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 September 30, 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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  x    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 October 30, 2009, there were 461,290,310 shares of the registrant’s common stock ($5 par value) outstanding.

 

 

 


Table of Contents

The PNC Financial Services Group, Inc.

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

 

     Pages

PART I – FINANCIAL INFORMATION

  

Item 1.        Financial Statements (Unaudited).

   62-110

Consolidated Income Statement

   62

Consolidated Balance Sheet

   63

Consolidated Statement Of Cash Flows

   64

Notes To Consolidated Financial Statements (Unaudited)

  

Note 1   Accounting Policies

   65

Note 2   National City Acquisition

   68

Note 3   Variable Interest Entities

   70

Note 4   Loans and Commitments To Extend Credit

   72

Note 5   Asset Quality

   73

Note 6   Purchased Impaired Loans Related to National City

   74

Note 7   Investment Securities

   75

Note 8   Fair Value

   80

Note 9   Goodwill and Other Intangible Assets

   91

Note 10 Loan Sales and Securitizations

   92

Note 11 Capital Securities of Subsidiary Trusts

   95

Note 12 Certain Employee Benefit And Stock-Based Compensation Plans

   95

Note 13 Financial Derivatives

   98

Note 14 Earnings Per Share

   102

Note 15 Total Equity And Other Comprehensive Income

   103

Note 16 Summarized Financial Information of BlackRock

   104

Note 17 Legal Proceedings

   105

Note 18 Commitments and Guarantees

   106

Note 19 Segment Reporting

   108

Statistical Information (Unaudited)

  

Average Consolidated Balance Sheet And Net Interest Analysis

   111-112

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

   1-61

Financial Review

  

Consolidated Financial Highlights

   1-2

Executive Summary

   3

Consolidated Income Statement Review

   9

Consolidated Balance Sheet Review

   13

Off-Balance Sheet Arrangements And Variable Interest Entities

   21

Fair Value Measurements And Fair Value Option

   25

Business Segments Review

   29

Critical Accounting Policies And Judgments

   43

Status Of Qualified Defined Benefit Pension Plan

   44

Risk Management

   45

Internal Controls And Disclosure Controls And Procedures

   56

Glossary Of Terms

   56

Cautionary Statement Regarding Forward-Looking Information

   59

Item 3.        Quantitative and Qualitative Disclosures About Market Risk.

   45-55

Item 4.        Controls and Procedures.

   56

PART II – OTHER INFORMATION

  

Item 1.        Legal Proceedings.

   113

Item 1A.    Risk Factors.

   113

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

   113

Item 6.        Exhibits.

   113

Exhibit Index.

   113

Signature

   113

Corporate Information

   114


Table of Contents

FINANCIAL REVIEW

CONSOLIDATED FINANCIAL HIGHLIGHTS

THE PNC FINANCIAL SERVICES GROUP, INC.

 

Dollars in millions, except per share data    Three months ended September 30      Nine months ended September 30  
Unaudited    2009 (a)     2008      2009 (a)     2008  

FINANCIAL PERFORMANCE (b)

           

Revenue

           

Net interest income

   $ 2,222      $ 1,000       $ 6,709      $ 2,831   

Noninterest income

     1,826        654         5,197        2,683   

Total revenue

     4,048        1,654         11,906        5,514   

Noninterest expense

     2,379        1,131         7,365        3,269   

Pretax, pre-provision earnings

   $ 1,669      $ 523       $ 4,541      $ 2,245   

Provision for credit losses

   $ 914      $ 190       $ 2,881      $ 527   

Net income

   $ 559      $ 259       $ 1,296      $ 1,160   
Net income attributable to common shareholders    $ 467      $ 248       $ 992      $ 1,130   

Diluted earnings per common share

   $ 1.00      $ .70       $ 2.17      $ 3.23   

Cash dividends declared per common share

   $ .10      $ .66       $ .86      $ 1.95   

Total preferred dividends declared

   $ 99         $ 269       

TARP Capital Purchase Program preferred dividends

   $ 95         $ 237       

Impact of TARP Capital Purchase Program preferred dividends per common share

   $ .21               $ .52           

SELECTED RATIOS

           

Net interest margin (c)

     3.76     3.46      3.72     3.34

Noninterest income to total revenue

     45        40         44        49   

Efficiency (d)

     59        68         62        59   

Return on:

           

Average common shareholders’ equity

     8.70     7.44      6.77     10.91

Average assets

     .81        .72         .62        1.09   

See page 56 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 and nine months ended September 30, 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) 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 September 30, 2009 and September 30, 2008 were $16 million and $9 million, respectively. The taxable-equivalent adjustments to net interest income for the nine months ended September 30, 2009 and September 30, 2008 were $47 million and $28 million, respectively.
(d) Calculated as noninterest expense divided by total revenue.

 

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CONSOLIDATED FINANCIAL HIGHLIGHTS (CONTINUED) (a)

 

Unaudited

  

September 30

2009 (b)

   

December 31

2008 (b)

   

September 30

2008

 

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

        

Assets

   $ 271,407      $ 291,081      $ 145,610   

Loans

     160,608        175,489        75,184   

Allowance for loan and lease losses

     4,810        3,917        1,053   

Interest-earning deposits with banks

     1,129        14,859        329   

Investment securities

     54,413        43,473        31,031   

Loans held for sale

     3,509        4,366        1,922   

Goodwill and other intangible assets

     12,734        11,688        9,921   

Equity investments

     8,684        8,554        6,735   

Noninterest-bearing deposits

     43,025        37,148        19,225   

Interest-bearing deposits

     140,784        155,717        65,729   

Total deposits

     183,809        192,865        84,984   

Borrowed funds

     41,910        52,240        32,139   

Shareholders’ equity

     28,928        25,422        14,218   

Common shareholders’ equity

     20,997        17,490        13,712   

Accumulated other comprehensive loss

     1,947        3,949        2,230   

Book value per common share

     45.52        39.44        39.44   

Common shares outstanding (millions)

     461        443        348   

Loans to deposits

     87     91     88
 

ASSETS UNDER ADMINISTRATION (billions)

        

Discretionary assets under management

   $ 104      $ 103      $ 64   

Nondiscretionary assets under administration

     113        125        105   

Total assets under administration

   $ 217      $ 228      $ 169   
 

FUND ASSETS SERVICED (billions)

        

Accounting/administration net assets

   $ 795      $ 839      $ 907   

Custody assets

     427        379        415   
 
CAPITAL RATIOS         

Tier 1 risk-based (c)

     10.9     9.7     8.2

Tier 1 common

     5.5        4.8        5.7   

Total risk-based (c)

     14.5        13.2        11.9   

Leverage (c) (d)

     9.6        17.5        7.2   

Common shareholders’ equity to assets

     7.7        6.0        9.4   
 
ASSET QUALITY RATIOS         

Nonperforming loans to total loans

     3.19     .95     1.12

Nonperforming assets to total loans and foreclosed and other assets

     3.50        1.24        1.16   

Nonperforming assets to total assets

     2.08        .75        .60   

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

     1.59        1.09        .66   

Allowance for loan and lease losses to total loans

     2.99        2.23        1.40   

Allowance for loan and lease losses to nonperforming loans

     94        236        125   
(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) 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.

Effective July 1, 2009, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. (SFAS) 168, “The FASB Accounting Standards Codification TM and the Hierarchy of Generally Accepted Accounting Principles – a replacement of FASB Statement No. 162” (FASB ASC 105-10, Generally Accepted Accounting Principles). The FASB Accounting Standards Codification TM (FASB ASC) will be the single source of authoritative nongovernmental US GAAP. The FASB ASC is effective for financial statements that cover interim and annual periods ending after September 15, 2009. Other than resolving certain minor inconsistencies in current GAAP, the FASB ASC is not intended to change GAAP, but rather to make it easier to review and research GAAP applicable to a particular transaction or specific accounting issue. Technical references to GAAP included in this Report are provided under the new FASB ASC structure.

 

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 and Note 2 National City Acquisition of this Report, on December 31, 2008, PNC acquired National City Corporation (National City). Our consolidated financial statements for the third quarter and first nine months of 2009 reflect the impact of National City. The impact of National City is described where appropriate throughout this Report; however, certain information may not be available subsequent to the first major conversion of National City customers to the PNC platform scheduled for completion by November 9, 2009.

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, Ohio, New Jersey, Michigan, Maryland, Illinois, Indiana, Kentucky, Florida, Missouri, Virginia, Delaware, Washington, D.C., and Wisconsin. PNC also provides certain investment servicing internationally.

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 $265 million pretax recognized in the first nine months of 2009, including $89 million pretax in the third quarter. The

transaction is expected to result in the reduction of more than $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 businesses 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


 

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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 balance sheet, strong bank level 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 Department of the Treasury’s Troubled Asset Relief Program (TARP) Capital Purchase Program and other regulatory restrictions on dividend capacity.

On March 1, 2009, our board of directors decided to reduce PNC’s quarterly common stock dividend from $.66 to $.10 per share. Accordingly, the board of directors declared a quarterly common stock cash dividend of $.10 per share in April, July and October 2009. Our Board recognizes the 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 enable us to 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 was 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. In May 2009 we raised $624 million in new common equity at market prices through the issuance of 15 million shares of common stock. In connection with the Supervisory Capital Assessment Program, we submitted a capital plan which was accepted by the Federal Reserve.

RECENT MARKET AND INDUSTRY DEVELOPMENTS

Since the middle of 2007 and with a heightened level of activity during the past 20 months, there has been unprecedented turmoil, volatility and illiquidity in worldwide financial markets, accompanied by uncertain prospects for sustaining a fragile economic recovery that began mid-year

2009. 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 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 and in a shareholder-friendly manner, subject to approval by our 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 our 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 December 31, 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, all non-interest bearing transaction accounts are fully guaranteed by the FDIC for the


 

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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. Beginning January 1, 2010, PNC Bank, N.A. will no longer participate in the TLGP-Transaction Account Guarantee Program. Thus, after December 31, 2009, funds held in noninterest-bearing transaction accounts will no longer be guaranteed in full under the TLGP-Transaction Account Guarantee Program, but will be insured up to $250,000 under the FDIC’s general deposit insurance rules.

Federal Reserve Commercial Paper Funding Facility (CPFF) – 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 February 1, 2010. Market Street had no borrowings under this facility at September 30, 2009.

Public-Private Investment Fund Programs (PPIFs) – 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 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.

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 Term Asset-Backed Loan Facility (TALF) and the US Treasury.

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

Home Affordable Modification Program (HAMP) – As part of its effort to stabilize the US housing market, in March 2009 the Obama Administration published detailed guidelines implementing HAMP, and authorized servicers to begin loan modifications. PNC began participating in the HAMP for GSE mortgages in May and for non-GSE mortgages in July, and plans to evaluate participation in the Second Lien Program. This program is scheduled to terminate as of December 31, 2012.

Home Affordable Refinance Program (HARP) – Another part of its efforts to stabilize the US housing market is the Obama Administration’s Home Affordable Refinance Program

(HARP), which provides a means for certain borrowers to refinance their mortgage loans. PNC began participating in HARP in May 2009. The program is scheduled to terminate as of June 10, 2010.

****

In June 2009 the US Treasury issued a report entitled “Financial Regulatory Reform: A New Foundation” which outlined five key objectives:

   

Promote robust supervision and regulation of financial firms,

   

Establish comprehensive supervision of financial markets,

   

Protect consumers and investors from financial abuse,

   

Provide the US government with the tools it needs to manage financial crises, and

   

Raise international regulatory standards and improve international cooperation.

To implement the proposals set forth in the US Treasury report, as well as to provide economic stimulus and financial market stability and to enhance the liquidity and solvency of financial institutions and markets, the US Congress and federal banking agencies have announced, and are continuing to develop, additional legislation, regulations and programs. These proposals 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, such as the Federal government initiatives outlined above:

   

General economic conditions, including the speed and stamina of the fragile recovery,

   

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 and regulatory 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.


 

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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 our overall asset quality and continuing to meet evolving regulatory capital standards,

   

Continuing to maintain and grow our deposit base as a low-cost funding source,

   

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
September 30
    Nine months ended
September 30
 
         2009             2008             2009             2008      

Net income, in millions

  $ 559      $ 259      $ 1,296      $ 1,160   

Diluted earnings per common share

  $ 1.00      $ .70      $ 2.17      $ 3.23   

Return on:

         

Average common shareholders’ equity

    8.70     7.44     6.77     10.91

Average assets

    .81     .72     .62     1.09

Highlights of the third quarter of 2009 included the following:

   

Pretax pre-provision earnings of $1.7 billion exceeded the provision for credit losses by more than $750 million in the third quarter of 2009.

