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Edited Transcript of PNC earnings conference call or presentation 21-Jan-04 3:00pm GMT

Q4 2003 PNC Financial Services Group Earnings Conference Call

PITTSBURGH May 30, 2019 (Thomson StreetEvents) -- Edited Transcript of PNC Financial Services Group Inc earnings conference call or presentation Wednesday, January 21, 2004 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bill Callihan

PNC Financial Services Group - Director of Investor Relations

* Jim Rohr

PNC Financial Services Group - Chairman, CEO

* Bill Demchak

PNC Financial Services Group - Vice Chairman, CFO

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Conference Call Participants

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* Tom McCandless

Deutsche Bank Securities - Analyst

* Nancy Bush

NAB Research - Analyst

* Mike Mayo

Prudential - Analyst

* John McDonald

UBS - Analyst

* Claire Percarpio

Janney Montgomery Scott - Analyst

* Denis Laplante

Keefe, Bruyette & Woods - Analyst

* Rodrigo Quintanilla

Merrill Lynch - Analyst

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Presentation

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Operator [1]

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Good morning. My name is Mandy and I will be your conference facilitator today. At this time I would like to welcome everyone to the PNC Financial Services Group fourth quarter and full year 2003 earnings conference call. (OPERATOR INSTRUCTIONS) As a reminder, this call is being recorded. I will now turn the call over to the Director of Investor Relations, Mr. Bill Callihan. Sir, please go ahead.

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Bill Callihan, PNC Financial Services Group - Director of Investor Relations [2]

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Thank you and good morning. Welcome to today's conference call for the PNC Financial Services Group. Participating in this call 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 due to a variety of factors, including those described in this call and today's earnings release and supplemental financial information, and in our 2002 Form 10-K and other SEC reports.

These statements speak only as of January 21st, 2004, and PNC undertakes no obligation to update them. The following comments also includes discussion of non-GAAP financial measures, which is qualified by the GAAP reconciliation information in our earnings release, financial supplement and other documents available on our website at www.thePNC.com in the Investor Section. At this time I would now like to introduce Jim Rohr.

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Jim Rohr, PNC Financial Services Group - Chairman, CEO [3]

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Thank you, Bill. And welcome to everyone joining us this morning. I am pleased to say that we had a good fourth quarter. And today we are going to take a few minutes to highlight those results, and review our full year performance from both a strategic and financial perspective.

Let me begin with the fourth quarter. We believe that we performed well. We earned $274 million, or 98 cents per share, a 6.5 percent increase in earnings per share over last year's fourth quarter. But prior to the accounting change discussed in the release, we earned $302 million, or $1.08 a per share, on a continuing operations basis. That is an 11 percent increase in earnings per share when compared with the 97 cents we earned on a continuing ops spaces in the fourth quarter of 2002. Of course, Bill Demchak will discuss our financial performance in some detail in a few minutes.

I would like to point out three particular areas that demonstrate our commitment to creating value. One, we delivered a 12 percent increase on noninterest income over last year's fourth quarter. Two, we significantly improved asset quality across the board. And three, we generated good returns, posting a 16.7 percent return on equity. Our continuing operations return on equity was 18.37 percent for the quarter.

Our fourth quarter results reflect the progress we made in 2003 toward achieving our strategic objectives. At the beginning of the year we met with our Board to outline our vision to grow PNC. We designed a plan to take advantage of our strengths, address the current economic environment, and of course create value for all of our constituencies.

Simply put, this plan calls for us to expand our high performing banking franchise and to continue to grow our leading asset management and processing companies. But these objectives need to be accomplished by, one, leveraging our customer base, deepening relationships and drive revenue growth. Two, leveraging our operating and technology platform to improve efficiency. And, three, building best-of-class corporate governance and risk management systems to guide our actions.

Let me briefly review the progress we have made on each front, and I will address these three in reverse order. One, we made dramatic improvements in corporate governance, and a number of third parties have recognized our success. Institutional Shareholder Services scored us in the 95th percentile for the financial services industry, one of the highest ratings in our industry. And Moody's also reviewed our corporate governance structure, complemented our practices and improved our rating. In risk management, process and the controls have also helped us significantly improve our asset quality and manage our interest rate risk, which you will hear about in Bill's presentation. I think you'll be pleased with our risk profile.

