Filed by The PNC Financial Services Group, Inc.
Pursuant to Rule 425 under the Securities Act of 1933 and
deemed filed pursuant to Rule 14a-12 of the Securities Exchange Act of 1934
Subject Company: United National Bancorp
Commission File No. 000-16931
The following is the transcript from a conference call for investors
that took place on October 16, 2003 in connection with financial results for The
PNC Financial Services Group, Inc. for the third quarter 2003.
Bill Callihan: Good morning and welcome to today's conference call for The
PNC Financial Services Group. Participating in the call this
morning will be PNC's Chairman and Chief Executive Officer,
Jim Rohr and Bill Demchak, the company's Vice Chairman and
Chief Financial Officer.
As a reminder, the following comments contain
forward-looking information. Actual results or future events
could differ - possibly materially - and due to a variety of
factors including those described in this call and today's
earnings release and supplementary financial information and
in our 2002 Form 10-K and other SEC reports.
These statements speak only as of October 16, 2003 and PNC
undertakes no obligation to update them.
The following comments also include a discussion of non-GAAP
financial measures, which is qualified by the GAAP
reconciliation information included in our earnings release,
financial supplement, and other documents available on our
web site at www.pnc.com in the Investor section.
Now let me turn over the call to Jim Rohr.
Jim Rohr: Thanks, Bill, and welcome to everyone joining us this
morning. Let me begin by saying that overall we're very
pleased with our performance. Most importantly, our reported
earnings exceeded Street expectations and our asset quality
remained stable with non-performing assets and
non-performing loans both lower than the previous quarter.
I'd also like to point out a few other notable achievements
from the quarter. The Federal Reserve Bank of Cleveland and
the Office of the Comptroller of the Currency lifted our
written agreements - confirming the quality of our
governance and risk management programs. And Moody's
recognized this progress just yesterday by affirming our
debt ratings with a positive outlook.
We also earned recognition from Information Week for our
premier technology platform and from Working Mother Magazine
for the strong culture our employees have ingrained
throughout the company. So we're pleased that we were
recognized for success on a number of fronts.
But let me now turn to the fact that our team remains
focused on executing our growth strategies. In the third
quarter we expanded our customer base and grew consumer
demand deposits 18% - two key elements of our plan. However,
weak loan demand and general economic conditions have
dampened our overall business results in what has been a
historically low interest rate environment.
We could have boosted our short-term revenue by betting the
balance sheet and extending the duration of our portfolio,
but that goes against our risk management philosophy, so we
didn't. Bill Demchak will provide some more detail about
these items in a few moments.
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But first let me highlight some of our broader
accomplishments and comment on the strategic significance of
each. As you know, our vision is to become a premier
financial services marketing company, one defined by
high-return business mix, above average growth, and moderate
risk profile. How are we going to get there?
Well many of you are familiar with the four key elements of
the plan. One is to expand our deposit group and banking
franchise. Two is to grow our asset management and
processing businesses. Three, to leverage our core operating
platform and customer base to enhance efficiencies and our
growth prospects. And four, to manage this process through
best-in-class corporate governance, financial discipline,
and risk management.
We've taken a number of actions so far this year,
particularly in the third quarter, that have helped us to
make progress against these three objectives.
As I mentioned, we've developed a successful banking model.
It continues to grow our targeted customer base and is
generating high returns and great cash flow and we're
focused on expanding it. As I've mentioned, as Bill will
talk in a moment, we've increased demand deposits 18% on an
annualized basis.
We recently announced also the opportunity to acquire United
National as well as to open offices in 40 Stop-and-Shop
locations in New Jersey. This will broaden our presence in
that state and give us an opportunity to add thousands of
core customers, private banking as well as business
customers, in markets that are extraordinarily wealthy and
rapidly growing.
We remain on schedule with our planning for the United
National acquisition and we anticipate a January close.
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Now with both PNC Advisors and PFPC, we continue to focus on
operating leverage. PNC Advisors is working to streamline
operations and to grow its client base, which is the real
challenge in this business.
To help with the latter we have re-engineered our sales
platform. We have a cost reduction program in place. And at
the end of the quarter we launched a very attractive managed
account product.
At PFPC - there they continue to gain momentum. We had one
of the best quarters in terms of new customer acquisitions
and the pipeline remains strong. And we also continue to
invest in this business, acquiring AdvisorPort, the robust,
technology-driven managed account platform in which we have
a significant presence.
To concentrate on our highest return segments we also
divested our retirement services business. I would also like
to point out that PFPC is on pace to exceed the $50 million
in cost savings we targeted by the end of the year and
that's before taking into account the sale of the retirement
business.
BlackRock continues to drive premium growth. Some of you may
have listened to Larry last night on his call - the fixed
income performance of BlackRock continues to be
extraordinary.
And since the beginning of the year we've also strengthened
our equity capabilities there. We've acquired a
fund-to-funds manager and expanded BlackRock's private
client sales and marketing capabilities.
I'm confident that our businesses will take advantage of
these initiatives because we've provided a strong platform.
We've dramatically enhanced our risk management organization
over the last 18 months and you can see that in
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our performance. From a credit risk perspective, once again,
asset quality remains stable. NPAs and NPLs were down as was
our loan loss position. And we've built provisions. And
we've built excellent reserve coverage relative to our
peers.
Our technology platform also differentiates PNC in the
marketplace. As I mentioned, last week Information Week
ranked us first in financial services and number 19 overall
in its annual list of 500 technology innovators.