   

Total revenue of $4.0 billion for the third quarter of 2009 reflected strong net interest income and noninterest income as our diverse sources of revenue continued to deliver high quality results. The net interest margin increased 16 basis points to 3.76% for the third quarter of 2009 compared with the second quarter of 2009 primarily due to a substantial reduction in the overall cost of funds.

   

Expenses remained well controlled and declined $279 million, or 10%, compared with the second quarter of 2009.

   

Capital ratios strengthened as we increased the Tier 1 risk-based capital ratio by 40 basis points to 10.9% at September 30, 2009 and added 20 basis points to the Tier 1 common equity ratio, which was 5.5% at that date.

   

We continued to maintain a strong liquidity position with an 87% loan to deposit ratio at September 30, 2009 combined with significant liquid assets and borrowing capacity. Transaction deposits increased $1 billion during the third quarter, reflecting growth of approximately $3 billion before the impact of the required branch divestitures that included $2 billion of transaction deposits. During the third quarter of 2009 we continued to manage deposit pricing, reducing nonrelationship certificates of deposit.

   

Loans declined 3% during the third quarter to $161 billion reflecting paydowns and reduced demand as customers decreased debt, as well as net charge-offs. We remain committed to responsible lending, and loans and commitments of approximately $28 billion were originated and renewed during the third quarter of 2009 as we continued to make credit available.

   

Credit quality deterioration occurred at a slower pace during the third quarter. We strengthened loan loss reserves. The provision for credit losses exceeded net charge-offs by $264 million and the ratio of allowance for loan and lease losses to total loans increased to 2.99% at September 30, 2009 from 2.77% at June 30, 2009. Net charge-offs to average loans were 1.59% on an annualized basis for the third quarter, down from 1.89% for the second quarter of 2009. The allowance for loan and lease losses of $4.8 billion combined with the fair value marks of $6.6 billion on purchased impaired loans represented approximately 7% loss coverage against the loan portfolio at September 30, 2009.

   

Overall the acquisition of National City Corporation continued to exceed expectations.

   

The transaction was accretive to earnings for the first nine months of 2009 and is expected to be accretive for the full year.

   

We realized cost savings of approximately $200 million in the third quarter of 2009, an increase of $60 million from the second quarter. This brings cumulative savings to more than $460 million, ahead of plan and on track to exceed our $1.2 billion two-year goal.

   

We completed the required divestiture of 61 branches including $4.1 billion of deposits and $.8 billion of loans by September 4, 2009.

   

The consolidation of bank charters and first major conversion of National City customers to the PNC platform is scheduled for completion by November 9, 2009, with the remaining conversions to be completed by June 2010.

   

The combined company is committed to delivering the PNC brand for client and business growth.


 

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Our Consolidated Income Statement Review section of this Financial Review describes in greater detail the various items that impacted our results for the third quarter and first nine months 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 nine months of 2009 included the impact of National City, which was the primary driver of increases compared with the first nine months of 2008. The Consolidated Balance Sheet Review section of this Financial Review provides information on changes in selected Consolidated Balance Sheet categories at September 30, 2009 compared with December 31, 2008.

Total average assets were $278.6 billion for the first nine months of 2009 compared with $141.7 billion for the first nine months of 2008. Total average assets for the first nine months of 2009 included $129.4 billion related to National City.

Average interest-earning assets were $241.0 billion for the first nine months of 2009, including $117.9 billion related to National City, compared with $113.4 billion in the first nine months of 2008. An increase of $96.3 billion in loans, including $94.1 billion related to National City, and a $15.6 billion increase in securities available for sale, including $11.4 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 $3.9 billion in the first nine months of 2009.

Average noninterest-earning assets totaled $37.6 billion in the first nine months of 2009 compared with $28.2 billion in the prior year period. For the first nine months of 2009, average noninterest-earning assets related to National City totaled $10.7 billion.

The increase in average total loans, which includes the impact of National City as indicated above, reflected growth in commercial loans of $32.4 billion, consumer loans of $32.0 billion, commercial real estate loans of $15.9 billion and residential mortgage loans of $12.4 billion. Loans represented 70% of average interest-earning assets for the first nine months of 2009 and 63% for the first nine months of 2008.

Average residential mortgage-backed securities increased $12.6 billion compared with the first nine months of 2008. Average US Treasury and government agencies securities increased $3.8 billion, average other debt increased $.9 billion, and average state and municipal securities increased $.7 billion in the comparison. These increases were largely as a result of the National City acquisition and were partially

offset by declines of $1.1 billion in average commercial mortgage-backed securities and $1.3 billion in average asset-backed securities compared with the prior year period. Investment securities comprised 21% of average interest-earning assets for the first nine months of 2009 and 28% for the first nine months of 2008.

Average total deposits were $191.2 billion for the first nine months of 2009, including $102.3 billion related to National City, compared with $83.5 billion for the first nine months of 2008. Average deposits grew from the prior year period primarily as a result of increases in retail certificates of deposit, money market balances, and demand and other noninterest-bearing deposits. Average total deposits represented 69% of average total assets for the first nine months of 2009 and 59% for the first nine months of 2008.

Average transaction deposits were $118.7 billion for the first nine months of 2009, including $51.9 billion related to National City, compared with $54.8 billion for the first nine months of 2008.

Average borrowed funds were $45.7 billion for the first nine months of 2009, including $18.9 billion related to National City, compared with $31.8 billion for the first nine months of 2008.

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 third quarter and first nine months of 2008 have been reclassified to reflect current methodologies and current business and management structure and present prior periods on the same basis.

Total business segment earnings were $1.8 billion for the first nine months of 2009 and $910 million for the first nine months of 2008. Third quarter 2009 business segment earnings totaled $598 million compared with $245 million for the third quarter of 2008. Results for the first nine months and third quarter of 2009 for all of our business segments except BlackRock and Global Investment Servicing reflect the impact of revenues and expenses associated with businesses acquired with National City. Highlights of results for the third quarter and first nine months of 2009 and 2008 are included below.


 

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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’s earnings were $161 million for the first nine months of 2009 compared with $260 million for the same period in 2008. For the third quarter of 2009, Retail Banking’s earnings were $50 million compared with $36 million for the third quarter of 2008. Results were challenged in this environment by ongoing credit deterioration, a lower yield assigned to our deposits, reduced consumer spending and increased FDIC insurance costs. Pre-tax, pre-provision earnings were $1.2 billion for the first nine months of 2009 and $394 million for the third quarter of 2009. Retail Banking continues to maintain its focus on customer and deposit 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 $749 million in the first nine months of 2009 compared with $271 million for the same period in 2008. For the first nine months of 2009, total revenue of $3.9 billion was strong given the current environment, driven primarily by net interest income. Noninterest expense was tightly managed, and earnings were impacted by the higher provision for credit losses, indicative of deteriorating credit quality and the weakened economy. For the third quarter of 2009, Corporate & Institutional Banking’s earnings were $283 million compared with $90 million for the third quarter of 2008. The increase was primarily due to higher net interest income.

Asset Management Group

Asset Management Group’s earnings were $82 million for the first nine months of 2009 compared with $97 million for the same period in 2008. Results for 2009 reflected a 63% increase in discretionary assets under management that drove higher asset management fees and strong revenue growth. The 15% decline in earnings over the prior year was driven by an increased provision for credit losses. The business achieved pretax, pre-provision earnings growth of 29% over the first nine months of 2008 as the business remained focused on client growth, retention and satisfaction, expense management and the National City integration. Earnings for the Asset Management Group totaled $35 million for the third quarter of 2009 compared with $26 million for the third quarter of 2008.

Residential Mortgage Banking

Residential Mortgage Banking earned $410 million for the first nine months of 2009, including $91 million in the third

quarter, driven by strong loan origination activity and net mortgage servicing rights hedging gains. This business segment consists primarily of activities acquired with National City. We do not expect to sustain this level of earnings in the near term.

BlackRock

Our BlackRock business segment earned $151 million in the first nine months of 2009 and $185 million in the first nine months of 2008. Lower equity markets in the first quarter of 2009 impacted BlackRock’s results in this comparison. Third quarter 2009 business segment earnings from BlackRock were $74 million compared with $56 million in the third quarter of 2008 as rallies in equity and fixed income markets along with improved investor sentiment drove improved results.

Global Investment Servicing

Global Investment Servicing earned $41 million for the first nine months of 2009 compared with $97 million for the same period of 2008. For the third quarter of 2009, Global Investment Servicing earned $19 million compared with $34 million for the third quarter of 2008. Results for 2009 were negatively impacted by declines in asset values, fund redemptions, and account closures as a result of the deterioration of the financial markets and the settlement of a legal matter in the first half of 2009.

Distressed Assets Portfolio

This business segment consists primarily of assets acquired with National City. The Distressed Assets Portfolio had earnings of $197 million for the first nine months of 2009, including $39 million in the third quarter. Earnings for the first nine months of 2009 were comprised largely of net interest income of $861 million. The provision for credit losses was $416 million, which reflected credit quality deterioration particularly in the residential development construction and mortgage portfolios. Noninterest expense was $197 million for the first nine months of 2009, comprised primarily of costs associated with foreclosed assets and servicing costs.

Other

“Other” reported a net loss of $495 million for the first nine months of 2009 compared with earnings of $250 million for the first nine months of 2008. The loss for 2009 included the after-tax impact of other-than-temporary impairment charges and alternative investment writedowns, integration costs related primarily to the National City acquisition, a special FDIC assessment, and equity management losses. These items were somewhat offset by a gain related to PNC’s BlackRock LTIP shares obligation in the first quarter and net gains on sales of securities. Earnings for 2008 reflected net securities gains and the partial reduction of the Visa indemnification liability, partially offset by trading losses.

“Other” reported a net loss of $39 million for the third quarter of 2009 compared with earnings of $14 million for the third quarter of 2008. The net loss in the 2009 quarter was primarily due to integration costs related largely to the National City acquisition.


 

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CONSOLIDATED INCOME STATEMENT REVIEW

Our Consolidated Income Statement is presented in Part I, Item 1 of this Report.

Net income for the first nine months of 2009 was $1.3 billion and for the first nine months of 2008 was $1.2 billion. Net income for the third quarter of 2009 was $559 million compared with net income of $259 million for the third quarter of 2008. Our Consolidated Income Statement for the third quarter and first nine months of 2009 includes operating results of National City. As a result, increases in income statement comparisons to the comparable 2008 periods, except as noted, are primarily due to the operating results of National City.

Total revenue for the first nine months of 2009 was $11.9 billion compared with $5.5 billion for the first nine months of 2008. Total revenue for the third quarter of 2009 increased to $4.0 billion from $1.7 billion for the third quarter of 2008.

NET INTEREST INCOME AND NET INTEREST MARGIN

 

     Three months ended
Sept. 30
    Nine months ended
Sept. 30
 
Dollars in millions    2009     2008     2009     2008  

Net interest income

   $ 2,222      $ 1,000      $ 6,709      $ 2,831   

Net interest margin

     3.76     3.46     3.72     3.34

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 both 2009 periods shown above compared with the respective 2008 periods reflected the increase in average interest-earning assets due to National City and the improvement in the net interest margin described below.

We expect our net interest income for the fourth quarter of 2009 to be relatively flat and our net interest margin to improve as we capture the remaining benefit from re-pricing our high-cost deposits and deploying some of our balance sheet liquidity into the investment securities portfolio in light of soft loan demand. This assumes 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 3.72% for the first nine months of 2009 and 3.34% for the first nine months of 2008. The following factors impacted the comparison:

   

A decrease in the rate accrued on interest-bearing liabilities of 99 basis points. The rate accrued on interest-bearing deposits, the largest component, decreased 109 basis points.

   

These factors were partially offset by a 54 basis point decrease in the yield on interest-earning assets. The yield on loans, which represented the largest portion of our earning assets in the first nine months of 2009, decreased 46 basis points.

   

In addition, the impact of noninterest-bearing sources of funding decreased 7 basis points.

The net interest margin was 3.76% for the third quarter of 2009 and 3.46% for the third quarter of 2008. The following factors impacted the comparison:

   

A decrease in the rate accrued on interest-bearing liabilities of 90 basis points. The rate accrued on interest-bearing deposits, the largest component, decreased 98 basis points.

   

These factors were partially offset by a 54 basis point decrease in the yield on interest-earning assets. The yield on loans, which represented the largest portion of our earning assets in the third quarter of 2009, decreased 41 basis points.