In addition, with regard to our disclosures, we've heard from a number of you that our disclosures are as complete as any of our peers. So again, we continue to move closer to best-in-class in both risk management and corporate governance.

Secondly, with regard to technology, I believe we are already there, at least according to Information Week, which rated us number one in the financial services industry and number 19 overall in its list of 500 technology innovators. Most importantly, we're using technology in each business to drive revenue, improve customer service and manage risk and expenses.

I have mentioned the risk already -- the risk management program already. But with regards to expenses, as you recall last year, we set a goal of $100 million in cost savings over the course of the year. We have eliminated $130 million on a run rate basis, and this and other initiatives should allow us to avoid any expense increase in 2004.

Now let me move on to the customer base. On a business by business basis I will start with our regional community bank, which is built on a model that works. Our performance driven culture is intensely focused on delivering an exceptional client experience at every touch. And we leading technology, our Web enabled branches and our award-winning call center to anticipate and meet customer needs. The result, we grew our checking account base 4 percent, continuing a three-year trend.

Two, we increased our retention rate to 94 percent, the best among our peers according to the data we have. And we continue to deepen relationships. For example, 8 out of 10 home equity loan customers also have checking accounts with us. Debit card accounts grew by 15 percent last year. And our online banking penetration is now at 43 percent, up from 37 percent last year.

Our investments have helped us to expand this deposit franchise. And we're being successful. I'm particularly excited about how I think we will be able to take this deposit franchise and take it to New Jersey with our new acquisition.

The addition of United National with more than 100,000 new clients, and our plan to open offices in roughly 40 Stop and Shop locations should expand our branch presence in that demographically attractive state by one-third over the next five years. And on the subject of United National, we're pleased that we were able to close the transaction as quickly as we did, and we anticipate a smooth and quick integration.

Moving on to Wholesale Banking and PNC Advisors, we're pleased with the improved growth trends. Wholesale Banking, we grew full year earnings 9 percent. We have had great success in winning customers who meet our targeted profile and generate better risk-adjusted returns. The one big reason for the success here is our leading non-credit products and services. Our Treasury Management team exceeded its sales plan, winning an impressive list of new clients, including Dell, and the Veteran's Administration in competition with virtually all of our major competitors.

Capital Markets also exceeded its sales plan and retained the number one ranking in the Northeast for middle market loan syndications. We expect another strong year in Wholesale Banking. Clearly, we would benefit from an increase in loan demand, but at this point we're not counting on it.

For PNC Advisors the environment has been challenging. This is a good business with even better potential. We are located in a number of very wealthy markets and competition is fragmented, so the opportunity is there. As part of our advice driven model in the fall we begin offering our clients managed accounts from about top 20 investment managers. This should help us improve sales and build on the success that we have had in retaining clients. And the customer feedback is promising. In addition to this revenue opportunity, PNC Advisors also reduced expenses by close to $20 million on a run rate basis moving into 2004.

On the asset management and processing side, BlackRock delivered an extraordinary year. Of course this comes as no surprise. As the BlackRock team announced this morning, they have grown earnings 22 percent, continuing a long trend of double-digit earnings growth. In addition, BlackRock grew assets under management to $309 billion, up 13 percent from 2002. And they're also a very efficient business, once again, posting a 40 percent operating margin.

But we also continued to make good progress in improving the performance of our global funds processing business, PFPC. We have energized the marketing engine and streamlined the operations. Our new business wins significantly exceeded 2002 in terms of client won and expected revenues. And our success is already evident with Accounting and Administration Asset Service, which now totals $670 billion, up 31 percent from year end '02.

We have also improved efficiency, taking on more than $50 million in cost before reinvestment. That includes reducing PFPC's workforce by 1,200 when you factor into the sale of Retirement Services, and approximately 800 without the sale of Retirement Services. Those efforts have helped us to post a 22 percent operating margin this year. And though competitive market conditions continue to pressure pricing, the robust pipeline has us encouraged about the future.

In summary, we have built a diverse and complementary mix of businesses that when combined with our disciplined capital management we believe can drive growth in the 10 to 12 percent range annually on average over a three to five year horizon. But in the end our team will determine our success. And I'm confident that our team is energized going into 2004. And if the economy continues to cooperate, we will be even more excited about our opportunities to perform.

