weighted-average constant prepayment rate

     30.82 %

Spread over forward interest rate swap rates

     651  

A sensitivity analysis of the hypothetical effect on the fair value of MSRs to adverse changes in key assumptions is presented below. Changes in fair value generally cannot be extrapolated because the relationship of the change in the assumption to the change in fair value may not be linear. Also, the effect of a variation in a particular assumption on the fair value of the MSRs is calculated independently without changing any other assumption. In reality, changes in one factor may result in changes in another (for example, changes in mortgage interest rates, which drive changes in prepayment rate estimates, could result in changes in the interest rate spread), which could either magnify or counteract the sensitivities.


 

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(Dollars in Millions)    March 31
2009

Prepayment rate:

    

Decline in fair value from 10% adverse change

   $ 85

Decline in fair value from 20% adverse change

   $ 158

Spread over forward interest rate swap rates:

    

Decline in fair value from 10% adverse change

   $ 11

Decline in fair value from 20% adverse change

   $ 22

Additional information regarding these policies is found elsewhere in this Financial Review and in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report.

In addition, see Note 1 Accounting Policies in the Notes To Consolidated Financial Statements regarding our adoption in the first quarter 2009 of the following:

   

SFAS 141(R), “Business Combinations

   

SFAS 160, “Accounting and Reporting of Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51

   

SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities

   

SFAS 163, “Accounting for Financial Guarantee Insurance Contracts – an Interpretation of FASB Statement No. 60”

   

FSP FAS 115-2, FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments

   

FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly”

   

FSP FAS 140-3, “Accounting for Transfers of Financial Assets and Repurchase Financing Transactions

   

FSP FAS 142-3, “Determination of the Useful Life of Intangible Assets

   

FSP APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement)”

   

FSP EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities

STATUS OF QUALIFIED DEFINED BENEFIT PENSION PLAN

We have a noncontributory, qualified defined benefit pension plan (plan or pension plan) covering eligible employees. Benefits are derived from a cash balance formula based on compensation levels, age and length of service. Pension contributions are based on an actuarially determined amount necessary to fund total benefits payable to plan participants. Consistent with our investment strategy, plan assets are primarily invested in equity investments and fixed income instruments. Plan fiduciaries determine and review the plan’s

investment policy, which is described more fully in Note 15 Employee Benefit Plans in the Notes To Consolidated Financial Statements under Part II, Item 8 of our 2008 Form 10-K.

We calculate the expense associated with the pension plan in accordance with SFAS 87, “Employers’ Accounting for Pensions, and we use assumptions and methods that are compatible with the requirements of SFAS 87, including a policy of reflecting trust assets at their fair market value. On an annual basis, we review the actuarial assumptions related to the pension plan, including the discount rate, the rate of compensation increase and the expected return on plan assets.

The discount rate and compensation increase assumptions do not significantly affect pension expense. However, the expected long-term return on assets assumption does significantly affect pension expense. The expected return on plan assets is a long-term assumption established by considering historical and anticipated returns of the asset classes invested in by the pension plan and the allocation strategy currently in place among those classes. While this analysis gives appropriate consideration to recent asset performance and historical returns, the assumption represents a long-term prospective return. We review this assumption at each measurement date and adjust it if warranted. The expected long-term return on plan assets for determining net periodic pension cost for 2009 is 8.25%, unchanged from 2008. Under current accounting rules, the difference between expected long-term returns and actual returns is accumulated and amortized to pension expense over future periods. Each one percentage point difference in actual return compared with our expected return causes expense in subsequent years to change by up to $7 million as the impact is amortized into results of operations.

The table below reflects the estimated effects on pension expense of certain changes in annual assumptions, using 2009 estimated expense as a baseline.

 

Change in Assumption   

Estimated
Increase to 2009
Pension
Expense

(In millions)

 

.5% decrease in discount rate

     (a )

.5% decrease in expected long-term return on assets

   $ 16  

.5% increase in compensation rate

   $ 2  
(a) De minimis.

We currently estimate a pretax pension expense of $124 million in 2009 compared with a pretax benefit of $32 million in 2008. The 2009 values and sensitivities shown above include the qualified defined benefit plan maintained by National City that we merged into the PNC plan as of December 31, 2008. The expected increase in pension cost is


 

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attributable not only to the National City acquisition, but also to the significant variance between 2008 actual investment returns and long-term expected returns.

Our pension plan contribution requirements are not particularly sensitive to actuarial assumptions. Investment performance has the most impact on contribution requirements and will drive the amount of permitted contributions in future years. Also, current law, including the provisions of the Pension Protection Act of 2006, sets limits as to both minimum and maximum contributions to the plan. We expect that the minimum required contributions under the law will be zero for 2009.

We maintain other defined benefit plans that have a less significant effect on financial results, including various nonqualified supplemental retirement plans for certain employees.

RISK MANAGEMENT

We encounter risks as part of the normal course of our business and we design risk management processes to help manage these risks. The Risk Management section included in Item 7 of our 2008 Form 10-K provides a general overview of the risk measurement, control strategies and monitoring aspects of our corporate-level risk management processes. Additionally, our 2008 Form 10-K provides an analysis of the risk management processes for what we view as our primary areas of risk: credit, operational, liquidity and market, as well as a discussion of our use of financial derivatives as part of our overall asset and liability risk management process. The following updates our 2008 Form 10-K disclosures in the credit, liquidity, market, and financial derivatives areas.