   

In addition, the impact of noninterest-bearing sources of funding decreased 6 basis points.

For comparing to the broader market, the average Federal funds rate was .17% for the first nine months of 2009 compared with 2.40% for the first nine months of 2008. The average Federal funds rate was .15% for the third quarter of 2009 compared with 1.96% for the third quarter of 2008.

NONINTEREST INCOME

Summary

Noninterest income totaled $5.2 billion for the first nine months of 2009, compared with $2.7 billion for the first nine months of 2008.

Noninterest income for the first nine months of 2009 included the following:

   

Net credit-related other-than-temporary impairments (OTTI) on debt and equity securities of $433 million,

   

Net gains on sales of securities of $406 million,

   

Gains on hedges of residential mortgage servicing rights of $320 million,

   

Net losses on private equity and alternative investments of $130 million, and

   

Gains of $103 million related to our BlackRock LTIP shares adjustment in the first quarter.


 

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

   

Valuation and sale losses related to our commercial mortgage loans held for sale, net of hedges, of $213 million,

   

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

   

Net OTTI on debt and equity securities of $138 million,

   

Net gains on sales of securities of $104 million,

   

A first quarter 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, and

   

Gains of $69 million related to our BlackRock LTIP shares adjustment.

Noninterest income totaled $1.8 billion for the third quarter of 2009, compared with $654 million for the third quarter of 2008. The third quarter of 2009 included net gains on sales of securities of $168 million and net credit-related OTTI on debt and equity securities of $129 million. The third quarter of 2008 included net OTTI on debt and equity securities of $129 million, net losses on private equity and alternative investments of $79 million, net trading losses of $54 million and a loss of $51 million related to our BlackRock LTIP shares adjustment.

Additional Analysis

Fund servicing fees totaled $586 million in the first nine months of 2009 compared with $695 million in the first nine months of 2008. For the third quarter of 2009, fund servicing fees were $194 million compared with $233 million in the third quarter of 2008. Fund servicing fees were negatively impacted by declines in asset values associated with the lower equity markets during the first nine months of 2009, particularly during the first quarter.

Global Investment Servicing provided fund accounting/ administration services for $795 billion of net fund investment assets and provided custody services for $427 billion of fund investment assets at September 30, 2009, compared with $774 billion and $399 billion, respectively at June 30, 2009 and $907 billion and $415 billion, respectively, at September 30, 2008. Increases in both categories compared with the balances at June 30, 2009 reflected the recovering market and client inflows. The decrease in accounting/administration net fund assets compared with the prior year balance was due to market levels and the loss of a client.

Asset management revenue increased $50 million to $639 million in the first nine months of 2009 compared with the first nine months of 2008. Asset management revenue increased $62 million in the third quarter of 2009, to $242 million, compared with the third quarter of 2008. These increases reflected improving equity markets, new business

generation and a shift in assets into higher yielding equity investments during the third quarter of 2009. Assets managed at September 30, 2009 totaled $104 billion compared with $98 billion at June 30, 2009 and $64 billion at September 30, 2008. Amounts for 2009 include the impact of National City. Higher equity earnings from our BlackRock investment also contributed to the improved third quarter results.

For the first nine months of 2009, consumer services fees totaled $975 million compared with $472 million in the first nine months of 2008. Consumer service fees were $330 million for the third quarter of 2009 compared with $153 million for the third quarter of 2008. Higher consumer service fees in the 2009 periods more than offset reduced fees from lower merchant and brokerage transaction volumes related to the recession.

Corporate services revenue totaled $761 million in the first nine months of 2009 and $547 million in the first nine months of 2008. For the third quarter of 2009, corporate services revenue totaled $252 million compared with $198 million for the third quarter of 2008. Corporate services fees include treasury management fees, which continued to be a strong contributor to revenue.

Residential mortgage fees totaled $883 million in the first nine months of 2009, including $207 million in the third quarter. Fees from strong mortgage refinancing volumes, especially in the first quarter, and $320 million of net hedging gains from mortgage servicing rights were reflected in the first nine months of 2009. Net hedging gains were $60 million in the third quarter. We do not expect to repeat this strong nine-month performance in the near term.

Service charges on deposits totaled $714 million for the first nine months of 2009 and $271 million for the first nine months of 2008. Service charges on deposits totaled $248 million for the third quarter of 2009 compared with $97 million for the third quarter of 2008. In both comparisons, service charges on deposits held firm as checking account growth offset declining customer transaction amounts and volumes.

Net gains on sales of securities totaled $406 million for the first nine months of 2009 and $104 million for the first nine months of 2008. Third quarter net gains on sales of securities were $168 million in 2009 and $55 million in 2008. Third quarter 2009 securities gains related primarily to sales of non-agency and agency residential mortgage-backed securities.

The net credit component of OTTI of securities recognized in earnings was a loss of $433 million in the first nine months of 2009, including $129 million in the third quarter. OTTI for the first nine months and third quarter of 2008 were $138 million and $129 million, respectively.


 

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Other noninterest income totaled $666 million for the first nine months of 2009 compared with $143 million for the first nine months of 2008. Other noninterest income for the first nine months of 2009 included gains on sales of loans of $174 million, trading income of $111 million, gains of $103 million related to our equity investment in BlackRock and net losses on private equity and alternative investments of $130 million.

Other noninterest income for the first nine months of 2008 included the $114 million gain from the sale of Hilliard Lyons, the $95 million Visa gain, gains of $69 million related to our equity investment in BlackRock, and losses related to our commercial mortgage loans held for sale, net of hedges, of $213 million.

Other noninterest income for the third quarter of 2009 totaled $314 million compared with a negative $133 million for the third quarter of 2008. The third quarter of 2009 included $88 million of gains on sales of loans. The third quarter of 2008 included net losses on private equity and alternative investments of $79 million, net trading losses of $54 million and a loss of $51 million related to our BlackRock LTIP shares adjustment.

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.

We expect client-related noninterest income to continue to improve in the fourth quarter of 2009. We also expect that the first conversion of National City customers to the PNC platform in early November 2009 will create more product cross-selling opportunities.

 

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.

Treasury management revenue, which includes fees as well as net interest income from customer deposit balances, totaled $840 million for the first nine months of 2009 and $415 million for the first nine months of 2008. For the third quarter of 2009, treasury management revenue was $281 million compared with $141 million for the third 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 purchasing cards and services provided to the Federal government and healthcare customers.

Revenue from capital markets-related products and services totaled $346 million in the first nine months of 2009 compared with $260 million in the first nine months of 2008. Third quarter 2009 revenue was $155 million compared with $80 million for the third quarter of 2008. The impact of National City-related revenue in both comparisons helped to offset declines in merger and acquisition revenues reflecting the difficult financing environment.

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 $352 million in the first nine months of 2009 compared with $11 million in the first nine months of 2008. For the third quarter of 2009, revenue from commercial mortgage banking activities totaled $119 million compared with a loss of $1 million for the third quarter of 2008. The first nine months of 2009 included gains of $62 million on commercial mortgage loans held for sale, net of hedges. Losses of $213 million on commercial mortgage loans held for sale, net of hedges, reduced revenue for the first nine months of 2008.


 

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PROVISION FOR CREDIT LOSSES

The provision for credit losses totaled $2.9 billion for the first nine months of 2009 compared with $527 million for the first nine months of 2008. For the third quarter of 2009, the provision for credit losses totaled $914 million compared with $190 million for the third quarter of 2008. The provisions for credit losses for the first nine months and third quarter of 2009 were in excess of net charge-offs of $1.9 billion and $650 million, respectively, due to required increases 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.

We expect the provision for credit losses in the fourth quarter of 2009 to be relatively consistent with the provision recognized in the third quarter of 2009.

NONINTEREST EXPENSE

Noninterest expense for the first nine months of 2009 was $7.4 billion compared with $3.3 billion in the first nine months of 2008. Noninterest expense totaled $2.4 billion in the third quarter of 2009 compared with $1.1 billion in the third quarter of 2008. The increases in both comparisons were substantially related to National City. We also recorded a special FDIC assessment of $133 million in the second quarter of 2009. This assessment was intended to build the FDIC’s Deposit Insurance Fund.

 

Integration costs totaled $266 million in the first nine months of 2009 compared with $41 million in the first nine months of 2008. Integration costs in the third quarter of 2009 totaled $89 million compared with $14 million in the third quarter of 2008.

Annualized National City acquisition cost savings of approximately $800 million were realized by the third quarter of 2009, on track to exceed our $600 million goal for 2009 and exceed our $1.2 billion two-year goal of reducing combined company annualized noninterest expense.

We expect total noninterest expense for the fourth quarter of 2009 to be approximately the same level as the third quarter of 2009 as ongoing integration costs should be offset by higher cost saves.

EFFECTIVE TAX RATE

Our effective tax rate was 21.9% for the first nine months of 2009 and 32.5% for the first nine months of 2008. For the third quarter of 2009, our effective tax rate was 26.0% compared with 22.2% for the third quarter of 2008. Both 2009 effective tax rates were significantly lower than the statutory rate due to the relationship of pretax income to tax credits and earnings that are not subject to tax.


 

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CONSOLIDATED BALANCE SHEET REVIEW

SUMMARIZED BALANCE SHEET DATA

 

In millions    Sept. 30
2009
   Dec. 31
2008

Assets

       

Loans

   $ 160,608    $ 175,489

Investment securities

     54,413      43,473

Cash and short-term investments

     9,982      23,936

Loans held for sale

     3,509      4,366

Equity investments

     8,684      8,554

Goodwill and other intangible assets

     12,734      11,688

Other

     21,477      23,575

Total assets

   $ 271,407    $ 291,081

Liabilities

       

Deposits

   $ 183,809    $ 192,865

Borrowed funds

     41,910      52,240

Other

     14,025      18,328

Total liabilities

     239,744      263,433

Total shareholders’ equity

     28,928      25,422

Noncontrolling interests

     2,735      2,226

Total equity

     31,663      27,648

Total liabilities and equity

   $ 271,407    $ 291,081

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

The decline in total assets at September 30, 2009 compared with December 31, 2008 was primarily due to reduced loan demand and lower interest-earning deposits with banks, partially offset by an increase in lower risk investment securities.

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 $3.2 billion at September 30, 2009 and $4.1 billion at December 31, 2008, respectively. Absent a significant improvement in the economy or higher loan demand, we expect our total loan portfolio at December 31, 2009 will decline compared with the balance at September 30, 2009.

Loans decreased $14.9 billion, or 8%, as of September 30, 2009 compared with December 31, 2008. Loans represented 59% of total assets at September 30, 2009 and 60% of total assets at December 31, 2008.

Commercial lending represented 54% of the loan portfolio and consumer lending represented 46% at September 30, 2009. Commercial lending declined 14% at September 30, 2009

compared with December 31, 2008. Commercial loans, which comprised 65% of total commercial lending, declined due to reduced demand for new loans, lower utilization levels and paydowns as clients continued to deleverage their balance sheets. Total consumer lending decreased slightly at September 30, 2009 from December 31, 2008.

Details Of Loans

 

In millions    Sept. 30
2009
   Dec. 31
2008

Commercial

       

Retail/wholesale

   $ 9,404    $ 11,482

Manufacturing

     10,639      13,263

Other service providers

     8,364      9,038

Real estate related (a)

     7,854      9,107

Financial services

     4,422      5,194

Health care

     2,888      3,201

Other

     13,357      17,935

Total commercial

     56,928      69,220

Commercial real estate

       

Real estate projects

     16,112      17,176

Commercial mortgage

     7,952      8,560

Total commercial real estate

     24,064      25,736

Equipment lease financing

     6,283      6,461

TOTAL COMMERCIAL LENDING

     87,275      101,417

Consumer

       

Home equity

       

Lines of credit

     24,272      24,024

Installment

     12,098      14,252

Education

     6,370      4,211

Automobile

     1,988      1,667

Credit card and other unsecured lines of credit

     3,533      3,163

Other

     4,614      5,172

Total consumer

     52,875      52,489

Residential real estate

       

Residential mortgage

     18,469      18,783

Residential construction

     1,989      2,800

Total residential real estate

     20,458      21,583

TOTAL CONSUMER LENDING

     73,333      74,072

Total loans (b)

   $ 160,608    $ 175,489
(a) Includes loans to customers in the real estate and construction industries.
(b) Includes purchased impaired loans related to National City, adjusted to reflect additional loan impairments effective December 31, 2008, amounting to $11.1 billion at September 30, 2009 and $12.7 billion at December 31, 2008.