When you combine technology with the risk management
efforts, business mix and our extraordinary people, that's a
platform from which we believe we can deliver above average
growth over time.
Our strategies work together to provide us with great
liquidity, a diverse revenue stream, and strong capital
positions. We plan to maintain a disciplined strategy to
managing capital and you know we're always - aspires to a
total return approach. That includes investing in our
businesses, as we're doing with the United National
acquisition, and returning capital to our shareholders
through dividend payouts and share repurchases. And as you
know, our Board of Directors approved a 4% dividend increase
only a couple of weeks ago.
These combined actions I think leave us well positioned to
take advantage of growth opportunities just through
executing our strategies and staying focused on the
customer. And I'm confident in our team's ability to do just
that in a recovering economy.
With that, I'll turn it over to Bill to discuss our earnings
in more detail. Bill?
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Bill Demchak: Thanks Jim. As you've seen, we reported net income of $281
million, or $1 per diluted share, for the third quarter.
This generated a 17% return on equity. As is usually the
case we had a few items that we would not consider to be
part of our normal earnings stream.
In excluding those items, and they're detailed in the press
release, normalized third quarter earnings were 95 cents per
share, which is up from 94 [cents] in the second quarter
and, importantly, it's up 8% from normalized results if you
look back in the third quarter of 2002.
Now without question, the single largest impact on our third
quarter disclosures was the early adoption of FIN 46. We
began consolidating several variable interest entities, or
VIEs, with assets and liabilities of approximately six and a
half billion [dollars] on July 1 based on the original
effective date of the standard and therefore we didn't need
to take advantage of the FASB postponement.
Now this having been said, guidance on this subject
continues to evolve and we will continue to pursue
alternatives that would allow us to possibly de-consolidate
some of these entities.
Consolidating the VIEs also increased various income and
expense items, most of which are reversed in minority
interest. And as you would expect, the comparability of many
financial ratios were also impacted. In an effort to provide
greater transparency pertaining to FIN 46, we provided a
consolidating balance sheet and income statement on pages 18
and 19 of the press release.
Let's take a look at some of the factors that drove the
quarter. First of all, business earnings were $291 million
in the third quarter, which is a decline of
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$5 million when compared with the prior quarter. And the
primary reason for this decline was margin compression due
to lower yields on earning assets. This impact was primarily
felt in the regional community bank and was only partially
offset by higher earnings in the wholesale bank.
It's important to note that while earnings are down in the
RCB the decrease is primarily related to the repricing of
securities and certainly is not due to a loss of clients or
activity. We had another successful quarter in net client
growth and as you will see, the growth in the home equity
loans and average demand deposits speak for themselves.
On a consolidated basis, total revenue was over a billion
four [$1.4 billion] on a reported basis, an increase of $121
million when compared with the second quarter. The impact of
FIN 46 was $117 million and is primarily in other income. As
expected in this low rate environment, spread revenue
decreased but was more than offset by an increase in
non-interest income.
Let's start off with net interest income. On a taxable
equivalent basis in the third quarter it was $514 million, a
decrease of $9 million when compared with the second
quarter. The margin for the third quarter was 3.49%, or down
42 basis points, on a comparable basis.
Now we expect the NII and the margin to decline due to this
low rate environment. And in the third quarter interest
rates accounted for declines of $24 million in net interest
income and 23 basis points in net interest margin on a
linked quarter basis.
There were also two accounting-related impacts on net
interest income, both of which are detailed in the press
release and when combined accounted for a
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$15 million increase in NII but a 19 basis point decline in
the margin on a linked quarter basis.
The first of these is related to FIN 46. Due to the
BlackRock Funds and the commercial paper conduits we brought
onto the balance sheet, spread revenue increased
approximately $29 million. The second issue was related to
FAS 150 and the reclassification of dividends on our trust
preferred of $14 million from non-interest expense to
interest expense.
As we indicated last quarter, we believe the second
quarter's NII and margin were somewhat of an anomaly and
frankly the more relevant comparison we believe is to the
first quarter. In that case, if you exclude the impact of
FIN 46 and the trust preferred, the change in NII was a
decline of only $7 million and the margin narrowed by eight
basis points.
On the asset front, average earning assets for the third
quarter were $58.4 billion, an increase of $5.2 billion from
the second quarter. And the consolidation of the VIEs
accounted for substantially all of this increase and were
recorded in other earning assets.
Home equity loans continued to be one of our best asset
classes from a returning growth perspective and in this
quarter average home equity loans increased 27% on an
annualized basis.
On the wholesale banking side, average commercial and
commercial real estate loans declined approximately $300
million when compared to the previous quarter principally
due to soft demand and low credit utilization rates that
remain in the mid-40s from our existing clients.
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But due to our customer focused approach, we are not seeing
- while we're not seeing net loan growth - we are pleased
with the firm's client growth in the wholesale space from a
future revenue generation perspective and we continue to see
improved activity in the pipeline.
In the RCB our strategy of growing DDA households continued
to be successful on several fronts. First we grew DDA
relationships by 29,000 and average DDA deposits by $529
million, or 18% annualized on a linked quarter basis. And as
we discussed before, building this deposit franchise reduces
the firm's funding cost and provides us with a strong source
of liquidity.
But just as important, a DDA account provides us with the
opportunity to sell more products and services to those
66,000 new clients that we've added in the last 12 months.