CREDIT RISK MANAGEMENT

Credit risk represents the possibility that a customer, counterparty or issuer may not perform in accordance with contractual terms. Credit risk is inherent in the financial services business and results from extending credit to customers, purchasing securities, and entering into financial derivative transactions and certain guarantee contracts. Credit risk is one of our most significant risks.

 

Nonperforming, Past Due And Potential Problem Assets

Credit quality deterioration continued during the first quarter of 2009 as expected, reflecting further economic weakening and resulting in net additions to loan loss reserves.

Nonperforming assets increased $1.3 billion at March 31, 2009 compared with December 31, 2008. The increase resulted from recessionary conditions in the economy and reflected a $1.1 billion increase in commercial lending nonperforming assets and a $.2 billion increase in consumer lending nonperforming assets. The increase in nonperforming commercial loans was from service providers, manufacturing and real estate, including residential real estate development and commercial real estate exposure. The increase in nonperforming consumer loans was mainly due to residential mortgage loans. While nonperforming assets increased across all applicable business segments during the first quarter of 2009, the largest increases were $639 million in Corporate & Institutional Banking and $396 million in Distressed Assets Portfolio. Impaired loans, as defined under SOP 03-3, are excluded from nonperforming loans. Rather, these loans are deemed performing over their lives and, to the extent they become 90 days past due, would be included in the Accruing Loans Past Due 90 Days or More table. Any decrease in expected cash flows of SOP 03-3 impaired loans would result in a charge to the provision for loan losses in the period in which the change becomes probable. Any increase in the expected cash flows of SOP 03-3 impaired loans would result in an increase to accretable yield for the remaining life of the impaired loans.

The allowance for loan and lease losses to commercial lending nonperforming loans remained relatively consistent from December 31, 2008 to March 31, 2009 at 34% and 32%, respectively. This is a result of approximately 65-70% of these nonperforming loans being deemed to be well collateralized. Additionally during the quarter, the allowance for loan and lease losses was reduced $83 million relating to additional loans deemed to be within the scope of SOP 03-3 as of December 31, 2008.

Nonperforming assets were 2.02% of total loans and foreclosed assets at March 31, 2009 compared with 1.23% at December 31, 2008. We remain focused on returning to a moderate risk profile.


 

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Nonperforming Assets By Type

 

In millions   

March 31

2009

  

Dec. 31

2008

Nonaccrual loans

       

Commercial

       

Retail/wholesale

   $ 149    $ 88

Manufacturing

     334      141

Other service providers

     224      114

Real estate related (a)

     226      151

Financial services

     58      23

Health care

     104      37

Other

     119      22

Total commercial

     1,214      576

Commercial real estate

       

Real estate projects

     1,012      659

Commercial mortgage

     200      107

Total commercial real estate

     1,212      766

Equipment lease financing

     121      97

TOTAL COMMERCIAL LENDING

     2,547      1,439

Consumer

       

Home equity

     75      66

Other

     24      4

Total consumer

     99      70

Residential real estate

       

Residential mortgage

     299      139

Residential construction

     15      14

Total residential real estate

     314      153

TOTAL CONSUMER LENDING

     413      223

Total nonaccrual loans

     2,960      1,662

Total nonperforming loans

     2,960      1,662

Foreclosed and other assets

       

Commercial lending

     41      34

Consumer lending

     465      469

Total foreclosed and other assets

     506      503

Total nonperforming assets

   $ 3,466    $ 2,165
(a) Includes loans related to customers in the real estate and construction industries.

Change In Nonperforming Assets

 

In millions    2009     2008  

January 1

   $ 2,165     $ 495  

Transferred from accrual

     1,992       276  

Charge-offs and valuation adjustments

     (310 )     (88 )

Principal activity including payoffs

     (235 )     (46 )

Returned to performing

     (20 )     (20 )

Asset sales

     (126 )     (2 )

March 31

   $ 3,466     $ 615  

At March 31, 2009 and December 31, 2008, nonperforming assets included $1.518 billion and $722 million, respectively, related to National City. These amounts excluded those loans that we impaired in accordance with AICPA Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer. We recorded such loans at estimated fair value and considered them to be performing, even if contractually past due (or if we do not expect to

receive payment in full based on the original contractual terms), when an accretable yield exists which will be recognized in interest income in future periods. The accretable yield represents the excess of the loans’ expected cash flows at the measurement date over their estimated fair value at their acquisition date. See Note 6 Loans Acquired in a Transfer in the Notes To Consolidated Financial Statements of this Report for additional information on those loans.

At March 31, 2009, our largest nonperforming asset was approximately $65 million and our average nonperforming loan associated with commercial lending was less than $1 million.

The amount of nonperforming loans that were current as to principal and interest was $1.1 billion at March 31, 2009 and $555 million at December 31, 2008.

Accruing Loans Past Due 90 Days Or More- Summary (a)

 

    Amount   Percent of Total
Outstandings
 
Dollars in millions  

March 31

2009

 

Dec. 31

2008

  March 31
2009
   

Dec. 31

2008

 

Commercial

  $ 179   $ 104   .27 %   .15 %

Commercial real estate

    586     723   2.31     2.81  

Equipment lease financing

      2     .03  

Consumer

    326     419   .63