Now let me turn it over to Bill to discuss the financial performance in more detail.

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Bill Demchak, PNC Financial Services Group - Vice Chairman, CFO [4]

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Thanks, Jim. This morning I want to briefly review the fourth quarter financial highlights, United National's expected impact on PNC in '04. And we will spend a little bit of time discussing our 2004 outlook. And let's begin with the fourth quarter.

As you saw, we reported net income of 274 million, or 98 cents per diluted share, for the fourth quarter. Now this reflects the impact, effective October 1st, of accumulative change in accounting related to our insurance activities that reduced earnings by 10 cents per share. As we discussed in the third quarter 10-Q, the Corporation adopted the provisions of the Derivatives Implementations Group, Statement 133, Implementation Issue B36. The change pertains to the need for separate accounting related to inventive derivatives and modified coinsurance contracts.

And marking these contracts to market on an ongoing basis will be recorded in the trading account. And while this is a relatively small business for PNC, we are implementing risk management strategies to mitigate future volatility.

The fourth quarter reported earnings generated a 16.7 percent return on capital and a 1.57 percent return on assets. The results were better than expected as higher noninterest income and lower loan loss provision more than offset higher expenses that were primarily compensation related.

In the fourth quarter, excluding the accumulative accounting change, along with special items that are detailed in the press release, normalized fourth quarter earnings were 99 cents per share, which was 4 cents per share higher than the third quarter and 11 percent higher than fourth quarter '02. It is worthwhile to note that the trend of normalized earnings has been positive throughout the year quarter to quarter.

As you may recall, PNC adopted -- in fact, as I am certain you recall, PNC adopted FIN 46 in the third quarter. And just to keep us on our toes on Christmas Eve FASB revised FIN 46, which had the following impact. The BlackRock CDO's and various Hawthorne private partnerships were deconsolidated effective July 1, and the trust preferred securities were deconsolidated effective December 31st. We have adjusted third quarter results to reflect the BlackRock and Hawthorne changes.

The revision had no impact on PNC's multiseller commercial paper conduit assets or certain affordable housing partnerships that remain consolidated. And as many of you know, several of our peers have made structural changes to their conduits which allowed them to deconsolidate. We continue to evaluate several approaches to determine if we want to pursue this strategy in the future. As we did in the third quarter, we provided consolidated balance sheet, income statements and selected financial ratios in the press release to show you the impact of FIN 46 on the firm.

Now let's look at some of the factors that drove this quarter's performance. First, total business earnings were 320 million, a increase of 37 million on a link quarter basis. The fourth quarter earnings were driven by improved results in the regional community and wholesale banking businesses in PFPC, combined with continued strong performance at BlackRock. Those improvements more than offset a modest decline in earnings from PNC Advisors.

Consolidated total revenue in the fourth quarter was over 1.3 billion on a reported basis, an increase of 35 million when compared to the previous quarter. Taxable equivalent net interest income was 488 million in the fourth quarter. This is essentially flat to the third quarter. Fourth quarter net interest margin was 3.38 percent, which is down 6 basis points compared to the third quarter. Again, this being driven primarily by growth of lower spread assets.

On the asset front, average earning assets for the fourth quarter were 57.1 billion, an increase of 800 million from the third quarter. Home equity loans, with continued strong demand, were once again the primary source of loan growth, increasing 450 million in the quarter. Offsetting this growth, commercial and real estate average loans declined by basically the same amount, down 450 million versus a third quarter.

Clearly in our region, wholesale loan demand remained soft. And we're not forecasting a meaningful the change in the near term, as the desire for credit and utilization rates at existing facilities remain essentially unchanged. Due to the lack of loan demand, we have continued to deploy the firm's excess liquidity and short-term securities, which accounts for the link quarter increase of roughly 320 million on an average basis.

Now on the Regional Community Bank, Jim mentioned the success we continue to have in growing checking account customers. During the quarter, the RCB grew average checking deposits by 264 million, or 9 percent on a link quarter basis annualized. In addition to serving as a gateway for deeper relationships, I would also point out that building our deposit franchise continues to reduce the firm's funding costs and provides us with a strong source of liquidity.