This quarter consumer fees and service charges on deposits
increased 5% when compared with the same quarter a year ago.
As previously disclosed during the first half of the year we
had an open position to falling interest rates. And with the
backup in rates this quarter, we reduced that position by
purchasing a combination of short-term securities and
received fixed swaps.
Going forward in this historic low rate environment, we
fully expect that net interest income for the industry will
be under pressure as NII lags changes in interest rates and
we are no exception.
Hopefully a simple example using the yield on the three-year
swap rate will help illustrate this point. If you go back to
June of 2000 the yield on the three-year swap was 7.2%. In
June of 2003 it was 1.95% and today the yield is 2.75%.
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As a result of this decline, assuming you're not taking on
more risk in leveraging your balance sheet, then the
alternative is to replace maturing assets with assets that
are more than 4% lower in yield.
At the same time with rates at these levels it would be
difficult to offset this impact again by repricing your
deposit costs lower. Therefore we think it's going to take
time for the impact of the low rate environment to move
through the system.
Now one factor that will mitigate this impact on PNC is our
distinct revenue mix. Only 36% of our total revenues are
spread-related, which is one of the lowest percentages in
our peer group. While we have clearly had pressure on our
margin, on a relative basis it should have less impact on
our revenues overall.
Now let me turn quickly to asset quality. Both NPAs and NPLs
declined this quarter when compared to the previous quarter,
principally due to the continued liquidation of our held for
sale loan portfolio, principal reductions, and a previously
disclosed charge-off on our asset-based lending unit.
This quarter net charge offs were $63 million, which is
unchanged when compared to last quarter. This quarter
included a $28 million charge related to our largest
non-performing asset-based lending credit that we mentioned
last quarter and we substantially reserved for last quarter.
Net charge-offs to average loans were 73 basis points in the
third quarter and our loan loss provision was $50 million or
58 basis points of average loans in the third quarter.
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I'm going to spend a second on our asset-based lending
portfolio. First, the credit we took a charge against this
quarter is an outlier both in terms of size and structure.
This is the largest single relationship we have in the
business or had in the business and was supported more by
its franchise value than a collateral value.
Approximately 99% of the performing credits in this business
are underwritten based on the value of collateral with an
average commitment size of just $16 million. Less than ten
commitments exceed $35 million and represent only 5% of the
portfolio.
And finally, the remaining NPAs in this business are modest
in size. For example the second largest NPA in Business
Credit is only $21 million, and is secured by accounts
receivable and inventory.
When we evaluate all the various credit risk aspects of our
total loan book, we remain comfortable with our asset
quality position and believe it should remain stable or
could possibly improve in the near term.
Turn for a second to non-interest income, in the third
quarter non-interest income was $906 million, compared with
$776 [million] in the second quarter. And excluding the
items we identified in the normalized chart on page 16, and
excluding $88 million associated with FIN 46, non-interest
income was $795 million. This is an increase of 15%
annualized when compared with the second quarter on the same
basis, due to higher asset management fees, corporate
services, and other income.
As you know, we've been focused on improving performance of
PNC Advisors and PFPC. Revenues at Advisors grew 3% on an
annualized linked
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quarter basis, excluding $76 million from consolidating the
Hawthorn Funds under FIN 46.
At PFPC, revenue growth was 13% on a linked quarter
annualized basis, excluding the impact of the retirement
services revenues from the comparison.
It's important to note that PFPC's operating margin for the
quarter continued its upward trend and was 23%, which is a
dramatic improvement when compared to the 17% just a year
ago. And that excludes the $19 million facilities
consolidation reversal we did in the third quarter of '02.
The improved operating margin reflects a successful
execution of the sales and efficiency initiatives we've been
talking to you about for some time now.
On the corporate services side, revenues increased $18
million on a linked quarter basis and excluding the held for
sale gains, the increase was $10 million and reflects a
positive progress we are making with our wholesale bank
strategy of adding or expanding fee-based activities in this
client base.
As you know, while we don't count equity management gains or
losses in our normalized earnings, it is positive to note
that the losses were down $13 million when compared to the
second quarter. And further, we believe that the valuation
trends are finally beginning to stabilize and expect to see
continued improvement in this area.
Let's move on to non-interest expense. These were $835
million in the third quarter, an increase of $20 million
when compared to the second quarter of $815 [million]. That
excludes the $120 million impact associated with the
Department of Justice agreement and the related legal and
consulting costs.
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The linked quarter expense increase reflects the following.
First, a $28 million increase as the result of FIN 46, $5
million related to staff and $23 million in other, a $22
million increase primarily associated with sales-based
compensation, corporate governance, and community relations
expenses.
These expense increases were partially offset by the reclass
of $14 million in trust preferred dividends, $8 million
reduction associated with a sale of the retirement services
business, and the benefit of $8 million associated with our
expense reduction initiatives.
And as you know as we previously mentioned, we have
identified approximately $100 million in efficiency
initiatives that should be in place by year-end. I'm very
confident we'll accomplish this objective. As of the third
quarter we have already realized approximately $66 million.
Finally in closing, I'd like to add a thought to what Jim
has said about capital. As you've heard us say before, PNC
uses economic capital to govern capital management and we
support this by being well capitalized from a regulatory
standpoint.
We ended the quarter with a strong capital position. The
recent affirmation of our rating by Moody's confirms this.