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.

Commercial lending is the largest category and is the most sensitive to changes in assumptions and judgments underlying the determination of the allowance for loan and lease losses. We have allocated $3.3 billion, or 69%, of the total allowance for loan and lease losses at September 30, 2009 to these loans.


 

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We allocated $1.5 billion, or 31%, of the remaining allowance at that date to consumer lending. 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.

Higher Risk Loans

Our home equity lines of credit and installment loans outstanding totaled $36.4 billion at September 30, 2009. 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 90%. Such loans totaled $1.2 billion or approximately 3% of the total home equity line and installment loans at September 30, 2009. These higher risk loans were concentrated in our geographic footprint with 29% in Pennsylvania, 14% in Ohio, 11% in New Jersey, 7% in Illinois, 6% Missouri, and 5% in Kentucky, with the remaining loans dispersed across several other states. Option ARM loans and negative amortization loans in this portfolio were not significant. Within the higher risk home equity portfolio, approximately 11% are in some stage of delinquency and 5% are in late stage (90+ days) delinquency status.

In our $18.5 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 $0.5 billion and comprised approximately 3% of this portfolio at September 30, 2009. Fifteen percent of the higher risk loans are located in California, 14% in Illinois, 13% in Florida, 9% in Maryland, 6% in Pennsylvania, 6% in Ohio, and 6% in New Jersey, with the remaining loans dispersed across several other states. Option ARM loans and negative amortization loans in this portfolio were not significant. Within the higher risk residential mortgage portfolio, approximately 48% are in some stage of delinquency and 36% are in 90+ days late stage delinquency status.

Our higher risk loans as defined above exclude government insured/government guaranteed loans. We believe that government insured/government guaranteed loans will not result in a significant loss because of their structure.

Within our home equity lines of credit, installment loans and residential mortgage portfolios, approximately 3% of the aggregate $54.9 billion loan outstandings have loan-to-value ratios in excess of 100%. The impact of housing price depreciation is reflected in the allowance for loans and lease losses as a result of the consumer reserve methodology process. The consumer reserve process is sensitive to collateral values which in turn affect loan loss severity. While our consumer reserve methodology strives to reflect all significant risk factors, there is an element of uncertainty

associated with, but not limited to, potential imprecision in the estimation process due to the inherent time lag of obtaining information such as housing price depreciation. We provide additional reserves where appropriate to provide coverage for losses attributable to such risks.

We obtain updated property values annually for select residential mortgage loan portfolios. We are expanding this valuation process to update the property values on the majority of our real estate secured consumer loan portfolios.

Valuation of FASB ASC 310-30 Purchased Impaired Loans

 

   

Original

December 31, 2008

    Revised
December 31, 2008
 
Dollars in billions   Balance     Fair Value
Mark
    Balance     Fair Value
Mark
 

Commercial and commercial real estate loans:

         

Unpaid principal balance

  $ 4.0        $ 6.3       

Fair value mark

    (2.2   (55 )%      (3.4   (54 )% 

Net investment

    1.8          2.9       

Consumer and residential mortgage loans:

         

Unpaid principal balance

    15.3          15.6       

Fair value mark

    (5.2   (34 )%      (5.8   (37 )% 

Net investment

    10.1          9.8       

Total FASB ASC 310-30 purchased impaired loans:

         

Unpaid principal balance

    19.3          21.9       

Fair value mark

    (7.4   (38 )%      (9.2   (42 )% 

Net investment

  $ 11.9            $ 12.7         

Subsequent to December 31, 2008, an additional $2.6 billion of acquired National City loans were identified as impaired under FASB ASC 310-30. A total fair value mark of $1.8 billion was recorded, resulting in a $.8 billion net investment. These impairments were effective December 31, 2008 based on additional information regarding the borrowers and credit conditions that existed as of the acquisition date.

The unpaid principal balance of purchased impaired loans declined from $21.9 billion at December 31, 2008 to $17.7 billion at September 30, 2009 due to amounts determined to be uncollectible, payoffs and disposals. The remaining fair value mark at September 30, 2009 was $6.6 billion and declined from $9.2 billion at December 31, 2008 primarily due to amounts determined to be uncollectible. The net investment of $12.7 billion at December 31, 2008 declined to $11.1 billion at September 30, 2009 due to payoffs and disposals, partially offset by accretion during the first nine months of 2009. We currently expect to collect total cash flows of $14.2 billion on purchased impaired loans, representing the $11.1 billion recorded investment at September 30, 2009 and the accretable net interest of $3.1 billion shown in the table.

Information related to purchase accounting accretion and accretable net interest recognized during 2009 in connection with our acquisition of National City follows.


 

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Purchase Accounting Accretion

 

In millions   

Three months
ended

Sept. 30 2009

   

Nine months
ended

Sept. 30 2009

 

Performing loans

   $ 172      $ 662   

Impaired loans

     204        720   

Reversal of contractual interest on impaired loans

     (167     (584

Net impaired loans

     37        136   

Securities

     25        97   

Deposits

     231        807   

Borrowings

     (58     (195

Total

   $ 407      $ 1,507   

Accretable Net Interest

 

In billions    December 31
2008
    Sept. 30
2009
 

Performing loans

   $ 2.4      $ 1.7   

Impaired loans

     3.7        3.1   

Total loans (a)

     6.1        4.8   

Securities

     .2        .1   

Deposits

     2.1        1.2   

Borrowings

     (1.8     (1.3

Total

   $ 6.6      $ 4.8   
(a) Prior to the reversal of contractual interest on impaired loans.

Adjustments to the recorded investment in purchased impaired loans include purchase accounting accretion, reclassifications from nonaccretable to accretable interest as a result of increases in estimated cash flows, and reductions in the accretable amount as a result of additional loan impairments as of the National City acquisition close date of December 31, 2008.

Net unfunded credit commitments are comprised of the following:

Net Unfunded Credit Commitments

 

In millions    Sept. 30
2009
   Dec. 31
2008

Commercial and commercial real estate (a)

   $ 60,222    $ 60,020

Home equity lines of credit

     21,021      23,195

Consumer credit card lines

     18,721      19,028

Other

     2,705      2,645

Total

   $ 102,669    $ 104,888
(a) Less than 5% of these amounts relate to commercial real estate.

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 $9.6 billion at September 30, 2009 and $8.6 billion at December 31, 2008.

 

Unfunded liquidity facility commitments and standby bond purchase agreements totaled $6.4 billion at September 30, 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 $9.9 billion at September 30, 2009 and $10.3 billion at 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

September 30, 2009

       

SECURITIES AVAILABLE FOR SALE

       

Debt securities

       

US Treasury and government agencies

   $ 6,892    $ 6,917

Residential mortgage-backed

       

Agency

     23,251      23,806

Non-agency

     11,064      8,771

Commercial mortgage-backed

       

Agency

     1,087      1,117

Non-agency

     3,974      3,751

Asset-backed

     1,921      1,513

State and municipal

     1,349      1,368

Other debt

     1,886      1,929

Corporate stocks and other

     553      576

Total securities available for sale

   $ 51,977    $ 49,748

SECURITIES HELD TO MATURITY

       

Debt securities

       

Commercial mortgage-backed (non-agency)

   $ 1,965    $ 2,170

Asset-backed

     2,541      2,629

Other debt

     159      161

Total securities held to maturity

   $ 4,665    $ 4,960

December 31, 2008

       

SECURITIES AVAILABLE FOR SALE

       

Debt securities

       

US Treasury and government agencies

   $ 738    $ 739

Residential mortgage-backed

       

Agency

     22,744      23,106

Non-agency

     13,205      8,831

Commercial mortgage-backed (non-agency)

     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 (non-agency)

   $ 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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The carrying amount of investment securities totaled $54.4 billion at September 30, 2009 and $43.5 billion at December 31, 2008 and represented 20% of total assets at September 30, 2009 compared with 15% of total assets at December 31, 2008. The increase in securities of $10.9 billion since December 31, 2008 primarily reflected the purchase of US Treasury and government agency securities as well as price appreciation in the available for sale portfolio, partially offset by maturities, prepayments and sales.

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. Overall, we consider the portfolio to be well-diversified and high quality. US Treasury and government agencies, agency residential mortgage-backed securities and agency commercial mortgage-backed securities collectively represented 59% of the investment securities portfolio at September 30, 2009.

At September 30, 2009, the securities available for sale portfolio included a net unrealized loss of $2.2 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, market volatility and liquidity conditions. 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 net unrealized losses at September 30, 2009 did not reflect significant credit quality concerns with the underlying assets. The decline in the unrealized pretax loss from year-end was primarily the result of improving fair values in non-agency residential mortgage-backed and non-agency commercial mortgage-backed securities. 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 expected weighted-average life of investment securities (excluding corporate stocks and other) was 4.0 years at September 30, 2009 and 3.1 years at December 31, 2008.

We estimate that at September 30, 2009 the effective duration of investment securities was 2.6 years for an immediate 50 basis points parallel increase in interest rates and 2.5 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.


 

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The following table provides detail regarding the current credit rating, vintage and FICO score of the underlying collateral at origination for residential mortgage-backed, commercial mortgage-backed and other asset-backed securities held in the available-for-sale and held-to- maturity portfolios:

 

     September 30, 2009  
     Agency     Non-agency  
Dollars in millions    Residential
Mortgage-Backed
Securities
    Commercial
Mortgage-Backed
Securities
    Residential
Mortgage-Backed
Securities
    Commercial
Mortgage-Backed
Securities
    Other
Asset-Backed
Securities
 

Fair Value – Available for Sale

   $ 23,806      $ 1,117      $ 8,771      $ 3,751      $ 1,513   

Fair Value – Held to Maturity

                             2,170        2,629   

Total Fair Value

   $ 23,806      $ 1,117      $ 8,771      $ 5,921      $ 4,142   

% of Fair Value:

              

By Vintage

              

2009

     28     81     1       25

2008

     26     2         13

2007

     11         16     16     24

2006

     13     1     23     34     17

2005 and earlier

     22     16     60     50     21

Total

     100     100     100     100     100

By Credit Rating

              

Agency

     100     100        

AAA

           16     95     71

AA

           8     2     5

A

           7     2     1

BBB

           11     1     2

BB

           15       6

B

           14       3

Lower than B

           29       9

No rating

                                     3

Total

     100     100     100     100     100

By FICO Score

              

>720

           61       4

<720 or >660

           30       12

<660

               4

No FICO score

     N/A        N/A        9     N/A        80

Total

                     100             100

 

At least quarterly we conduct a comprehensive security-level impairment assessment on all securities in an unrealized loss position to determine whether the loss represents OTTI. Our assessment considers the security structure, recent security collateral performance metrics, external credit ratings, failure of the issuer to make scheduled interest or principal payments, our judgment and expectations of future performance, and relevant independent industry research, analysis and forecasts. We also consider the severity of the impairment and the length 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.

New US GAAP issued in April 2009 amended 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 and it is not more likely than not that the entity would be

required to sell the security prior to expected recovery. The remaining portion of OTTI charges is included in accumulated other comprehensive loss.

PNC adopted this guidance effective January 1, 2009. Upon adoption, we 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. During the first nine months of 2009, we recognized OTTI losses of $1.5 billion, of which $433 million represented the credit portion of the losses recognized as a reduction of noninterest income in our Consolidated Income Statement. The remaining noncredit portion of the OTTI losses totaled $1.1 billion and was recognized in accumulated other comprehensive loss on the Consolidated Balance Sheet at September 30, 2009. The credit portion of OTTI recognized in our Consolidated Income Statement for the third quarter of 2009 was $129 million. Included below is detail on the net

unrealized losses and OTTI credit losses recorded on non-agency residential and commercial mortgage-backed and

other asset-backed securities, which represent the portfolios that have generated the majority of the OTTI losses.


 

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A summary of all OTTI credit losses recognized for the third quarter and first nine months of 2009 by investment type is included in Note 7 Investment Securities in the Notes To Consolidated Financial Statements of this Report.