Let me turn to asset quality quickly. As a result of many of the initiatives that we've taken to reduce credit risks, NPA's declined significantly this quarter, by 17 percent when compared to the previous quarter. Total NPAs are 328 million in the fourth quarter, which is down -- which is a decline of 68 million, driven primarily by principal reductions and payoffs.

In the fourth quarter net charge-offs were 49 million, which is a decrease of 14 million when compared to last quarter. Net charge-offs to average loans were 57 basis points in the fourth quarter. The provision was 34 million, or 40 basis points of average loans in the fourth quarter. And this is within the range that we hope to maintain over time. This quarter net charge-offs exceeded loan loss provision as we effectively resolved credits for which there were specific reserves established.

Turning to noninterest income. In the fourth quarter noninterest income was 861 million compared with 825 million in the third quarter. NICs (ph) grew on a healthy 17 percent on a link quarter basis annualized. Higher asset management, fund accounting, brokerage revenues and gains on asset sales fueled the increase. Asset management fees were 229 million, an increase of 13 million on the link quarter races. This increase was primarily driven by growth in BlackRock's fixed income products.

Earnings from PNC Advisors totaled 16 million for the fourth quarter, compared with 20 million for the third quarter. Earnings declined in the fourth quarter as higher fee income, driven by improved equity markets and increased brokerage activity, more than offset by the impact of lower trading in underwriting income and higher noninterest expense. Noninterest expense for the fourth quarter of '03 included a onetime $5 million charge related to certain employment contracts.

Fund servicing revenue grew 11 percent on a link quarter basis driven by PFPC's continuing success at growing their client base. In '03 PFPC successfully executed on their initiatives designed to improve efficiency. Their fourth quarter operating margin was 22 percent, which was a dramatic improvement when compared to the 16 percent in the fourth quarter of '02.

In '04 -- in 2004 we expect a reduction in the benefit from the ISG purchase accounting adjustments -- sorry, the ISG purchase accounting adjustments of approximately 13 million after-tax, related to customer contracts that expire in the second quarter. On a full year basis, the impact from this reduction is about 20 million after-tax. We believe that the impact of this reduction will be offset by new business wins, market improvements and continued efforts designed to improve efficiency.

Corporate Services revenues were 123 million, a decline of 9 million compared to the third quarter. However, after excluding the gains on loans held for sale from the fourth and third quarters of 16 million and 23 million respectively, this line item declined a modest 2 million on a link quarter basis.

And finally, this quarter for the first time in several quarters Equity Management generated breakeven results. We believe evaluation trends are stabilizing and expect to see continued improvement in this area.

Moving on to noninterest expenses. There were 858 million in the fourth quarter, an increase of 31 million compared to the third. Again, this increase is primarily related to an increase in sales based incentive compensation and increased benefit costs. On a full year basis, expenses were approximately 3.5 billion, an increase of 249 million, or 8 percent, when compared to '02. Approximately half of that increase was related to the DOJ settlement.

We're focused on managing expenses, and I'm pleased to report that we've accomplished our 100 million efficiency goals in '03. Further on a run rate basis, we exceeded that goal by 30 percent, which will give us a head start in '04 as we continue to explore ways to operate PNC more efficiently.

Our plan -- while our 2004 plan calls for continued investment in value added initiatives, as you have heard Jim say, we believe expenses will be flat, including the impact of the United acquisition compared to 2003.

Before moving onto the firm's consolidated '04 outlook, I would like to discuss the estimated impact of the United National acquisition in the first quarter. We still estimate the net benefit of adding the United franchise in '04 will be roughly 3 cents per share. We anticipate there will be a 2 cent per share benefit each quarter. But in the first quarter that benefit will be offset by 5 cents per share of additional expenses associated with eliminating redundant activities in facilities, along with preconsolidation activities.

On the asset side, United will add approximately 3 billion of earning assets to PNC. The majority of their assets are consumer and banking -- consumer and business banking loans and securities. Subsequent to year-end, we liquidated United's 500 million securities book, and reinvested the proceeds into commercial real estate securities and agencies. The net interest margin for United is in the 3.7 percent range.

Regarding asset quality, we are comfortable with the risk in United's loan book. This transaction should add approximately 25 million to non-performing assets in the first quarter, and roughly 2 million in additional loan loss provision per quarter going forward.

