10-Q 1 d10q.htm FORM 10-Q Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended March 31, 2011

or

 

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

For the transition period from                     to                    

Commission file number 001-09718

The PNC Financial Services Group, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Pennsylvania   25-1435979

(State or other jurisdiction of

incorporation or organization)

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

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

(Address of principal executive offices, including zip code)

(412) 762-2000

(Registrant’s telephone number, including area code)

 

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

 

 

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

Yes  x    No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  x    No   ¨

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

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

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

Yes  ¨    No   x

As of April 29, 2011, there were 526,282,991 shares of the registrant’s common stock ($5 par value) outstanding.

 

 

 


Table of Contents

The PNC Financial Services Group, Inc.

Cross-Reference Index to First Quarter 2011 Form 10-Q

 

     Pages  

PART I – FINANCIAL INFORMATION

  

Item 1.        Financial Statements (Unaudited).

  

Consolidated Income Statement

     59   

Consolidated Balance Sheet

     60   

Consolidated Statement Of Cash Flows

     61   

Notes To Consolidated Financial Statements (Unaudited)

  

Note 1   Accounting Policies

     63   

Note 2   Divestiture

     66   

Note 3   Loan Sale and Servicing Activities and Variable Interest Entities

     67   

Note 4   Loans and Commitments to Extend Credit

     71   

Note 5   Asset Quality and Allowances for Loan and Lease Losses and Unfunded Loan

  

Commitments and Letters of Credit

     72   

Note 6   Purchased Impaired Loans

     80   

Note 7   Investment Securities

     81   

Note 8   Fair Value

     86   

Note 9   Goodwill and Other Intangible Assets

     96   

Note 10 Capital Securities of Subsidiary Trusts and Perpetual Trust Securities

     98   

Note 11 Certain Employee Benefit And Stock-Based Compensation Plans

     99   

Note 12 Financial Derivatives

     101   

Note 13 Earnings Per Share

     108   

Note 14 Total Equity And Other Comprehensive Income

     109   

Note 15 Income Taxes

     110   

Note 16 Legal Proceedings

     110   

Note 17 Commitments and Guarantees

     112   

Note 18 Segment Reporting

     116   

Statistical Information (Unaudited)

  

Average Consolidated Balance Sheet And Net Interest Analysis

     119   

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

  

Financial Review

  

Consolidated Financial Highlights

     1   

Executive Summary

     3   

Consolidated Income Statement Review

     9   

Consolidated Balance Sheet Review

     11   

Off-Balance Sheet Arrangements And Variable Interest Entities

     20   

Fair Value Measurements

     21   

Business Segments Review

     22   

Critical Accounting Estimates And Judgments

     33   

Status Of Qualified Defined Benefit Pension Plan

     34   

Recourse And Repurchase Obligations

     35   

Risk Management

     38   

Internal Controls And Disclosure Controls And Procedures

     53   

Glossary Of Terms

     53   

Cautionary Statement Regarding Forward-Looking Information

     57   

Item 3.         Quantitative and Qualitative Disclosures About Market Risk.

    
 
38-52 and
101-107
  
  

Item 4.        Controls and Procedures.

     53   

PART II – OTHER INFORMATION

  

Item 1.        Legal Proceedings.

     121   

Item 1A.    Risk Factors.

     121   

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

     121   

Item 6.        Exhibits.

     121   

Exhibit Index.

     121   

Signature

     121   

Corporate Information

     122   

 


Table of Contents

FINANCIAL REVIEW

CONSOLIDATED FINANCIAL HIGHLIGHTS

THE PNC FINANCIAL SERVICES GROUP, INC.

 

Dollars in millions, except per share data    Three months ended March 31  
Unaudited        2011             2010      

FINANCIAL RESULTS (a)

      

Revenue

      

Net interest income

   $ 2,176     $ 2,379  

Noninterest income

     1,455       1,384  

Total revenue

     3,631       3,763  

Noninterest expense

     2,070       2,113  

Pretax, pre-provision earnings from continuing operations (b)

     1,561       1,650  

Provision for credit losses

     421       751  

Income from continuing operations before income taxes and noncontrolling interests (pretax earnings)

   $ 1,140     $ 899  

Income from continuing operations before noncontrolling interests

   $ 832     $ 648  

Income from discontinued operations, net of income taxes (c)

             23  

Net income

   $ 832     $ 671  

Less:

      

Net income (loss) attributable to noncontrolling interests

     (5     (5

Preferred stock dividends, including TARP (d)

     4       93  

Redemption of TARP preferred stock discount accretion (d)

             250  

Net income attributable to common shareholders (d)

   $ 833     $ 333  

Diluted earnings per common share

      

Continuing operations

   $ 1.57     $ .61  

Discontinued operations (c)

             .05  

Net income

   $ 1.57     $ .66  

Cash dividends declared per common share (e)

   $ .10     $ .10  

PERFORMANCE RATIOS

      

Net interest margin (f)

     3.94     4.24

Noninterest income to total revenue

     40       37  

Efficiency

     57       56  

Return on:

      

Average common shareholders’ equity

     11.12       5.37  

Average assets

     1.29       1.02  

See page 53 for a glossary of certain terms used in this Report.