 

     September 30, 2009  
In millions    Residential Mortgage-
Backed Securities
    Commercial Mortgage-
Backed Securities
   

Other Asset-Backed

Securities

 

AVAILABLE FOR SALE SECURITIES NON-AGENCY

            
     Fair
Value
  Net Unrealized
Gain (Loss)
    Fair
Value
  Net Unrealized
Gain (Loss)
    Fair
Value
  Net Unrealized
Gain (Loss)
 

By Credit Rating

                  

AAA

   $ 1,434   $ (241   $ 3,444   $ (106   $ 610   $ (22

Other Investment Grade (AA, A, BBB)

     2,214     (300     277     (103     121     (21

Total Investment Grade

     3,648     (541     3,721     (209     731     (43

BB

     1,323     (422     30     (14     245     (79

B

     1,248     (419           133     (70

Lower than B

     2,551     (911           347     (194

No Rating

     1                           57     (22

Total Sub-Investment Grade

     5,123     (1,752     30     (14     782     (365

Total

   $ 8,771   $ (2,293   $ 3,751   $ (223   $ 1,513   $ (408

Investment Grade:

                  

OTTI has been recognized

   $ 57   $ (12            

No OTTI recognized to date

     3,591     (529   $ 3,721   $ (209   $ 731   $ (43

Total Investment Grade

   $ 3,648   $ (541   $ 3,721   $ (209   $ 731   $ (43

Sub-Investment Grade:

                  

OTTI has been recognized

   $ 2,031   $ (870         $ 495   $ (238

No OTTI recognized to date

     3,092     (882   $ 30   $ (14     287     (127

Total Sub-Investment Grade

   $ 5,123   $ (1,752   $ 30   $ (14   $ 782   $ (365

SECURITIES HELD TO MATURITY NON-AGENCY

                  

By Credit Rating

                  

AAA

         $ 2,170   $ 205      $ 2,314   $ 97   

Other Investment Grade (AA, A, BBB)

                                 211     10   

Total Investment Grade

                   2,170     205        2,525     107   

B

                 4    

Lower than B

                 40     (4

No Rating

                                 60     (15

Total Sub-Investment Grade

                                 104     (19

Total

                 $ 2,170   $ 205      $ 2,629   $ 88   

 

Residential Mortgage-Backed Securities

At September 30, 2009, our residential mortgage-backed securities portfolio was comprised of $23.8 billion fair value of US government agency-backed securities and $8.8 billion fair value of non-agency (private issuer) securities. The agency securities are generally collateralized by 1-4 family, conforming, fixed-rate residential mortgages. The non-agency securities are also generally collateralized by 1-4 family residential mortgages. The mortgage loans underlying the non-agency 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 securitization structure and have credit protection in the form

of credit enhancement, over-collateralization and/or excess spread accounts.

During the first nine months of 2009, we recorded OTTI credit losses of $340 million on non-agency residential mortgage-backed securities, including $92 million in the third quarter. As of September 30, 2009, $302 million of the year-to-date credit losses related to securities rated below investment grade. As of September 30, 2009, the noncredit portion of OTTI losses recorded in accumulated other comprehensive loss for non-agency residential mortgage-backed securities totaled $882 million and the related securities had a fair value of $2.1 billion.

The fair value of sub-investment grade investment securities for which we have not recorded an OTTI credit loss as of September 30, 2009 totaled $3.1 billion, with unrealized net losses of $882 million. The results of our security-level assessments indicate that we will recover the entire cost basis


 

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of these securities. Note 7 Investment Securities in the Notes To Consolidated Financial Statements of this Report provides further detail regarding our process for assessing OTTI for these securities.

Commercial Mortgage-Backed Securities

The fair value of the non-agency commercial mortgage-backed securities portfolio was $5.9 billion at September 30, 2009 and consisted of fixed-rate, private-issuer securities collateralized by non-residential properties, primarily retail properties, office buildings, and multi-family housing. The agency commercial mortgage-backed securities portfolio was $1.1 billion fair value at September 30, 2009 consisting of multi-family housing. Substantially all of the securities are the most senior tranches in the subordination structure.

During the first nine months of 2009, we recorded OTTI credit losses of $6 million on non-agency commercial mortgage-backed securities. There were no OTTI credit losses on commercial mortgage-backed securities recorded during the third quarter. The remaining fair value of the securities for which OTTI was recorded approximates zero. All of the impaired securities were rated below investment grade.

Other Asset-Backed Securities

The fair value of the asset-backed securities portfolio was $4.1 billion at September 30, 2009 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 securitization structure and have credit protection in the form of credit enhancement, over-collateralization and/or excess spread accounts.

During the first nine months of 2009, we recorded OTTI credit losses of $76 million on other asset-backed securities, including $34 million in the third quarter of 2009. All of the securities were collateralized by second-lien residential mortgage loans and were rated below investment grade. As of September 30, 2009, the noncredit portion of OTTI losses recorded in accumulated other comprehensive loss for other asset-backed securities totaled $238 million and the related securities had a fair value of $495 million.

For the sub-investment grade investment securities for which we have not recorded an OTTI loss through September 30, 2009, the remaining fair value was $391 million, with unrealized net losses of $146 million. The results of our security-level assessments indicate that we will recover the entire cost basis of these securities. Note 7 Investment Securities in the Notes To Consolidated Financial Statements of this Report provides further detail regarding our process for assessing OTTI for these securities.

If the current housing and economic crisis 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 investment securities portfolio could continue to be adversely affected and we could incur additional OTTI credit losses that would impact our Consolidated Income Statement.

Loans Held For Sale

 

In millions   

Sept. 30

2009

  

Dec. 31

2008

Commercial mortgages at fair value (a)

   $ 1,121    $ 1,401

Commercial mortgages at lower of cost or market

     689      747

Total commercial mortgages

     1,810      2,148

Residential mortgages at fair value (a)

     1,551      1,824

Residential mortgages at lower of cost or market

     1      138

Total residential mortgages

     1,552      1,962

Other

     147      256

Total

   $ 3,509    $ 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.

We stopped originating certain commercial mortgage loans designated as held for sale during the first quarter of 2008 and intend to continue pursuing opportunities to reduce these positions at appropriate prices. Strong origination volumes partially offset sales to government agencies of $4.0 billion of commercial mortgages held for sale at lower of cost or market during the first nine months of 2009, including $0.8 billion in the third quarter.

We recognized net gains of $62 million in the first nine months of 2009 on the valuation and sale of commercial mortgage loans held for sale, net of hedges, including $28 million in the third quarter. Losses of $213 million on the valuation and sale of commercial mortgage loans held for sale carried at fair value, net of hedges, were recognized in the first nine months of 2008, including losses of $75 million in the third quarter of that year. We sold $.2 billion and $.5 billion, respectively, of commercial mortgage loans held for sale carried at fair value in the first nine months of 2009 and 2008.

Residential mortgage loans held for sale decreased during the first nine months of 2009 despite strong refinancing volumes, especially in the first quarter. Loan origination volume was $16.9 billion, including $3.6 billion in the third quarter. Substantially all such loans were originated to agency standards. We sold $17.0 billion of loans and recognized related gains of $409 million during the first nine months of 2009, of which $83 million occurred in the third quarter.

Net interest income on residential mortgage loans held for sale was $261 million for the first nine months of 2009, including $83 million in the third quarter.

Goodwill and Other Intangible Assets

Goodwill increased $418 million and other intangible assets increased $628 million at September 30, 2009 compared with December 31, 2008. Note 2 National City Acquisition and


 

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Note 9 Goodwill and Other Intangible Assets in the Notes to Consolidated Financial Statements of this Report have further details on the National City-related items that were the primary drivers of these increases.

FUNDING AND CAPITAL SOURCES

Details Of Funding Sources

 

In millions    Sept. 30
2009
   Dec. 31
2008

Deposits

       

Money market

   $ 73,754    $ 67,678

Demand

     47,877      43,212

Retail certificates of deposit

     50,524      58,315

Savings

     6,375      6,056

Other time

     1,935      13,620

Time deposits in foreign offices

     3,344      3,984

Total deposits

     183,809      192,865

Borrowed funds

       

Federal funds purchased and repurchase agreements

     3,996      5,153

Federal Home Loan Bank borrowings

     11,953      18,126

Bank notes and senior debt

     12,424      13,664

Subordinated debt

     10,501      11,208

Other

     3,036      4,089

Total borrowed funds

     41,910      52,240

Total

   $ 225,719    $ 245,105

Total funding sources decreased $19.4 billion at September 30, 2009 compared with December 31, 2008 driven by declines in other time deposits, retail certificates of deposit and Federal Home Loan Bank borrowings.

Total deposits decreased $9.1 billion at September 30, 2009 compared with December 31, 2008. Relationship-growth driven increases in money market, demand and savings deposits were more than offset by declines in other time deposits, reflecting a planned run-off of brokered certificates of deposits, and retail certificates of deposits. Interest-bearing deposits represented 77% of total deposits at September 30, 2009 compared with 81% at December 31, 2008.

The $10.3 billion decline in borrowed funds since December 31, 2008 primarily resulted from repayments of Federal Home Loan Bank borrowings. During the first quarter of 2009, PNC issued $1.0 billion of senior notes guaranteed by the FDIC under the Temporary Liquidity Guarantee Program. In addition, PNC issued $1.5 billion of senior notes during the second and third quarters of 2009, which were not issued under the Temporary Liquidity Guarantee Program. 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 that began 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.

Total shareholders’ equity increased $3.5 billion, to $28.9 billion, at September 30, 2009 compared with December 31, 2008 primarily due to the following:

   

A decline of $2.0 billion in accumulated other comprehensive loss primarily as a result of decreases in net unrealized securities losses as more fully described in the Investment Securities portion of this Consolidated Balance Sheet Review,

   

An increase of $.7 billion in retained earnings, and

   

An increase of $.5 billion in capital surplus-common stock and other, primarily due to the May 2009 common stock issuance.

Common shares outstanding were 461 million at September 30, 2009 and 443 million at December 31, 2008. As described in the Executive Summary section of this Financial Review, in May 2009 we raised $624 million in new common equity at market prices through the issuance of 15 million shares of common stock. The offering was related to our plan for increasing common equity following the results of the stress tests conducted under the Supervisory Capital Assessment Program by the Board of Governors of the Federal Reserve System and the Office of the Comptroller of the Currency.

We expect to continue to increase our common equity as a proportion of total capital through growth in retained earnings and will consider other capital opportunities as appropriate. 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.

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 nine months 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


 

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cumulative preferred stock, dividend payments for this preferred stock must be current before dividends may 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    Sept. 30
2009
    Dec. 31
2008
 

Capital components

      

Shareholders’ equity

      

Common

   $ 20,968      $ 17,490   

Preferred

     7,960        7,932   

Trust preferred capital securities

     2,991        2,898   

Noncontrolling interests

     1,644        1,506   

Goodwill and other intangible assets

     (10,550     (9,800

Eligible deferred income taxes on goodwill and other intangible assets

     768        594   

Pension, other postretirement benefit plan adjustments

     619        666   

Net unrealized securities losses, after-tax

     1,556        3,618   

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

     (245     (374

Other

     (195     (243

Tier 1 risk-based capital

     25,516        24,287   

Subordinated debt

     5,474        5,676   

Eligible allowance for credit losses

     2,946        3,153   

Total risk-based capital

   $ 33,936      $ 33,116   

Tier 1 common capital

      

Tier 1 risk-based capital

   $ 25,516      $ 24,287   

Preferred equity

     (7,960     (7,932

Trust preferred capital securities

     (2,991     (2,898

Noncontrolling interests

     (1,644     (1,506

Tier 1 common capital

   $ 12,921      $ 11,951   

Assets

      

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

   $ 233,375      $ 251,106   

Adjusted average total assets

     266,654        138,689   

Capital ratios

      

Tier 1 risk-based

     10.9     9.7

Tier 1 common

     5.5        4.8   

Total risk-based

     14.5        13.2   

Leverage

     9.6        17.5   

 

Capital levels were strengthened during the first nine months of 2009. Higher capital levels were net of dividend payments including $237 million paid to the US Department of the Treasury during the first nine months of 2009, of which $95 million was paid during the third quarter, on $7.6 billion of preferred stock. We plan to redeem the Treasury Department’s investment as soon as appropriate and in a shareholder-friendly manner, subject to approval by our banking regulators.

PNC’s Tier 1 risk-based capital ratio increased by 110 basis points to 10.8% at September 30, 2009 from 9.7% at December 31, 2008. The increase in the ratio was due to higher risk-based capital primarily from retained earnings and the May 2009 common equity issuance coupled with a decline in risk-weighted assets. Our Tier 1 common capital ratio was 5.5% at September 30, 2009 compared with 4.8% at December 31, 2008.

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 September 30, 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. We merged the charter of PNC Bank Delaware into PNC Bank, N.A. during August 2009. We are merging the charter of National City Bank into PNC Bank, N.A. effective as of the close of business on November 6, 2009.