I am encouraged by the execution of our integration plans. In the first quarter I would expect that United will add approximately 36 million of expenses, including a onetime charge of 14 million. The remaining 22 million should decrease to 16 million by the second quarter as we execute on our plans. In terms of capital, we expect the acquisition to cause a reduction of approximately 60 to 70 basis points in our current regulatory capital ratios.

To wrap up 2003, we feel we had a good year, and we expect 2004 to be an even better one. The easiest way to look at 2004 from an earnings perspective is to start with the $3.96 we earned in '03, excluding the DOJ settlement and the accumulative impact from the accounting change. On the plus side going forward, we have plans in place to generate overall business earnings growth in the 6 to 7 percent range, or approximately 25 cents per share.

Now on the capital management front, the roll forward impact of share repurchases in '03, combined with continued repurchases in '04, could contribute another 10 cents per share. Frankly, the wild-card is net interest income. In this low rate environment I think this will be a major issue for the industry. As banks continue to replace higher yielding assets with lower yielding ones net interest income will come down, unless they're taking on more risk. Depending on how interest rates and loan demand plays out as we go forward, the outcome could put us in the lower or the higher end of the existing First Call range.

In terms of the quarterly sequence there are several seasonal impact in the fourth quarter, such as lower debit card and merchant activity, and lower student loan gains, combined with the onetime charge for United that I just mentioned. As a result, we expect first quarter earnings to be modestly below reported fourth quarter, and anticipate growth in earnings momentum throughout the remainder of the year.

With that, I will turn the call back over to Jim for some closing comments before we take your questions.

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Jim Rohr, PNC Financial Services Group - Chairman, CEO [5]

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Thank you, Bill. Let me close by just reinforcing a few key points. One, we believe we have built a model that will differentiate us over time from our competitors. It consists of a strong platform for growth and a high return to diverse and complementary mix of businesses. And three, strong corporate governance and risk management programs.

This platform helped us accomplished a great deal in 2003. It grew our customer base across all of our businesses. We exceeded our efficiency goals and we improved asset quality. But most importantly, this platform leaves us well positioned to achieve our objectives in 2004, which are growing our customer base in every business in every market, improving our revenue expense relationship, and creating value for our customers, our shareholders, our employees and our communities. As Bill described, we are comfortable with the current First Call range, and we look forward to a good year.

Thank you for your time. And at this point we would be happy to entertain your questions. Operator, could you give our guests the instructions please?

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Questions and Answers

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Operator [1]

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Yes, sir. (OPERATOR INSTRUCTIONS) Tom McCandless of Deutsche Bank Securities.

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Tom McCandless, Deutsche Bank Securities - Analyst [2]

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Two minor questions, if I may. Was there a little bit of a slowdown in the incremental growth of your noninterest bearing deposits this quarter?

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Jim Rohr, PNC Financial Services Group - Chairman, CEO [3]

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Incremental growth in our demand deposit accounts?

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Tom McCandless, Deutsche Bank Securities - Analyst [4]

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Your noninterest bearing. It looked like they didn't grow as fast as it did on a link quarter basis.

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Jim Rohr, PNC Financial Services Group - Chairman, CEO [5]

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They grew 9 percent. So I would say, no. I would say they were as good, if not better.

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Tom McCandless, Deutsche Bank Securities - Analyst [6]

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Not on a year over year basis, on a linked quarter basis.

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Jim Rohr, PNC Financial Services Group - Chairman, CEO [7]

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On a linked corner basis. Hang on a second.

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Bill Demchak, PNC Financial Services Group - Vice Chairman, CFO [8]

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You know what, Tom, we are getting that. Why don't you give us the second question and we will come back.

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Tom McCandless, Deutsche Bank Securities - Analyst [9]

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The second question relates to Demchak's parting comments on the wild-card question about noninterest income. Could you update us about your rate sensitivity on the balance sheet? It appears that you are beginning to build a little cash, because your fed funds position is starting to build up again. And does that mean that you're just sitting tight, thinking rates are going to go up?

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Bill Demchak, PNC Financial Services Group - Vice Chairman, CFO [10]

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No, there are a couple of things. We still have a small funds borrowed position, I think, very small. Remember, we had done a subdebt issue, and then we did a trust preferred issue as well, which gave rise to some cash that wasn't there. I don't think that was there in the third quarter. We're basically -- we continue to hold the profile where we're kind of neutral to changes in rates right now. I think if you saw rates back up from here a modest degree you would see us change that profile and probably leverage a little bit more.