As Jim said, yesterday they moved us from negative watch to
stable. I think Jim actually suggested they might have moved
us to positive and while we aspire to get there we're not
yet there today.
From a regulatory capital perspective, PNC's Tier One
capital ratio is 8.2% on September 30. In the press release
we detailed the impact on the firm's capital ratios related
to adopting FIN 46. Even though we reclassed the trust
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preferred to debt it still counts as Tier One and I would
remind you that Market Street gets regulatory relief until
April of next year.
Further, since we manage PNC based on economic capital we
had already captured the amount of economic capital - or
risk - required to support these VIEs and it was included in
our capital management plan before we consolidated them.
In January we indicated that through the course of the year
we would either have or would generate through earnings
approximately $1 billion of excess available capital. So far
this year we've deployed this capital by repurchasing almost
10 million shares that have cost us $452 million, agreeing
to acquire United National for approximately 6.6 million
shares of PNC stock and $320 million in cash, and finally
the $87 million for the Department of Justice agreement.
And based on our analysis we ended the quarter with excess
economic capital again and continuing to repurchase our
shares clearly remands a value-added option.
Having said that given the blackout dates associated with
the United proxy solicitation, I would expect the repurchase
activity this quarter to be lower, when compared with the
third quarter.
And with that I will turn the call back over to Jim for some
closing comments before we take your questions.
Jim Rohr: Thank you Bill. Before the closing comments we'd be happy to
take any of your questions now.
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Bill Callihan: Operator, could you give our participants the instructions
for the questions please?
Operator: At this time I would like to remind everyone in order to ask
a question, please press Star then the number 1 on your
telephone keypad.
Your first question comes from Tom McCandless with Deutsche
Bank Securities.
Jim Rohr: Hi, Tom.
Tom McCandless: Good morning gentlemen. How are you all?
Jim Rohr: Well - yourself?
Bill Demchak: Just great.
Tom McCandless: Good, thanks. A couple of questions if I may - how much in
the earning asset category do you still have in Fed Funds
that you're rolling daily?
Bill Demchak: It's zero.
Tom McCandless: So all the excess liquidity has been deployed?
Bill Demchak: Yes.
Tom McCandless: Second question is, within the regional community bank, can
you speak to some loan growth trends, one is the persistent
decline in residential mortgage and the other is more on the
commercial side.
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And I think last quarter there was some positive commentary
about perhaps some reemergence of credit demand in small
business and middle market and then I think PNC had an
economic overview talking about a survey recently that
talked about perhaps a promise of some uptick in activity.
It did not appear to be manifested in the commercial loan
volumes in that business unit this quarter. So a little
additional guidance there.
And then the last question would be overall expectations for
net interest income in the fourth quarter - up, down,
sideways?
Bill Demchak: A lot of linked questions. Why don't I start with just the
question on residential mortgages. And just to remind you,
we don't have a residential mortgage business where we
originate and hold. So the bulk of the loans that you see in
the RCB are either loans that were there that came from the
business we sold over a year ago or loans that we purchased
in whole loan form from other originators.
So in effect, trying to ascertain sort of client trends or
volume trends from that line item is kind of a mistake
because it's really a function of whether we chose to deploy
liquidity there versus putting it in securities and so
forth.
You know, I'd contrast that clearly to the home equity line
item, which we are in the business of doing, and it's been
growing substantially. Jim, maybe you want to comment on the
small business loan growth and what we just got out of the
economic survey.
Jim Rohr: Yes, Tom, we just did finish the economic - the update of
the economic survey that we did in the second quarter. And
the customers came back I think more positive - well, they
were more positive than they were in March.
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I was surprised that they were as positive in March as they
were. They were more positive today.
The confidence level were well in the 60s in terms of people
who think that they will - and this is a survey of 2000
middle market and small business customers. Over 60% of them
believe they will employ as many people and make more money
over the next six months than they did before. So it's a
positive outlook by our customers.
The one question that you asked is - and I think this is
true nationally - is what are you expecting for growth in
capital expenditures and borrowing requirements and, you
know, that question comes up that there's just a modest
amount of improvement, really. And I think the optimism is
continuing to improve.
I think when we look at our business, our business is
improving whether it's, you know, across virtually all of
the businesses there's some growth - not robust as yet. So
we're delivering our performance based upon modest growth,
which is, you know, similar to the economy. Also taking some
costs out and buying some of the stock back.
So given - and I think we're well positioned to the extent
this economy continues to move - I think we're better
positioned than others in terms of being able to participate
in that because of the business mix that we have as you know
Tom. Bill?
Bill Demchak: Yeah, to answer the third part of your question on margin,
you know, current thoughts for the fourth quarter - just in
terms of dollar income as opposed to percentage margin - it
ought to be roughly around flat.
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You know, as we mentioned, we closed off the position to
lowering rates and took advantage of the big backup that we
had sort of through July. So that will, you know, in effect
stabilize at least in the short term some of the trend we've
seen and our margins falling off.
But we'll, you know, as we also said it takes a while to
flush through what has been a three-year decline in rates.
And so we'll face pressure into next year still.
Tom McCandless: Just as a last follow up to Bill - to Jim's comment - is
there any evidence that you can give us, metrics, measures,
etc., that shows that you've grown your commercial customer
base in RBC?