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

(a) The Executive Summary and Consolidated Income Statement Review portions of the Financial Review section of this Report provide information regarding items impacting the comparability of the periods presented.
(b) We believe that pretax, pre-provision earnings from continuing operations, a non-GAAP measure, is useful as a tool to help evaluate our ability to provide for credit costs through operations.
(c) Includes results of operations for PNC Global Investment Servicing Inc. (GIS). We sold GIS effective July 1, 2010. See Sale of PNC Global Investment Servicing in the Executive Summary section of the Financial Review section of this Report and Note 2 Divestiture in the Notes To Consolidated Financial Statements of this Report for additional information.
(d) We redeemed the Series N (TARP) Preferred Stock on February 10, 2010. In connection with the redemption, we accelerated the accretion of the remaining issuance discount on the Series N Preferred Stock and recorded a corresponding reduction in retained earnings of $250 million in the first quarter of 2010. This resulted in a one-time, noncash reduction in net income attributable to common shareholders and related basic and diluted earnings per share. The impact on diluted earnings per share was $.50 for the first quarter of 2010. Total dividends declared for the first quarter of 2010 included $89 million on the Series N Preferred Stock.
(e) In April 2011, the PNC Board of Directors declared a quarterly cash dividend on common stock of 35 cents per share, an increase of 25 cents per share, or 250%, from the prior quarterly dividend of 10 cents per share. The increased dividend was paid May 5, 2011 to shareholders of record at the close of business on April 18, 2011.
(f) Calculated as annualized taxable-equivalent net interest income divided by average earning assets. The interest income earned on certain earning assets is completely or partially exempt from federal income tax. As such, these tax-exempt instruments typically yield lower returns than taxable investments. To provide more meaningful comparisons of net interest margins for all earning assets, we use net interest income on a taxable-equivalent basis in calculating net interest margin by increasing the interest income earned on tax-exempt assets to make it fully equivalent to interest income earned on taxable investments. This adjustment is not permitted under GAAP in the Consolidated Income Statement. The taxable-equivalent adjustments to net interest income for the three months ended March 31, 2011 and March 31, 2010 were $24 million and $18 million, respectively.

 

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CONSOLIDATED FINANCIAL HIGHLIGHTS (CONTINUED) (a)

 

Unaudited    March 31
2011
    December 31
2010
    March 31
2010
 

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

        

Assets

   $ 259,378     $ 264,284     $ 265,396  

Loans (b) (c)

     149,387       150,595       157,266  

Allowance for loan and lease losses (b)

     4,759       4,887       5,319  

Interest-earning deposits with banks (b)

     1,359       1,610       607  

Investment securities (b)

     60,992       64,262       57,606  

Loans held for sale (c)

     2,980       3,492       2,691  

Goodwill and other intangible assets

     10,764       10,753       12,714  

Equity investments (b)

     9,595       9,220       10,256  

Noninterest-bearing deposits

     48,707       50,019       43,122  

Interest-bearing deposits

     133,283       133,371       139,401  

Total deposits

     181,990       183,390       182,523  

Transaction deposits

     134,516       134,654       126,420  

Borrowed funds (b)

     34,996       39,488       42,461  

Shareholders’ equity

     31,132       30,242       26,818  

Common shareholders’ equity

     30,485       29,596       26,466  

Accumulated other comprehensive income (loss)

     (309     (431     (1,288

Book value per common share

     58.01       56.29       50.32  

Common shares outstanding (millions)

     526       526       526  

Loans to deposits

     82     82     86
 

ASSETS UNDER ADMINISTRATION (billions)

        

Discretionary assets under management

   $ 110     $ 108     $ 105  

Nondiscretionary assets under administration

     109       104       104  

Total assets under administration

     219       212       209  
 

CAPITAL RATIOS

        

Tier 1 common

     10.3     9.8     7.9

Tier 1 risk-based (d)

     12.6       12.1       10.3  

Total risk-based (d)

     16.2       15.6       13.9  

Leverage (d)

     10.6       10.2       8.8  

Common shareholders’ equity to assets

     11.8       11.2       10.0  
 

ASSET QUALITY RATIOS

        