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Bill Demchak, PNC Financial Services Group - Vice Chairman, CFO [11]

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Tom, just going back on your demand deposit growth fourth quarter versus third quarter where we see -- I guess the change is 1 percent quarter to quarter on absolute deposits. And if I remember correctly, the change third quarter to second was pretty dramatic. So there might just be some statistical noise in the actual number of balances. The growth in DDA households has been the consistent throughout the year and we're pretty pleased with our performance there.

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Operator [12]

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Nancy Bush with NAB Research.

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Nancy Bush, NAB Research - Analyst [13]

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I guess if you could just drill down a bit more in the PNC Advisers issue, Jim. When in your view can we sort of look for a turn in the fortunes there? And how are the performance numbers, etc., etc.?

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Jim Rohr, PNC Financial Services Group - Chairman, CEO [14]

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I think, Nancy, when you look at PNC Advisers you would have to break it into really two pieces. One is Hilliard Lyons, the brokerage arm, and that is doing well. As a matter of fact the numbers that Hilliard Lyons has is probably as good as any regional broker. So they're doing very well these days.

But on the adviser side and the private advising side, as you know, we did lose a number of customers as a result of some of the performance -- earnings performance, as did many other private banking operations with the downturn in the market. We relatively stabilized the employee base. And I think, frankly, we are excited about the separate account and the Advisory Choice initiative that we started at the end of the third quarter. And the initial results, the feedback we are getting from our customers are pretty good. So I think I'm optimistic for 2004 for PNC Advisers.

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Nancy Bush, NAB Research - Analyst [15]

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If I was not mistaken I heard that you took out sort of $20 million in expenses there. Is that correct?

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Jim Rohr, PNC Financial Services Group - Chairman, CEO [16]

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Yes.

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Nancy Bush, NAB Research - Analyst [17]

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How did that -- what did not come out of? It is sort of counterintuitive. I would think that you would be reinvesting in personnel, etc., there?

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Bill Demchak, PNC Financial Services Group - Vice Chairman, CFO [18]

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It is Bill, Nancy. We have been reinvesting in personnel. It is kind of a reconfiguring of the expense base. There were savings -- efficiency savings there, it is just on operational systems that we are somewhat redundant, as well as changing the way that we allocate resources. So we had some people let go and replaced them with others to put more of a asset gathering sales mentality work force in place than perhaps we had before.

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Operator [19]

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Mike Mayo with Prudential.

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Mike Mayo, Prudential - Analyst [20]

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Just to get some more clarity on your guidance for 2004, you said start with kind of annualize the fourth quarter -- or anyway 396, add 25 cents for business growth, add 10 cents for capital management. So that gets us up to 430 for the year. What is the current First Call range that you're looking at? And what is the potential swing of NII? I just want to understand what you are saying?

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Bill Demchak, PNC Financial Services Group - Vice Chairman, CFO [21]

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I guess the range right now is around $4 to 4.35 or thereabouts. In NII you have the impact of interest rates and loan demand, and that can be a big jump as to whether we're at the lower end of the range or the higher end of that range.

Everybody is forecasting at this point that loan growth is going to take off. We haven't yet seen it. If it does, that's a big benefit to us. And if concurrent with that we see interest rates rise, which would give us cause to leverage the balance sheet more, that also would be a big benefit to us. But to sit today and pick a midpoint, I have trouble doing that.

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Mike Mayo, Prudential - Analyst [22]

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But based on your analysis, NII could have hurt the earnings by as much as 30 cents? It just seems a little bit higher than I would have thought.

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Jim Rohr, PNC Financial Services Group - Chairman, CEO [23]

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Yes, that's pretty extreme. You're trying to get us nailed down into some point in the range that we don't want to be nailed down to. But the point was that within that range the biggest thing that is going to cause us to outperform or underperform right now is what is going to happen to net interest income.

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Mike Mayo, Prudential - Analyst [24]

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With regard to consolidation, there's been a couple of big mergers since your last quarterly call. What are your plans for additional acquisitions? Might you consider more acquisitions in New Jersey, or even New York region? And what is your thought about merger of equals?