Jim Rohr: We have a modest amount of that information. We have
targeted - well, we have some detail on the regional bank
that Bill gave you in terms of new households that we've
brought onstream. We don't have - I don't have at hand right
now - the increase that we have in the customer base on the
commercial side. But we can get that back to you and put it
in the release.
Tom McCandless: Thank you.
Jim Rohr: Next question please?
Operator: Your next question comes from John McDonald with UBS.
Jim Rohr: Hi, John.
John McDonald: Hi, good morning. Bill, I wondered if you could give us your
thoughts on the credit quality outlook for the fourth
quarter.
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Bill Demchak: You know, as I said sort of in the comments, we feel pretty
comfortable about where we are and we expect asset quality
to remain stable and, you know, if things hold some slight
improvement going forward.
John McDonald: Okay, and do you see further margin improvement possible at
PFPC?
Bill Demchak: You know, to answer quickly, we do, and, you know, the
client momentum, and I'm sure Jim will want to comment on
this - the client momentum there has been really strong. So
the combination of the efficiency initiatives that continue
to roll through their income statement plus client activity
makes us feel pretty good about that business.
Jim Rohr: I think John, we said at the beginning of the year that we
had a $40 million cost initiative. We said in the second
quarter we thought that we would move that to $50 [million].
And I think - I'm certain we'll be in excess of $50 million
of cost saves in that business.
I mentioned that the new customers - and you've seen
announcements whether it was Eaton Vance or Strong or others
- that we've been able to principal that we brought onstream
in the third quarter or rolled forward with increased
activity is important has been realized.
And I think you'll - this is the strongest pipeline that we
have in place right now than we've had in years, quite
frankly. So the combination of new business as well as the
cost saves I think will increase the margin over the rest of
the quarter.
Now that having been said, you know, new business takes a
while to come on. Once you get the award it takes, you know,
sometimes as long as six months
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before it comes onstream. So, but the announcement...I'd
rather have the announcements than not.
Bill Callihan: Next question please?
Operator: Your next question comes from Nancy Bush with NAB
Research, LLC.
Jim Rohr: Hi, Nancy.
Nancy Bush: Good morning gentlemen, how are you?
Bill Demchak: Just great.
Jim Rohr: Fine thank you, how are you?
Nancy Bush: Good.
Jim Rohr: Good.
Nancy Bush: Can you just tell us, I mean, you're generating some pretty
extraordinary rates of core deposit growth in the regional
community bank. Sort of what is happening at the branch
level, you know, to generate this kind of growth?
And secondly if I may ask Bill, does the downgrading to junk
status of Pittsburgh debt have any impact on the investment
portfolio or, you know, anything else to the company?
Bill Demchak: We'll answer the second question first. No it does not.
Nancy Bush: Okay, thank you.
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Jim Rohr: Somebody owns those bonds. But we didn't buy them or
sell them.
Bill Demchak: Somebody insured those bonds.
Jim Rohr: Somebody insured those bonds. In any event...
Bill Demchak: Core deposit, do you want to...
Jim Rohr: Yeah. The core deposit growth is the result of four
different initiatives. One being branch origination where we
have a - as you know Nancy, we now have through our Genesis
program have - all of our branches are Web-enabled and tied
directly to our award-winning call center.
So when you think about the position that we have where
we're the dominant ATM provider in the region combined with
those two initiatives, the origination at the branch level
is very good.
Add to that a workplace banking product that from the data
that we have would show us as being ahead of our peers in
origination and that's based - we also have a very strong
position with universities in terms of new account growth
there.
But last but not least, we inaugurated a thing almost two
years ago now called Chairman's Challenge where we have our
non-sales employees involved in referring business.
And over the last 18 months over 80% of our non-sales
employees have referred and actually brought in new business
to the company. And it's been
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perhaps the most successful sales program in the industry in
the last 18 months.
So the demand deposits are our focus, you know, that's how
you drive profitability. You not only get the spread on the
demand deposits but you also get the ATM fees and the
foreign charges and the debit fees - debit card fees - and
the overdraft fees. And so it's been very successful for us
and we're real pleased about how that initiative is working.
Bill Demchak: The only thing I'd add Nancy is the $529 million growth in -
I guess RCB deposits - while we're extremely pleased with
that I wouldn't straight-line trend that amount of growth.
Instead I would focus on the growth we've been able to
maintain in households.
Nancy Bush: All right, thanks very much.
Jim Rohr: Next question please?
Operator: Your next question comes from Brock Vandervliet with
Lehman Brothers.
Jim Rohr: Hi, Brock.
Bill Demchak: Good morning, Brock.
Brock Vandervliet: Good morning. I was wondering if you could just comment on
overall credit trends? I know Bill we've talked a bit
offline about this in the past, what you're seeing going
forward and what your level of confidence is that we could
see some further relief in the provisioning line. Thanks.
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Bill Demchak: You know, no change from what we've been saying for a couple
of quarters now, where, you know, our goal is sort of to get
to a 45 basis point provision charge kind of line item.
We're working our way through that. You've seen us take over
the last couple of quarters, you know, sort of one-off
sizeable individual exposures charging those through.
But, you know, we feel comfortable that we can hit that sort
of number through time. The trends are going in the right
way. You know, and we feel pretty good about where we are.
Jim Rohr: The flow on to not performing status has been reducing and
again fell again this quarter. So we're pretty comfortable
with that stable environment that Bill projected.