OFF-BALANCE SHEET ARRANGEMENTS AND VARIABLE INTEREST ENTITIES

We engage in a variety of activities that involve unconsolidated entities including qualified special purpose entities (QSPEs) 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


 

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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.

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 September 30, 2009 and December 31, 2008.

Consolidated VIEs – PNC Is Primary Beneficiary

 

In millions   

Aggregate

Assets

  

Aggregate

Liabilities

 

Partnership interests in tax credit investments (a)

       

September 30, 2009

   $ 2,051    $ 825   

December 31, 2008

   $ 1,690    $ 921 (b) 

Credit Risk Transfer Transaction

       

September 30, 2009

   $ 900    $ 900   

December 31, 2008

   $ 1,070    $ 1,070   
(a) Amounts reported primarily represent investments in low income housing projects.
(b) We have revised this amount 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
 

September 30, 2009

          

Market Street

   $ 3,939    $ 3,965    $ 6,413 (a) 

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

     1,767      1,218      734   

Collateralized debt obligations

     25             2   

Total

   $ 5,731    $ 5,183    $ 7,149   

December 31, 2008

          

Market Street

   $ 4,916    $ 5,010    $ 6,965 (a) 

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

     1,517      1,041      811   

Collateralized debt obligations

     20             2   

Total

   $ 6,453    $ 6,051    $ 7,778   
(a) PNC’s risk of loss consists of off-balance sheet liquidity commitments to Market Street of $5.8 billion and other credit enhancements of $.6 billion at September 30, 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 and are factored into our regulatory capital ratios.
(b) Amounts reported primarily represent investments in low income housing projects.
(c) Aggregate assets and aggregate liabilities represent estimated balances due to limited availability of financial information associated with certain acquired National City partnerships.

Market Street

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/F1 by Standard & Poor’s, Moody’s, and Fitch, 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 nine months of 2009, Market Street met all of its funding needs through the issuance of commercial paper.

Market Street commercial paper outstanding was $3.3 billion at September 30, 2009 and $4.4 billion at December 31, 2008. The weighted average maturity of the commercial paper was 26 days at September 30, 2009 and 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 February 1, 2010. Market Street had no borrowings under this facility at September 30, 2009.

During the first nine months of 2009, PNC Capital Markets, acting as a placement agent for Market Street, held a maximum daily position in Market Street commercial paper of $135 million with an average balance of $25 million. This compares with a maximum daily position of $75 million with an average balance of $12 million for the year ended December 31, 2008. PNC Capital Markets owned no Market Street commercial paper at September 30, 2009 and December 31, 2008. PNC Bank, N.A. made no purchases of Market Street commercial paper during the first nine months of 2009.

PNC Bank, N.A. provides certain administrative services, the program-level credit enhancement and all of the liquidity facilities to Market Street in exchange for fees negotiated based on market rates. Program administrator fees related to PNC’s portion of liquidity facilities were $32 million for the first nine months of 2009 and $14 million for the first nine months of 2008. Commitment fees related to PNC’s portion of the liquidity facilities for the first nine months of 2009 and 2008 were insignificant.

The commercial paper obligations at September 30, 2009 and December 31, 2008 were effectively collateralized by Market Street’s assets. While PNC may be obligated to fund under the $5.8 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 $.6 billion of the liquidity facilities if the underlying assets are in


 

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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 September 30, 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 (a)

 

In millions    Outstanding    Commitments    Weighted
Average
Remaining
Maturity
In Years
September 30, 2009                

Trade receivables

   $ 1,549    $ 3,960    2.06

Automobile financing

     624      624    3.93

Auto fleet leasing

     382      554    1.12

Collateralized loan obligations

     141      166    .63

Residential mortgage

     14      14    26.25

Other

     594      662    2.36

Cash and miscellaneous receivables

     635            

Total

   $ 3,939    $ 5,980    2.22

December 31, 2008

          

Trade receivables

   $ 1,516    $ 3,370    2.34

Automobile financing

     992      992    3.94

Auto fleet leasing

     473      560    1.34

Collateralized loan obligations

     306      405    1.58

Credit cards

     400      400    .19

Residential mortgage

     14      14    27.00

Other

     695      765    2.06

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 nine months of 2009.

Market Street Commitments by Credit Rating (a)

 

     

September 30,

2009

   

December 31,

2008

 

AAA/Aaa

   12   19

AA/Aa

   45      6   

A/A

   40      72   

BBB/Baa

   3      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. Based on this analysis, we are not the primary beneficiary and therefore the assets and liabilities of Market Street are not included in our Consolidated Balance Sheet.

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.

QSPEs

We also transfer loans to QSPEs sponsored by PNC or third parties in connection with loan sales and securitization transactions. These transactions effectively transfer the risk to the QSPE and permit the loans to be excluded from our Consolidated Balance Sheet. See Note 10 Loan Sales and Securitizations for additional information.

Estimated Impact of New Accounting Guidance in 2010

In June 2009, the FASB issued guidance that removes the nonconsolidation exception for QSPEs and includes new criteria for determining the primary beneficiary of a VIE. The guidance also increases the frequency of required reassessments to determine whether an entity is the primary beneficiary of a VIE and requires enhanced disclosures. We must adopt this guidance effective January 1, 2010. Based on our preliminary analysis of the new guidance, we expect that we would consolidate Market Street effective January 1, 2010. Accordingly, we would recognize the assets, liabilities and noncontrolling interests of Market Street in our Consolidated Balance Sheet based on their respective carrying amounts as prescribed by the guidance. We also expect that we would consolidate certain QSPEs for the securitization of pools of credit card and jumbo mortgage loans effective January 1, 2010. We expect these changes will have a minimal impact on our capital ratios.

The pro forma impact on total assets of adopting this new accounting standard on January 1, 2010 (based on financial information as of September 30, 2009) for those VIEs that are expected to be consolidated would be as follows:

 

In millions  

Estimated

Incremental
Assets

Market Street

  $ 3,939

Credit cards

    1,621

Jumbo mortgages

    247

Total

  $ 5,807

The actual impact of adopting this new accounting standard on January 1, 2010 could differ as financial information changes from the September 30, 2009 estimates and as we further analyze the impact of this new guidance on PNC.


 

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Credit Risk Transfer Transaction

PNC’s subsidiary, National City Bank (NCB), (which will merge into PNC Bank, N.A. in early November 2009) 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 equity 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.

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 $605 million at September 30, 2009.

In connection with the credit risk transfer agreement, NCB held the right to put the mezzanine notes to the independent third-party once credit losses in the mortgage loan pool exceeded the principal balance of the subordinated equity notes. During the first nine months of 2009, cumulative credit losses in the mortgage loan pool surpassed the principal balance of the subordinated equity notes which resulted in NCB exercising its put option on two of the subordinate mezzanine notes. Cash proceeds received from the third party for the exercise of these put options totaled $36 million. In addition, during the first nine months of 2009 NCB entered into an agreement with the third party to terminate a portion of each party’s rights and obligations under the credit risk transfer agreement for the remaining mezzanine notes. In exchange for $126 million, NCB agreed to terminate its contractual right to put the remaining mezzanine notes to the third party. A pretax gain of $10 million was recognized in noninterest income as a result of these transactions.

Management assessed what impact the reconsideration events above had 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.

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


 

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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

In addition to the following, see Note 8 Fair Value in the Notes To Consolidated Financial Statements under Part 1, Item 1 of this Report for further information regarding fair value. In April 2009, new GAAP was issued 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.

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 GAAP, the assets and liabilities acquired from National City on December 31, 2008 are excluded from the following disclosures as of that date, but are included as of and for the nine months ended September 30, 2009.

At September 30, 2009, assets recorded at fair value represented 23% 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.


 

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Fair Value Measurements – Summary

 

     September 30, 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

   $ 6,634    $ 29,076    $ 14,038    $ 49,748    $ 347    $ 21,633    $ 4,837    $ 26,817

Financial derivatives (a)

     8      4,850      84      4,942      16      5,582      125      5,723

Residential mortgage loans held for sale (b)

        1,551         1,551              

Trading securities (c)

     1,626      351      98      2,075      89      529      73      691

Residential mortgage servicing rights (d)

           1,282      1,282            6      6

Commercial mortgage loans held for sale (b)

           1,121      1,121            1,400      1,400

Equity investments

     1         1,160      1,161            571      571

Customer resale agreements (e)

        1,024         1,024         1,072         1,072

Loans (f)

        80         80              

Other assets (g)

            190      496      686             144             144

Total assets

   $ 8,269    $ 37,122    $ 18,279    $ 63,670    $ 452    $ 28,960    $ 7,012    $ 36,424

Liabilities

                           

Financial derivatives (h)

   $ 4    $ 3,840    $ 284    $ 4,128    $ 2    $ 4,387    $ 22    $ 4,411

Trading securities sold short (i)

     1,208      31         1,239      182      207         389

Other liabilities

            6             6             9             9

Total liabilities

   $ 1,212    $ 3,877    $ 284    $ 5,373    $ 184    $ 4,603    $ 22    $ 4,809
(a) Included in other assets on the Consolidated Balance Sheet.
(b) Included in loans held for sale on the Consolidated Balance Sheet. PNC has elected the fair value option for certain commercial and residential mortgage loans held for sale.
(c) Included in trading securities on the Consolidated Balance Sheet. Fair value includes net unrealized gains of $28 million at September 30, 2009 compared with net unrealized losses of $28 million at December 31, 2008.
(d) Included in other intangible assets on the Consolidated Balance Sheet.
(e) Included in Federal funds sold and resale agreements on the Consolidated Balance Sheet. PNC has elected the fair value option for this item.
(f) Included in loans on the Consolidated Balance Sheet. PNC has elected the fair value option for residential mortgage loans originated for sale. Certain of these loans have been subsequently reclassified into portfolio loans.
(g) Includes BlackRock Series C Preferred Stock.
(h) Included in other liabilities on the Consolidated Balance Sheet.
(i) Included in other borrowed funds on the Consolidated Balance Sheet.
(j) Excludes assets and liabilities associated with the acquisition of National City.

 

Valuation Hierarchy

The following is an outline of the valuation methodologies used for measuring fair value for the major items above. GAAP 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.

Securities Available for Sale and Trading Securities

Securities measured at fair value include both the available for sale and trading portfolios. We use prices obtained from pricing services, dealer quotes or recent trades to determine the fair value of securities. Approximately 50% 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). For approximately 30% more of our positions, we use prices obtained from the pricing services as the primary 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 pricing 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,


 

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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 using a discounted cash flow approach or, in certain instances, identifying a proxy security, market transaction or index. 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. For purposes of determining fair value at September 30, 2009, the relevant pricing service information was the predominant input. In the proxy 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.

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.

Residential Mortgage Loans Held for Sale

We account for residential mortgage loans originated for sale on a recurring basis at fair value. 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 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.

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.

Commercial Mortgage Loans Held for Sale

We account for certain commercial mortgage loans held for sale at fair value. The election of the fair value option aligns the accounting for the commercial mortgages with the related hedges. 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 determine the fair value of commercial mortgage loans held for sale 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. Adjustments are made to these assumptions to account for situations when uncertainties exist, including market conditions and liquidity. Credit risk was included as part of our valuation process for these loans by considering


 

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expected rates of return for market participants for similar loans in the marketplace. Based on the significance of unobservable inputs, we classified this portfolio as Level 3.

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.

Customer Resale Agreements

We account for structured resale agreements, which are economically hedged using free-standing financial derivatives, at fair value. The fair value for structured resale agreements is determined using a model which includes observable market data such as interest rates as inputs. Readily observable market inputs to this model can be validated to external sources, including yield curves, implied volatility or other market-related data. These instruments are classified as Level 2.

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 economically hedges 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.

Level 3 Assets and Liabilities

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 September 30, 2009, Level 3 fair value assets of $18.3 billion represented 29% of total assets at fair value and 7% 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 $284 million at September 30, 2009 represented 5% 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 nine months of 2009, securities transferred into Level 3 from Level 2 exceeded securities transferred out by $8.2 billion. Total securities measured at fair value at September 30, 2009 and December 31, 2008 included securities available for sale and trading securities consisting primarily of 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 nine months of 2009. Other Level 3 assets include commercial mortgage loans held for sale, certain equity securities, auction rate securities, corporate debt securities, trading securities, certain private issuer asset-backed 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.


 

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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 nine months of 2008 have been reclassified to reflect current methodologies and current business and management structure and to present prior periods on the same basis.

Results for the first nine months of 2009 for all of our business segments except BlackRock and Global Investment Servicing include revenues and expenses associated with businesses acquired with National City.