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Jim Rohr, PNC Financial Services Group - Chairman, CEO [25]

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I'll take the second in the reverse order. One, we think we built a platform that we can grow and perform for shareholders. That's the most important thing.

Secondly, merger of equals, although I do acknowledge the complementary nature of the business mixes that came together with Banc One and J.P. Morgan Chase, there's a lot to happen in that consolidation. And for the most part, the merger of equals has been difficult to perform for shareholders. I think in our case, we think we have a platform that delivers for shareholders over time. And I think we would look at small acquisitions if they make sense for the shareholder.

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Operator [26]

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John McDonald with UBS.

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John McDonald, UBS - Analyst [27]

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Bill, I am wondering if you could just repeat what you said about credit, where you expect kind of a normalized charge off-ratio, or what you are shooting for as a charge-off ratio in 2004? And then whether you're comfortable that we might see some reserve release going forward?

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Bill Demchak, PNC Financial Services Group - Vice Chairman, CFO [28]

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I won't comment on the reserve release. We have put out our goal of having provisioned and charges around 40 to 45 basis points of loan balances. Reserve release, I suppose, is going to be a function of continued improvement in the economy where we will see upgrades in the portfolio, and maybe that occurs. But we're comfortable with our current sort of credit portfolio and our client acquisition targets that going forward we will be able to hold that to this 40 to 45 basis point charge ratio.

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Operator [29]

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Claire Percarpio with Janney.

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Claire Percarpio, Janney Montgomery Scott - Analyst [30]

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The balance sheet shrinkage in the quarter, if I look at -- whether I look at assets or credits or earning assets, it is a little more than I was expecting. Can you comment on the balance sheet size, excluding United, for '04? Well, I mean you commented on it, but are you going to keep shrinking the loans and shrinking investment securities?

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Bill Demchak, PNC Financial Services Group - Vice Chairman, CFO [31]

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We're running through numbers here wondering if you were picking up a FIN 46 impact, but we reversed that out of 30. So we're down slightly, I guess, September to December. But shrinkage in the balance sheet certainly isn't a target. We continue -- in terms of loan assets we have had -- we continue getting rid of the last bit of the held for sale, which is hurting us, to run off of the lease portfolio. And we just haven't seen a pickup in loan demand to offset that. We would like to see that. In the interim, we continue to put excess liquidity to work in securities, and we will do that. So you shouldn't see, certainly on a targeted basis, a shrinkage in the balance sheet. We would like to see it grow.

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Operator [32]

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Denis Laplante with KBW.

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Denis Laplante, Keefe, Bruyette & Woods - Analyst [33]

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I bet your accountants are -- you have a full employment act with the accountants with all of these restatements.

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Jim Rohr, PNC Financial Services Group - Chairman, CEO [34]

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And not just ours.

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Denis Laplante, Keefe, Bruyette & Woods - Analyst [35]

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In terms of -- what are your unrealized gains in your securities portfolio at the end of the quarter? And then question two is, in that 396 how much in security gains have you basically factored in? Some quarters you take them some out. This quarter you didn't adjust for any security gains that you took to get to an operating number. So just trying to get a sense of where you stand.

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Bill Demchak, PNC Financial Services Group - Vice Chairman, CFO [36]

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With respect to unrealized gains, and I'm going to talk to securities and our swap portfolio as well. On the security side, at the end of year we were essentially flat in gains, and the received fixed swap portfolio had gains of about 275 million. As you as you know, rates rally pretty substantially since the end of year. And as of today we have 60 million in unrealized gains on the securities book, and the swap portfolio is up to 325 million of unrealized gains.

With respect to security gains that we back out of a normalization table, basically if we take gains in excess of 15 million in any given quarter we think that is beyond what we otherwise should be able to generate in this environment. So if we have gains in excess of 15, we back them out of that normalization table, otherwise we leave them in there.

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Jim Rohr, PNC Financial Services Group - Chairman, CEO [37]

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We have 60 in total for the year?

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Bill Demchak, PNC Financial Services Group - Vice Chairman, CFO [38]

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Sixty normalized in security gains for the year '03.

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Denis Laplante, Keefe, Bruyette & Woods - Analyst [39]

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Sixty, so after-tax you're talking roughly about 14 cents? Did I do the math right?