Brock Vandervliet: Okay, and as a follow up on PFPC, you've talked about the
cost savings that you're targeting. How visible will they be
in terms of the stated expense line, or is that going to be
buried by increases in expenses as business activity picks
up?
Bill Demchak: It's going to be pretty hard to pull out because both, you
know, there's activity level expenses but there's also core
investment that we've been making in some of the technology,
you know, to build capacity away from the efficiency
initiatives.
At some point, you know, we will actually try to break that
out as we - maybe as we get toward the end of the year and
sort of show the breakdown of spend and save within PFPC.
Jim Rohr: You can look to the margin to some extent because, you know,
the margin at this time last year was 17% and it's up
significantly now.
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Brock Vandervliet: Okay, thank you.
Jim Rohr: Next question please?
Operator: Your next question comes from Mike Mayo with Prudential.
Jim Rohr: Good morning, Mike.
Mike Mayo: Hi. It looks like the assets were down at PNC Advisors, if
you could just give some color on that?
Jim Rohr: Well I think, you know, the PNC Advisors program has been
relatively stable to down for the last few quarters. And the
initiative that we have there has been to work hard on the
retention program and I think that's starting to come around
and we put the new managed account platform in place which
is a very competitive position.
Managed accounts have been the fastest growing part of
private banking for the last few years and we frankly did
not have a product in that space. And so with the addition
of that, that I think is a very competitive product with a
number of new managers being added, I think that positions
us better than we have been before on the product side.
And the sales organization has been changed quite a bit and
restructured, you know, because they frankly haven't been as
productive as they should be in the last 18 months. So I
think we've been - thirdly, not the last but not least, but
the cost structure of the private bank I think was outsized
and that's being addressed as we speak.
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Mike Mayo: Any metrics on that retention there? I know it's not new
news, but you said it's getting better.
Jim Rohr: It's getting better. It's significantly better than it was.
Mike Mayo: Okay, and just a follow up to the other question about the
Pittsburgh downgrade. On a conference call with a credit
analyst at one of the rating agencies, they thought that
might be an issue from a secondary effect standpoint. In
other words, to the extent that hurts other companies who
you have dealings with. Is that something you're monitoring
more closely even if you're not directly hurt by the
downgrade?
Jim Rohr: No, I don't - I don't think so. I'm not aware of any other
company that might be hurt by the downgrade.
Mike Mayo: Okay, thanks.
Jim Rohr: I'd be interested in hearing if there was.
Bill Demchak: We had a meeting yesterday Mike to go through various
iterations of what this may or may not mean and nothing
really came out of it that causes us concern at this point.
Jim Rohr: I'm very much involved with a committee here in Pittsburgh
in order to, you know, stem the tide on that. And, you know,
I'm confident that will be - we have a political process
involved. So there are ways for the City of Pittsburgh to
deal with this issue.
Mike Mayo: Okay, thanks.
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Jim Rohr: Next question please?
Operator: Your next question comes from John Kline with Sandler,
O'Neil.
Jim Rohr: Hi, John, good morning.
Bill Callihan: John? Hello?
Operator: That question has been withdrawn.
Bill Callihan: Next question please?
Operator: Your next question - I'm sorry, is from John Kline with
Sandler, O'Neil.
Jim Rohr: Hi, John.
John Kline: Good morning. I wasn't aware that I withdrew anything. But
anyway, my question has to deal with non-performing assets.
Kind of just looking at it here, it doesn't seem as if
you've got the same sort of kick that some of the other
large regional banks did this quarter.
Kind of looking through the change in non-performing asset
schedule that you have, I see that there were purchases of
$42 million. It looks like it's the first time you've done
that this year. Curious, you know, what that is. What's
driving that?
Bill Demchak: The bulk of that was the exercise by National Bank of Canada
of the put on their business credit portfolio that we had
been servicing. So we took on $36 million of non-accrual
loans when they exercised that. I should mention we took
them on at what we think is a very favorable price, so we're
kind of
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pleased by that. But nonetheless they do show up in the
non-performing asset line item. And that is specifically why
you didn't see a larger drop quarter to quarter in our NPAs.
John Kline: Yes, I mean, especially given that your largest
non-performer was resolved last quarter, right?
Bill Demchak: Yeah, I mean, the trends are positive for the retained
portfolio. The thing that, you know, causes us to stand out
sometimes is the fact that a disproportionate share of our
portfolio is in Business Credit, which we like. But by the
nature of that business you will have, you know, higher
percentages of NPAs against our balances than sort of the
unsecured sector.
In this particular quarter because we took on the NBOC
portfolio we saw that sort of one-time jump of $36 million.
John Kline: Okay, great. Thanks.
Jim Rohr: It's a good catch John because I want you to know that we're
not in the strategic business of buying non-performing
assets.
John Kline: Right.
Bill Callihan: Next question please?
Operator: Your next question comes from Gerard Cassidy with RBC
Capital Markets.
Jim Rohr: Good morning, Gerard.
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Gerard Cassidy: Good morning Jim. My question has to do with commercial
deposits. Have you guys seen any changes in the trends of
your commercial customers and what they're doing with their
excess liquidity? Are they drawing down on their deposits to
possibly be a foreteller sign that maybe loan growth will be
picking up next year?
Jim Rohr: No, we really haven't seen much in the way of any trends
with terms of drawing that down. Our balance sheet doesn't
really necessarily reflect all of the commercial activity
because in order to have a particularly attractive lockbox
operation and to a significant extent we sweep balances to
the BlackRock Liquidity Fund.