Nonperforming loans to total loans

     2.94     2.97     3.66

Nonperforming assets to total loans, OREO and foreclosed assets

     3.50       3.50       4.14  

Nonperforming assets to total assets

     2.03       2.01       2.46  

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

     1.44       2.09       1.77  

Allowance for loan and lease losses to total loans

     3.19       3.25       3.38  

Allowance for loan and lease losses to nonperforming loans (e)

     108       109       92  
(a) The Executive Summary and Consolidated Balance Sheet Review portions of the Financial Review section of this Report provide information regarding items impacting the comparability of the periods presented.
(b) Amounts include consolidated variable interest entities. See Consolidated Balance Sheet in Part I, Item 1 of this Report for additional information. Also includes our equity interest in BlackRock under Equity investments.
(c) Amounts include assets for which we have elected the fair value option. See Consolidated Balance Sheet in Part I, Item 1 of this Report for additional information.
(d) The minimum US regulatory capital ratios under Basel I are 4.0% for Tier 1 risk-based, 8.0% for Total risk-based, and 4.0% for Leverage. The well-capitalized levels are 6.0% for Tier 1 risk-based, 10.0% for Total risk-based, and 5.0% for Leverage.
(e) The allowance for loan and lease losses includes impairment reserves attributable to purchased impaired loans. Nonperforming loans do not include purchased impaired loans or loans held for sale.

 

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FINANCIAL REVIEW

THE PNC FINANCIAL SERVICES GROUP, INC.

This Financial Review, including the Consolidated Financial Highlights, should be read together with our unaudited Consolidated Financial Statements and unaudited Statistical Information included elsewhere in this Report and with Items 6, 7, 8 and 9A of our 2010 Annual Report on Form 10-K (2010 Form 10-K). We have reclassified certain prior period amounts to conform with the current period presentation, which we believe is more meaningful to readers of our consolidated financial statements. For information regarding certain business and regulatory risks, see the Risk Management section in this Financial Review, Item 1A and the Risk Management section of Item 7 of our 2010 Form 10-K, and Note 16 Legal Proceedings and Note 17 Commitments and Guarantees in the Notes to Consolidated Financial Statements included in Part I, Item 1 of this Report. Also, see the Cautionary Statement Regarding Forward-Looking Information and Critical Accounting Estimates And Judgments sections in this Financial Review for certain other factors that could cause actual results or future events to differ, perhaps materially, from historical performance and those anticipated in the forward-looking statements included in this Report. See Note 18 Segment Reporting in the Notes To Consolidated Financial Statements included in Part I, Item 1 of this Report for a reconciliation of total business segment earnings to total PNC consolidated net income from continuing operations before noncontrolling interests as reported on a generally accepted accounting principles (GAAP) basis.

 

EXECUTIVE SUMMARY

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

PNC has businesses engaged in retail banking, corporate and institutional banking, asset management, and residential mortgage banking, providing many of its products and services nationally and others in PNC’s primary geographic markets located in Pennsylvania, Ohio, New Jersey, Michigan, Maryland, Illinois, Indiana, Kentucky, Florida, Virginia, Missouri, Delaware, Washington, D.C., and Wisconsin. PNC also provides certain products and services internationally.

KEY STRATEGIC GOALS

We manage our company for the long term and are focused on managing toward a moderate risk profile while maintaining strong capital and liquidity positions, investing in our markets and products, and embracing our corporate responsibility to the communities where we do business.

Our strategy to enhance shareholder value centers on driving growth in pre-tax, pre-provision earnings by achieving growth in revenue from our balance sheet and diverse business mix that exceeds growth in expenses controlled through disciplined cost management.

The primary drivers of revenue growth are the acquisition, expansion and retention of customer relationships. We strive to expand our customer base by offering convenient banking options and leading technology solutions, providing a broad range of fee-based and credit products and services, focusing on customer service, and through a significantly enhanced branding initiative. This strategy is designed to give our consumer customers choices based on their needs. Rather than striving to optimize fee revenue in the short term, our approach is focused on effectively growing targeted market share and “share of wallet.” We may also grow revenue

through appropriate and targeted acquisitions and, in certain businesses, by expanding into new geographical markets.

We are focused on our strategies for quality growth. We are committed to a moderate risk philosophy characterized by disciplined credit management and limited exposure to earnings volatility resulting from interest rate fluctuations and the shape of the interest rate yield curve. We made substantial progress in transitioning our balance sheet over the past two years, working to return to our moderate risk profile throughout our expanded franchise. Our actions have created a well-positioned balance sheet, strong bank level liquidity and investment flexibility to adjust, where appropriate and permissible, to changing interest rates and market conditions.