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Bill Demchak, PNC Financial Services Group - Vice Chairman, CFO [40]

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Yes.

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Jim Rohr, PNC Financial Services Group - Chairman, CEO [41]

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We came up with that number, really, by going back over time, Denis and just find finding that even all of the various different interest rate scenarios, the size of the portfolio has thrown off those fed (ph) types of results. Obviously, in a rapidly declining interest rate environments, the opportunity is greater than that, but we take that out of normalized.

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Denis Laplante, Keefe, Bruyette & Woods - Analyst [42]

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Is there something tactical to the gains that you have taken over the last couple of quarters, the gains you have reaped in terms of repositioning the portfolio for asset liability purposes?

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Bill Demchak, PNC Financial Services Group - Vice Chairman, CFO [43]

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It varies. Sometimes there is just an opportunity. We saw massive outperformance in CMBS Securities, for example. And would take gains in those and just reinvest in other asset class. As you know, earlier on in the year when we unwound the Padgett transaction there was a big security gain associated with that, which had nothing to do with anything other than we tore up that transaction.

So as Jim said, there always seems to be something. But we do think that we can generate 10 to 15 million a quarter just through opportunistic reposition in the portfolio.

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Operator [44]

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(OPERATOR INSTRUCTIONS) Tom McCandless with Deutsche Bank Securities.

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Tom McCandless, Deutsche Bank Securities - Analyst [45]

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On your PFPC unit, two questions. One, given the fairly rapid buildup of the assets in your servicing statistics area, is it fair to say that perhaps the fund servicing revenues tend to lag that a bit because of the nature of the business and more front end costs when the revenues start to come in?

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Jim Rohr, PNC Financial Services Group - Chairman, CEO [46]

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That is a very good observation. Sometimes it takes us as much as six months to bring a customer on after we have been awarded the business. So it does take time after the awards before the revenue shows up.

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Tom McCandless, Deutsche Bank Securities - Analyst [47]

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Can you share with us much shifting in the asset totals from going out of the -- or have the equity components changed over time?

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Jim Rohr, PNC Financial Services Group - Chairman, CEO [48]

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Switch of assets. Tom, we don't have the answer to that.

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Bill Demchak, PNC Financial Services Group - Vice Chairman, CFO [49]

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We don't have it here at hand right now. But you mean the mix of the assets we service, Tom?

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Tom McCandless, Deutsche Bank Securities - Analyst [50]

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Correct.

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Bill Demchak, PNC Financial Services Group - Vice Chairman, CFO [51]

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I don't have that here today.

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Tom McCandless, Deutsche Bank Securities - Analyst [52]

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And final question. I think this time last year that unit won a lot of business, I think, from Fleet on the Galaxy Fund, the money market fund. Does that go away?

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Jim Rohr, PNC Financial Services Group - Chairman, CEO [53]

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It doesn't appear to. It is under contract. So at this point in time, it should be with us for the duration of the contract which is another few years. I do know about that specific contract, but usually they are three to five years.

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Tom McCandless, Deutsche Bank Securities - Analyst [54]

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And if the break it your are paid out?

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Jim Rohr, PNC Financial Services Group - Chairman, CEO [55]

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Yes. And a fee. There's a break up fee.

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Operator [56]

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Rodrigo Quintanilla with Merrill Lynch.

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Rodrigo Quintanilla, Merrill Lynch - Analyst [57]

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Just a clarification. When we were thinking about securities gains for '04, you were saying 15 normalized per quarter. Should we be thinking in those terms when you're talking about your guidance, the range, is that a number that we should be including?

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Bill Demchak, PNC Financial Services Group - Vice Chairman, CFO [58]

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I think -- the way I think about that, Rodrigo, is if we continue to exist in the interest rate environment we are in then you would see those types of gains. If rates were to rise, you wouldn't see the same volume of gains, but it would be offset by higher net interest income. So it is kind one or the other.

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Operator [59]

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At this time, sir, there are no further questions.

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Jim Rohr, PNC Financial Services Group - Chairman, CEO [60]

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Well, thank you very much for attending this morning. We're very pleased with the quarter, and look forward to the first quarter of '04. Thank you.

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Operator [61]

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Thank you for participating in today's PNC Financial Services Group earnings conference call. You may now disconnect.