So, you know, the amount of money that actually flows
through here is significantly greater than what the balance
sheet might reflect. But nonetheless we haven't seen a great
deal of change in the activity.
Gerard Cassidy: And the second question is it looks like you had an
unrealized gain in the securities portfolio of about $147
million at the end of the September period. Where is it now
considering rates have changed a bit from that period?
And second, what's the best interest rate that we should be
looking at to see whether that number will go up or go down?
Bill Demchak: Good questions. I don't have a detailed number on the gain
in the securities portfolio with me. It changed from the end
of the quarter until now. It's still substantially a
positive number. You know, I would think about sort of the
three-year swap rate is the benchmark with respect to
repricing our portfolio.
Gerard Cassidy: Thank you.
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Bill Callihan: Next question please?
Operator: Your next question comes from Denis Laplante with KBW.
Jim Rohr: Good morning, Denis.
Denis Laplante: Good morning Jim. I want to by the way compliment you on
your disclosure on FIN 46. It's the best I saw this quarter
in a very confusing accounting adoption.
Jim Rohr: Thank you.
Bill Demchak: We enjoyed it.
Denis Laplante: I bet you did. I had a couple of questions on - in the real
estate finance line of business - your other income was up.
Is that securitization gains in the quarter?
Bill Demchak: Yes.
Denis Laplante: And how much were they versus the recent run rate?
Bill Demchak: It's been trending up. I actually should clarify. They are
in effect securitization gains but really what we do is sell
the loans into some third party securitization. The end
result is the same but the gains come through the sale as
opposed to an outright securitization.
These have gone up from I think in the third quarter of '02
they were $5 million up to $15 million. This quarter they
were maybe - they were $12 [million] - looking around the
table here - $12 [million] last quarter.
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I think they're running at above what we would consider a
normal run rate. And a large part of that has to do with how
wide credit spreads got back in, you know, third and fourth
quarter of last year. And that's the pipeline of loans which
are now being securitized to tighter spreads.
So they're $15 [million] this quarter. You know, I don't
know that we can carry that sort of level on an ongoing
basis. I think they're a little bit high just because of the
swing we saw in credit spreads.
Denis Laplante: Okay, so that's the $15 million number but there was also a
$29 million number in wholesale banking up from $13
[million] linked quarter - that was a huge increase. I was
wondering what was that.
Bill Demchak: Yeah, that's the held for sale gains.
Denis Laplante: That's the held for sale gains.
Bill Demchak: Yeah.
Denis Laplante: Okay, good. In terms of the carry value of your NPAs versus
contractual value, do you have a sense of what that is?
Bill Demchak: You know, I don't off the top of my head on the overall
portfolio. But what I will say to you is that the residual
in the held for sale book which is of course quite small
today is marked, you know, at market but at substantial
discounts to par. And the value that we took the NBOC loans
on - which was this recent $36 million - was down in the
sixties somewhere.
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So they are just with respect to the loans that are in some
sort of mark-to-market or marked when we took them on,
they're at substantial discounts. And we have, you know,
what we think is an appropriate reserve against the NPAs
that come through the straight loan book.
Denis Laplante: Okay. On PFPC if I may, you sold the business so your $188
million in revenues does not include roughly as I recall $7
million in business sales in the divestiture?
Bill Demchak: Yes.
Denis Laplante: Okay so you made up - so your numbers were flat. Was there a
gain in those numbers at all from the business sale?
Bill Demchak: The gain was sort of a rounding error.
Denis Laplante: Okay, so it didn't even - it was less than a million.
Jim Rohr: It wasn't a lot.
Denis Laplante: Okay, okay. And one last question, and within your margin,
how much of that was a premium amortization on securities?
And will that come back?
Bill Demchak: Could you repeat that?
Denis Laplante: In the securities book your net interest margin was probably
influenced a little bit by some runoff or maybe it wasn't.
But the prepayments and then therefore your amortization of
premium accelerated. Was the - have you been able to
quantify that?
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Bill Demchak: I don't have that number off the top of my head. I'm sure we
have it.
Denis Laplante: I guess the point of the question is, is that a source of
rebound in margin linked quarter?
Bill Demchak: I don't think it would be. Part of the issue, remember that
the, you know, basically what you're suggesting are we
buying mortgage securities at premium to par when we put
them on the books. There is some of that but we buy such
short dated stuff and sort of hybrid ARMs that the premiums
aren't that large anyway. So I wouldn't look to that as
being a big impact on our margin one way or the other.
Denis Laplante: Okay, great. That's perfect. One last question, I am sorry -
I lied. I had one more. On security gains you've been
allowing roughly about 3 or 4 cents a share to fall to the
bottom line. In this quarter your operating number you call
95. It looks like there's 3 to 4 cents in securities gains
that you did not exclude from that so your operating number
will be less.
Given the tougher environment on gains and rising rates,
you're going to have to make up for that. Are you confident
you'll be able to do that?
Bill Demchak: Yes. The, you know, I would tell you that there is no - it's
not as if we sort of budget and say okay, we're going to,
you know, we're purposely going to take $15 million in a
given quarter.
Through the course of the quarter there's always some
trading opportunity or something rich to something else. And
we take advantage of it. And by and large it's come out to
be kind of $15 million a quarter.
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You know, going forward where we get into an environment
with rapidly rising rates and so nothing has a gain, it
wouldn't shock me if we had $15 million of losses a quarter.