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 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. Certain prior period amounts have been reclassified to reflect current methodologies and our current business and management structure. Financial results are presented, to the extent practicable, as if each business operated on a stand-alone basis. 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 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, exited businesses, 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

 

    

Sept. 30

2009 (a)

 

Dec. 31

2008 (a)

 

Sept. 30

2008

Full-time employees

       

Retail Banking

  21,644   9,304   9,160

Corporate & Institutional Banking

  3,861   2,502   2,611

Asset Management Group

  3,067   1,836   1,822

Residential Mortgage Banking

  3,606      

Global Investment Servicing

  4,561   4,934   4,969

Distressed Assets Portfolio

  157      

Other

       

Operations & Technology

  9,400   4,491   4,452

Staff Services and other

  4,233   2,246   2,209

Total Other

  13,633   6,737   6,661

Total full-time employees

  50,529   25,313   25,223

Retail Banking part-time employees

  4,859   2,347   2,340

Other part-time employees

  1,520   561   566

Total part-time employees

  6,379   2,908   2,906

Total National City legacy employees (a)

      31,374    

Total

  56,908   59,595   28,129
(a) National City’s legacy employees are included in total at December 31, 2008 but are included in the appropriate business segments at September 30, 2009.

Employee data as reported by each business segment in the table above reflects staff directly employed by the respective


 

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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. In addition to reductions of full-time and part-time

employees since the closing of the National City acquisition, we significantly reduced outside contract programmers related to National City systems scheduled for conversion to PNC systems.


 

RESULTS OF BUSINESSES – SUMMARY

(Unaudited)

 

     Earnings (Loss)      Revenue      Average Assets (a)
Nine months ended September 30 – in millions    2009     2008    2009    2008    2009    2008

Retail Banking (b)

   $ 161      $ 260    $ 4,342    $ 2,063    $ 65,281    $ 32,739

Corporate & Institutional Banking

     749        271      3,889      1,328      86,385      46,149

Asset Management Group

     82        97      701      431      7,388      2,955

Residential Mortgage Banking

     410           1,152         8,289     

BlackRock

     151        185      191      244      4,599      4,529

Global Investment Servicing (c)

     41        97      576      702      3,846      4,501

Distressed Assets Portfolio

     197               932             23,632       

Total business segments

     1,791        910      11,783      4,768      199,420      90,873

Other (b) (d) (e)

     (495     250      123      746      79,140      50,781

Total consolidated

   $ 1,296      $ 1,160    $ 11,906    $ 5,514    $ 278,560    $ 141,654
(a) Period-end balances for BlackRock and Global Investment Servicing.
(b) Amounts for 2009 include the results of the 61 branches divested by early September 2009. 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 nine months of 2009 includes $266 million of pretax integration costs primarily related to National City while “Other” for the first nine months of 2008 includes $66 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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RETAIL BANKING

(Unaudited)

 

Nine months ended September 30

Dollars in millions

   2009 (a)     2008  

INCOME STATEMENT

      

Net interest income

   $ 2,689      $ 1,196   

Noninterest income

      

Service charges on deposits

     701        261   

Brokerage

     186        113   

Consumer services

     662        311   

Other

     104        182   

Total noninterest income

     1,653        867   

Total revenue

     4,342        2,063   

Provision for credit losses

     921        299   

Noninterest expense

     3,158        1,327   

Pretax earnings

     263        437   

Income taxes

     102        177   

Earnings

   $ 161      $ 260   

AVERAGE BALANCE SHEET

      

Loans

      

Consumer

      

Home equity

   $ 27,505      $ 13,206   

Indirect

     4,049        2,044   

Education

     5,278        1,762   

Credit cards

     2,151        251   

Other consumer

     1,787        467   

Total consumer

     40,770        17,730   

Commercial and commercial real estate

     12,488        5,063   

Floor plan

     1,307        992   

Residential mortgage

     2,120        2,067   

Total loans

     56,685        25,852   

Goodwill and other intangible assets

     5,828        5,146   

Other assets

     2,768        1,741   

Total assets

   $ 65,281      $ 32,739   

Deposits

      

Noninterest-bearing demand

   $ 16,238      $ 9,229   

Interest-bearing demand

     18,327        8,033   

Money market

     39,401        16,745   

Total transaction deposits

     73,966        34,007   

Savings

     6,621        2,696   

Certificates of deposit

     54,765        15,793   

Total deposits

     135,352        52,496   

Other liabilities

     58        342   

Capital

     8,564        3,305   

Total liabilities and equity

   $ 143,974      $ 56,143   

PERFORMANCE RATIOS

      

Return on average capital

     3     11

Noninterest income to total revenue

     38        42   

Efficiency

     73        64   

OTHER INFORMATION (b)

      

Credit-related statistics:

      

Commercial nonperforming assets

   $ 311      $ 131   

Consumer nonperforming assets

     191        48   

Total nonperforming assets (c)

   $ 502      $ 179   

Impaired loans (d)

   $ 1,161       

Commercial lending net charge-offs

   $ 245      $ 90   

Consumer lending net charge-offs

     442        82   

Total net charge-offs

   $ 687      $ 172   

Commercial lending annualized net charge-off ratio

     2.37     1.99

Consumer lending annualized net charge-off ratio

     1.38     .55

Total annualized net charge-off ratio

     1.62     .89

Other statistics:

      

ATMs

     6,463        4,018   

Branches (e)

     2,553        1,135   

 

At September 30

Dollars in millions, except as noted

   2009 (a)     2008  

OTHER INFORMATION (CONTINUED) (b)

  

   

Home equity portfolio credit statistics:

      

% of first lien positions (f)

     35     38

Weighted average loan-to-value ratios (f)

     74     73

Weighted average FICO scores (g)

     727        726   

Annualized net charge-off ratio

     .70     .46

Loans 90 days past due

     .73     .49

Customer-related statistics (h):

      

Retail Banking checking relationships

     5,040,000        2,400,000   

Retail online banking active customers

     2,682,000        1,193,000   

Retail online bill payment active customers

     753,000        364,000   

Brokerage statistics:

      

Financial consultants (i)

     655        402   

Full service brokerage offices

     42        23   

Brokerage account assets (billions)

   $ 30      $ 16   

Managed credit card loans:

      

Loans held in portfolio

   $ 2,476      $ 286   

Loans securitized

     1,654           

Total managed credit card loans

   $ 4,130      $ 286   

Net charge-offs:

      

Securitized credit card loans

   $ 101       

Managed credit card loans

   $ 253      $ 7   

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

      

Securitized credit card loans

     7.26    

Managed credit card loans

     8.46     3.73
(a) Includes the impact of National City, which we acquired on December 31, 2008.
(b) Presented as of September 30 except for net charge-offs and annualized net charge-off ratios, which are for the nine months ended.
(c) Includes nonperforming loans of $490 million at September 30, 2009 and $164 million at September 30, 2008.
(d) These are purchased impaired loans related to National City, adjusted to reflect additional loan impairments effective December 31, 2008.
(e) Excludes certain satellite branches that provide limited products and/or services.
(f) Includes loans from acquired portfolios for which lien position and loan-to-value information was limited.
(g) Represents the most recent FICO scores we have on file.
(h) Amounts as of September 30, 2009 include the impact of National City prior to application system conversions. These amounts may be refined subsequent to system conversions.
(i) Financial consultants provide services in full service brokerage offices and traditional bank branches.

Retail Banking’s earnings were $161 million for the first nine months of 2009 compared with $260 million for the same period in 2008. Results were challenged in this environment by ongoing credit deterioration, a lower yield assigned to our deposits, reduced consumer spending and increased FDIC insurance costs. Pre-tax, pre-provision earnings were $1.2 billion for the first nine months of 2009, a 61% increase over the same period in 2008. Retail Banking continues to maintain its focus on customer and deposit 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 nine months of 2009 include the following:

 

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

   

Added over 1,400 branches,

   

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.

 

The required divestiture of 61 branches and 73 ATMs from the National City acquisition was completed by early September.

 

Retail Banking expanded the number of customers it serves and grew checking relationships. Excluding relationships added from acquisitions and the impact of the required divestitures, net new consumer and business checking relationships for legacy PNC grew by 101,000 since December 31, 2008 compared with 68,000 during the same period last year.

 

Our investment in online banking capabilities continued to pay off. Excluding customers added from acquisitions and the impact of the required divestitures, active online bill pay customers have increased 14% since December 31, 2008. We continue to seek customer growth by expanding our use of technology, such as the launch of our “Virtual Wallet” online banking product about a year ago. We leveraged our understanding of this market along with our extensive university banking program and launched a new product in the second quarter of 2009 for college students and their parents, called “Virtual Wallet Student.”

 

Employee engagement and customer satisfaction/loyalty results are tracking at all time highs. PNC recently received the “Gallup Great Workplace Award” in recognition of its extraordinary ability to create an engaged workplace culture.

 

At September 30, 2009, Retail Banking had 2,553 branches and an ATM network of 6,463 machines giving PNC one of the largest distribution networks among U.S. banks. 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. In the first nine months of 2009, we opened 18 traditional branches and 40 in-store branches, added 302 ATMs, and divested 61 branches and 73 ATMs. To continue to optimize our network, we

   

also consolidated 24 and relocated 10 branches in the first nine months of 2009. The in-store branches and the ATMs were primarily opened under our previously reported exclusive banking services agreement with Giant Food LLC supermarkets.

Total revenue for the first nine months of 2009 was $4.3 billion compared with $2.1 billion for the same period in 2008. Net interest income of $2.7 billion increased $1.5 billion compared with the first nine months of 2008. The increase in net interest income was driven by the National City acquisition and was partially offset by declines in legacy net interest income as a result of the negative impact of a lower yield assigned to deposits in this low rate environment.

Noninterest income for the first nine months of 2009 was $1.7 billion, an increase of $786 million over the prior year same period. 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 brokerage account activities and consumer related fees have been negatively impacted by current economic conditions. The Market Risk Management – Equity and Other Investment Risk section of this Financial Review includes further information regarding our investment in Visa.

We anticipate that the proposed and/or passed legislation or regulations will negatively impact revenue associated with credit cards, overdraft fees associated with demand deposit accounts and guaranteed education loans issued under the current Federal program.

In the first nine months of 2009, the provision for credit losses was $921 million compared with $299 million in the same period of 2008. Net charge-offs were $687 million for the first nine months of 2009 and $172 million in the same period last year. The increases in provision and net charge-offs were primarily a result of a loan portfolio that has increased 119%, including a significantly larger credit card portfolio, and the continued credit deterioration in both the commercial and consumer loan portfolios which is requiring an increase to loan loss reserves.

Noninterest expense for the first nine months of 2009 totaled $3.2 billion, an increase of $1.8 billion over the same period last year. Increases were attributable to the impact of acquisitions, increased FDIC insurance costs, and continued investments in the business.

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. The deposit strategy of Retail Banking is to remain disciplined on pricing,


 

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target specific products and markets for growth, and focus on the retention and growth of balances for relationship customers. Average total deposits increased $82.9 billion compared with the first nine months of 2008.

 

Average money market deposits increased $22.7 billion over the first nine months 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 nine months of 2009, average certificates of deposit increased $39 billion over the same period of the prior year. 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. We expect a continued decline in certificates of deposits which began in 2009 and which will continue for the remainder of 2009 and into 2010 due to the planned run off of higher rate certificates of deposits.

 

Average demand deposits increased $17.3 billion over the first nine months of 2008. This increase was driven by acquisitions and organic growth.

 

Currently, we are predominately focused on a relationship-based lending strategy that targets specific customer sectors (homeowners, students, small businesses and auto dealerships).

 

In the first nine months of 2009, average total loans were $56.7 billion, an increase of $30.8 billion over the same period in 2008. In the current environment, consumer and commercial loan demand is being outpaced by refinances, paydowns, and charge-offs.

 

Average commercial and commercial real estate loans grew $7.4 billion compared with the first nine months of 2008. The increase was primarily due to the National City acquisition.

 

Average home equity loans grew $14.3 billion over the first nine months of 2008. The majority of the increase is attributable to the National City acquisition. Our home equity loan portfolio is relationship based, with 96% 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 $3.5 billion compared with the first nine months of 2008. The increase was due to the National City acquisition and an increase in the core business. The core business increase was primarily 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 first nine months of 2008. The increase was primarily the result of the National City acquisition and also reflected legacy growth of 68% over the first nine months of 2009.