But having said that, in a rapidly rising rate environment,
our margin and the economy and everything else will be doing
better and we expect the company to do better.
Denis Laplante: Thank you very much.
Bill Callihan: Next question please?
Operator: Your next question comes from Claire Percarpio with Janney
Montgomery Scott.
Jim Rohr: Hi, Claire.
Claire Percarpio: Hi. Two questions - one, do you continue to expect a
difference between operating earnings and reported and when
do you think that will sort of quiet down?
And then second, I just want to ask on PFPC, if you could
talk a little bit about the business wins in the pipeline,
sort of what the pricing looks like, where you're winning
the business. I'm sort of wondering if - are you losing
ground in transfer agency and gaining ground in the
sub-accounting? And are staff cuts in PFPC complete?
Jim Rohr: Well let me try and take that backwards. The staff
reductions are pretty much complete and the roll forward
effect of the cost saves will simply continue throughout the
rest of the year and into next year. And so we've made an
awful lot of progress in that space.
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You know, we won fund accounting business in the last couple
of - in the last nine months we've won two of the three
largest fund accounting changes that have taken place in
terms of Wells Fargo and Armada. And we continue to increase
our activity in Eaton Vance, Strong, Principal.
Some of the new business is coming transfer agency, most of
it in fund accounting. Fund accounting is a much higher
margin business so we like that mix, quite frankly. And we
really can't discuss the pipeline because we've got
competitors maybe on the line as well. But we're very, very
pleased with the position that we have with probably the
strongest pipeline we've had in multi services across the
board.
Last but not least, the sub-accounting business is doing
extremely well. We are really - our product there is
particularly dominant.
Bill Demchak: I guess just to follow up on your question on normalized
versus reported earnings; you know, I guess we'd like to
think through time that there would be less volatility
between the two numbers but, you know, at the end of the day
we're in the banking business and the banking business has
risk in it. You know, every quarter there seems to be
something.
We also within those two line items because in particular we
separate out our equity management activities and a few
other things that are sort of away from business volume type
earnings. You'll probably always see some disparity between
the two.
Claire Percarpio: Thanks.
Bill Callihan: Next question please?
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Operator: Your next question comes from Tom McCandless with Deutsche
Bank Securities.
Jim Rohr: Hi, Tom, welcome back.
Tom McCandless: Hi, I guess we're recycling here. Two questions broadly
speaking - is there any kind of early read you could give us
with respect to re-upping or re-affirming cost initiatives
for 2004, given that you've got some momentum here on that
front this year.
And then the flip side of that is, is there any discussion
or expansion of discussion that you could give us on
initiatives related to cross-selling services across your
various business units?
Jim Rohr: Well the - two things. One is we're just in the process of
doing the budget right now and, you know, all the excitement
around cost savings usually takes place after the first
round of that.
And I think, you know, everybody has their thinking cap on
in terms of cost saves for next year. I would love to
believe that the economy is going to come roaring back and
the revenues will come flowing in so costs aren't important,
but since I've been CEO that hasn't been true. So cost is
something that we have to continue to focus on all the time.
And I think we will - I'm certain we will have a cost
initiative in place kicking off next year in the budget
process because that's turned out to be an annual event. And
it should be, because we should become more and more
efficient all the time.
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In terms of cross selling, we have not disclosed a lot of
data around that simply because the industry data is kind of
unusual. But all of the growth that we have for example in
the home equity loans are all with existing customers. I
think that number is 23% or 24% this year growth in the home
equity loans. So I think that is reflective really of how
we're leveraging different customer bases in order to
enhance other products.
Tom McCandless: Thanks, Jim.
Bill Callihan: We have time for I think one more question.
Operator: Your final question comes from John McDonald with UBS.
Jim Rohr: Yes, John. Welcome back.
John McDonald: Thanks. I think I got my answer. Bill, just a final thing on
the valuation and judgments, this is the same question about
the normalized versus the reported. What will drive your
realization of further gains, net of valuation adjustments
going forward?
Bill Demchak: I'm not sure I follow the question.
John McDonald: What determines, you know, whether you have those gains? Is
that a portfolio that's still running down?
Bill Demchak: The held for sale gains.
John McDonald: Yes.
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Bill Demchak: Yeah, there's only - it's a portfolio running down. We have
$99 million left on it. You know, it's at the point in its
life cycle where a lot of those gains are coming simply
because things pulled apart, mature, or get refinanced. So
we're selling outfits but other stuff is maturing.
John McDonald: Okay.
Bill Demchak: And we're just optimizing value, we're not, you know,
attempting to make so much one quarter or the next.
John McDonald: Okay, that's been a big source of the difference between the
normalized and the...
Bill Demchak: Yeah.
John McDonald: So that should go away over time.
Bill Demchak: Well eventually it has to because there's only $99 million
left.
John McDonald: Okay, thanks a lot.
Bill Callihan: Thank you.
Jim Rohr: Well if there are no more questions I'd like just to thank
everyone for joining us again. We're all pleased with our
performance on a number of fronts in the third quarter. And
I like our position.
We ended the quarter with a strong balance sheet, a very
good mix of businesses I think, and a plan that we're
executing on - in terms of - to
37
deliver growth to the shareholders. So right now it's about
executing our strategies and staying focused on the
customer.
Thank you for your support and we're confident that we can
continue to deliver for you.
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