 

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CORPORATE & INSTITUTIONAL BANKING

(Unaudited)

 

Nine months ended September 30

Dollars in millions except as noted

   2009 (a)    2008  

INCOME STATEMENT

       

Net interest income

   $ 2,824    $ 957   

Noninterest income

       

Corporate service fees

     680      455   

Other

     385      (84

Noninterest income

     1,065      371   

Total revenue

     3,889      1,328   

Provision for credit losses

     1,362      194   

Noninterest expense

     1,356      707   

Pretax earnings

     1,171      427   

Income taxes

     422      156   

Earnings

   $ 749    $ 271   

AVERAGE BALANCE SHEET

       

Loans

       

Commercial

   $ 42,540    $ 20,020   

Commercial real estate

     15,560      5,430   

Commercial – real estate related

     3,922      2,987   

Asset-based lending

     6,443      5,179   

Equipment lease financing

     5,397      1,447   

Total loans

     73,862      35,063   

Goodwill and other intangible assets

     3,532      3,128   

Loans held for sale

     1,728      2,172   

Other assets

     7,263      5,786   

Total assets

   $ 86,385    $ 46,149   

Deposits

       

Noninterest-bearing demand

   $ 18,756    $ 8,136   

Money market

     9,402      5,736   

Other

     7,636      2,977   

Total deposits

     35,794      16,849   

Other liabilities

     9,355      5,128   

Capital

     7,811      2,986   

Total liabilities and equity

   $ 52,960    $ 24,963   

 

Nine months ended September 30

Dollars in millions except as noted

   2009 (a)     2008  

PERFORMANCE RATIOS

      

Return on average capital

     13     12

Noninterest income to total revenue

     27        28   

Efficiency

     35        53   

COMMERCIAL MORTGAGE SERVICING PORTFOLIO (in billions)

      

Beginning of period

   $ 270      $ 243   

Acquisitions/additions

     31        23   

Repayments/transfers

     (26     (19

End of period

   $ 275      $ 247   

OTHER INFORMATION

      

Consolidated revenue from: (b)

      

Treasury Management

   $ 840      $ 415   

Capital Markets

   $ 346      $ 260   

Commercial mortgage loans held for sale (c)

   $ 138      $ (150

Commercial mortgage loan servicing (d)

     214        161   

Total commercial mortgage banking activities

   $ 352      $ 11   

Total loans (e)

   $ 68,352      $ 37,395   

Credit-related statistics:

      

Nonperforming assets (e) (f)

   $ 2,992      $ 640   

Impaired loans (e) (g)

   $ 1,482       

Net charge-offs

   $ 711      $ 151   

Net carrying amount of commercial mortgage servicing rights (e)

   $ 897      $ 698   
(a) Includes the impact of National City, which we acquired on December 31, 2008.
(b) Represents consolidated PNC amounts.
(c) 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.
(d) Includes net interest income and noninterest income from loan servicing and ancillary services.
(e) At September 30.
(f) Includes nonperforming loans of $2.9 billion at September 30, 2009 and $635 million at September 30, 2008.
(g) These are purchased impaired loans related to National City, adjusted to reflect additional loan impairments effective December 31, 2008.

Corporate & Institutional Banking earned $749 million in the first nine months of 2009, an increase of $478 million from 2008. The acquisition of National City positively impacted operating results as revenues approximately tripled while expense approximately doubled in the comparison. As a result, operating leverage increased $1.9 billion which more than offset a six-fold or $1.2 billion increase in the provision for credit losses.

Highlights of Corporate & Institutional Banking performance over the first nine months of 2009 include:

 

Net interest income for the first nine months of 2009 was $2.8 billion, an increase of $1.9 billion from 2008 driven primarily by the National City acquisition, improved loan spreads, and higher deposit levels.

 

Corporate service fees were $680 million for the first nine months of 2009, an increase of $225 million over the same period last year. The major components of corporate service fees are treasury management, corporate finance fees and commercial mortgage servicing revenue.


 

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We continued to invest in our healthcare initiative which will help provide our customers opportunities to reduce operating costs. Healthcare-related revenues in the first nine months of 2009 increased 25% from the same period in 2008, to $64 million.

   

Our loan syndications group has maintained its leadership position in the marketplace as we are ranked #1 nationally, in terms of number of deals, for Traditional Middle Market Bookrunner.

   

The commercial real estate servicing portfolio remained relatively flat except for the impact of the National City acquisition. Growth within the agency servicing portfolio offset the impact of the downturn in the CMBS market during 2008 and 2009. Rising commercial real estate delinquencies and defaults have resulted in growth in the special servicing portfolio, which increased from $2.9 billion at year-end 2008, to $9.9 billion at September 30, 2009.

   

Midland Loan Services is the only company in the industry to hold the highest US CMBS primary, master and special servicer ratings from both Fitch and Standard & Poor’s.

   

Our multi-family origination activities for FNMA and FHMLC remained robust with 2009 originations of $3.4 billion.

   

Merger and advisory revenues declined $58 million from the same period in 2008 reflecting the impact of the difficult financing environment on acquisition activity.

 

Other noninterest income was $385 million for the first nine months of 2009, an increase of $469 million from the same period in 2008 primarily due to the National City acquisition.

   

Operating lease revenues were $78 million in 2009, largely due to the National City acquisition. The combined leasing operations are the 5th largest bank-affiliated leasing company.

   

Gains were $62 million in 2009 on commercial mortgage loans held for sale, net of hedges, compared with losses of $213 million in 2008. Inventory carried at fair value at September 30, 2009 was $1.1 billion, reduced from $1.5 billion at September 30, 2008.

   

Gains on sales of loans related to our portfolio management activities were $69 million in 2009. We

   

sold approximately $400 million of commitments during the first nine months of 2009, approximately $300 million of which were impaired.

Provision for credit losses was $1.4 billion in the first nine months of 2009, an increase of $1.2 billion from 2008, driven by general credit deterioration, primarily in the real estate, middle market and transportation related portfolios, and the National City acquisition. Net charge-offs increased by $560 million from the same period in 2008, due primarily to the National City acquisition and net charge-offs in the middle market. Growth in nonperforming assets was driven by increasing difficulty being experienced by customers in our commercial real estate, financial, transportation-related and corporate loan portfolios.

Noninterest expense was $1.4 billion for the first nine months of 2009, an increase of $649 million from 2008, due to the National City acquisition. Otherwise, expenses were essentially flat as lower compensation-related costs offset higher credit-related and FDIC insurance costs.

Average loans were $73.9 billion for the first nine months of 2009, an increase of $38.8 billion from the same period a year earlier, driven by the National City acquisition. We continue to experience declines in utilization rates across our middle-market and large-corporate customer groups. We continue to pursue new customers that meet our risk profile. During 2009 we have added approximately 350 new corporate clients.

Average deposits were $35.8 billion for the first nine months of 2009, an increase of $18.9 billion over the same period last year primarily due to the National City acquisition. During the first nine months of 2009, PNC continued to experience deposit growth including the return of deposits from National City customers who had previously moved funds to other institutions. The third quarter of 2009 also reflected seasonal increases due to the tax receipts of many of our municipal and school district customers.

See the additional revenue discussion regarding treasury management, capital markets-related products and services, and commercial mortgage banking activities on page 11.


 

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ASSET MANAGEMENT GROUP

(Unaudited)

 

Nine months ended September 30

Dollars in millions except as noted

   2009 (a)     2008 (b)  

INCOME STATEMENT

      

Net interest income

   $ 241      $ 95   

Noninterest income

     460        336   

Total revenue

     701        431   

Provision for credit losses

     72        2   

Noninterest expense

     499        274   

Pretax earnings

     130        155   

Income taxes

     48        58   

Earnings

   $ 82      $ 97   

AVERAGE BALANCE SHEET

      

Loans

      

Consumer

   $ 3,929      $ 2,085   

Commercial and commercial real estate

     1,691        574   

Residential mortgage

     1,104        66   

Total loans

     6,724        2,725   

Goodwill and other intangible assets

     404        41   

Other assets

     260        189   

Total assets

   $ 7,388      $ 2,955   

Deposits

      

Noninterest-bearing demand

   $ 1,079      $ 882   

Interest-bearing demand

     1,551        691   

Money market

     3,233        1,765   

Total transaction deposits

     5,863        3,338   

Certificates of deposit and other

     1,129        557   

Total deposits

     6,992        3,895   

Other liabilities

     109        14   

Capital

     589        249   

Total liabilities and equity

   $ 7,690      $ 4,158   

PERFORMANCE RATIOS

      

Return on average capital

     19     52

Noninterest income to total revenue

     66        78   

Efficiency

     71        64   

OTHER INFORMATION

      

Total nonperforming assets (c)

   $ 129      $ 3   

Impaired loans (c) (d)

   $ 206       

Total net charge-offs

   $ 41      $ 2   
 

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

      

Personal

   $ 93      $ 72   

Institutional

     124        97   

Total

   $ 217      $ 169   

Asset Type

      

Equity

   $ 98      $ 77   

Fixed Income

     56        43   

Liquidity/Other

     63        49   

Total

   $ 217      $ 169   

Discretionary assets under management

      

Personal

   $ 66      $ 44   

Institutional

     38        20   

Total

   $ 104      $ 64   

Asset Type

      

Equity

   $ 47      $ 34   

Fixed Income

     34        18   

Liquidity/Other

     23        12   

Total

   $ 104      $ 64   

Nondiscretionary assets under administration

      

Personal

   $ 27      $ 28   

Institutional

     86        77   

Total

   $ 113      $ 105   

Asset Type

      

Equity

   $ 51      $ 43   

Fixed Income

     22        25   

Liquidity/Other

     40        37   

Total

   $ 113      $ 105   
(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 September 30.
(d) These are purchased impaired loans related to National City, adjusted to reflect additional loan impairments effective December 31, 2008.
(e) Excludes brokerage account assets.

Asset Management Group’s earnings were $82 million for the first nine months of 2009 compared with $97 million for the same period in 2008. Results for 2009 reflected a 63% increase in discretionary assets under management that drove higher asset management fees and strong revenue growth. The 15% decline in earnings over the prior period was driven by an increase in provision for credit losses reflective of deteriorating credit quality and a weakened economy. The business achieved pretax, pre-provision earnings growth of 29% over the first nine months of 2008, as the business remained focused on client growth, expense management and the National City integration.

Highlights of Asset Management Group’s performance during the first nine months of 2009 include the following:

 

Increased assets under management,

 

Solid sales and client retention,

 

Increased client satisfaction, and

 

Disciplined expense management.

Assets under administration of $217 billion at September 30, 2009 increased $48 billion compared with the balance at September 30, 2008. Discretionary assets under management of $104 billion at September 30, 2009 increased $40 billion compared with the balance at September 30, 2008. The increase in discretionary assets under management is attributable to the National City acquisition, somewhat mitigated by the impact of the lower equity markets in 2009.

Nondiscretionary assets under administration of $113 billion at September 30, 2009 increased $8 billion compared with the balance at September 30, 2008. This increase was driven by the National City acquisition but was somewhat offset by a decline in institutional assets related to the exit of a noncore product offering.

Total revenue for the first nine months of 2009 was $701 million, compared with $431 million for the same period in 2008. Net interest income of $241 million reflects the additional revenue from the National City loan and deposit portfolios and solid yields from the loan portfolio. The year-over-year increase in net interest income was partially offset by lower funds brokering revenue on deposits as a lower yield is being assigned to deposit balances in this low interest rate environment. Noninterest income of $460 million increased $124 million compared with the first nine months of 2008 primarily in asset management fees. The growth was attributable primarily to the National City acquisition.

The provision for credit losses of $72 million increased from $2 million in the first nine months of 2008 as loan loss


 

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reserves were increased beyond charge-offs due to credit quality deterioration. Net charge-offs were $41 million for the first nine months of 2009 and $2 million for the first nine months of 2008.

Noninterest expense of $499 million increased $225 million in the first nine months of 2009 compared with the same period of 2008. The increase is attributable to the National City acquisition but implementation of various integration-related initiatives has mitigated this increase. Expense management remains a key focal point for this business and the implementation of efficiency initiatives will continue through the remainder of the year.

Balance sheet activity for the first nine months of 2009 reflects both core and acquisition-related growth. Average loans of $6.7 billion increased $4.0 billion compared with 2008. Average total deposits of $7.0 billion increased $3.1 billion compared with the first nine months of 2008. During the economic downturn, customers have shifted from riskier equity investments into safer deposit products resulting in solid money market and demand deposit growth. In addition, the recapture of former National City customers bolstered deposit growth.

RESIDENTIAL MORTGAGE BANKING

(Unaudited)

 

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