2011 CAPITAL ACTIONS

On April 7, 2011, our Board of Directors approved an increase to PNC’s quarterly common stock dividend from $.10 per common share to $.35 per common share, which was paid on May 5, 2011. Our Board of Directors also confirmed that PNC may begin to purchase common stock under its existing 25 million share repurchase program in open market or privately negotiated transactions. PNC plans to repurchase up to $500 million of common stock during the remainder of 2011. The discussion of capital within the Consolidated Balance Sheet Review section of this Financial Review includes additional information regarding our common stock repurchase program.

Our ability to take these actions had been subject to the results of the supervisory assessment of capital adequacy undertaken by the Board of Governors of the Federal Reserve System (Federal Reserve) and our primary bank regulators as part of the capital adequacy assessment of the 19 bank holding companies that participate in the Supervisory Capital Assessment Program. As we announced on March 18, 2011, the Federal Reserve accepted the capital plan that we submitted for their review and did not object to our capital actions.

 

 

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RECENT MARKET AND INDUSTRY DEVELOPMENTS

In addition to numerous legislative and regulatory developments, there have been dramatic changes in the competitive landscape of our industry over the last several years.

Beginning in late 2008, efforts by the Federal government, including the US Congress, the US Department of the Treasury, the Federal Reserve, the FDIC, and the Securities and Exchange Commission, to stabilize and restore confidence in the financial services industry have impacted and will likely continue to impact PNC and our stakeholders. These efforts, which will continue to evolve, include the Emergency Economic Stabilization Act of 2008, the American Recovery and Reinvestment Act of 2009, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), in particular, and other legislative, administrative and regulatory initiatives, including the new rules set forth in Regulation E related to overdraft charges.

Dodd-Frank is extensive, complicated and comprehensive legislation that impacts practically all aspects of a banking organization. Dodd-Frank will negatively impact revenue and increase both the direct and indirect costs of doing business for PNC. It includes provisions that could increase regulatory fees and deposit insurance assessments and impose heightened capital and prudential standards, while at the same time impacting the nature and costs of PNC’s businesses, including consumer lending, private equity investment, derivatives transactions, interchange fees on debit card transactions, and asset securitizations.

Until such time as the regulatory agencies issue final regulations implementing all of the numerous provisions of Dodd-Frank, a process that will extend at least over the next year and might last several years, PNC will not be able to fully assess the impact the legislation will have on its businesses. However, we believe that the expected changes will be manageable for PNC and will have a smaller impact on us than on our larger peers.

Included in these recent legislative and regulatory developments are evolving regulatory capital standards for financial institutions. Dodd-Frank requires the Federal Reserve Board to establish capital requirements that would, among other things, eliminate the Tier 1 treatment of trust preferred securities following a phase-in period expected to begin in 2013. Evolving standards also include the so-called “Basel III” initiatives that are part of the Basel II effort by international banking supervisors to update the original international bank capital accord (Basel I), which has been in effect since 1988. The recent Basel III capital initiative, which has the support of US banking regulators, includes heightened capital requirements for major banking institutions in terms of both higher quality capital and higher regulatory capital ratios. Basel III capital standards will require implementing regulations by the banking regulators. These regulations will

become effective under a phase-in period beginning January 1, 2013, and will become fully effective January 1, 2019.

Dodd-Frank also establishes, as an independent agency organized as a bureau within the Federal Reserve, the Bureau of Consumer Financial Protection (CFPB). Starting July 21, 2011, the CFPB will have the authority to prescribe rules governing the provision of consumer financial products and services, and it is expected that the CFPB will issue new regulations, and amend existing regulations, regarding consumer protection practices. Also on that date, the authority of the Office of the Comptroller of the Currency (OCC) to examine PNC Bank, N.A. for compliance with consumer protection laws, and to enforce such laws, will transfer to CFPB.

Additionally, new provisions concerning the applicability of state consumer protection laws will become effective on July 21, 2011. Questions may arise as to whether certain state consumer financial laws that may have previously been preempted are no longer preempted after this date. Depending on how such questions are resolved, we may experience an increase in state-level regulation of our retail banking business and additional compliance obligations, revenue impacts, and costs.

Dodd-Frank and its implementation, as well as other statutory and regulatory initiatives that will be ongoing, will introduce numerous regulatory changes over the next several years. While we believe that we are well positioned to navigate through this process, we cannot predict the ultimate impact of these actions on PNC’s business plans and strategies.

RESIDENTIAL MORTGAGE FORECLOSURE MATTERS

Beginning in the third quarter of 2010, mortgage foreclosure documentation practices among US financial institutions received heightened attention by regulators and the media. PNC’s US market share for residential servicing is approximately 1.5%. The vast majority of our servicing business is on behalf of other investors, principally the Federal Home Loan Mortgage Corporation (FHLMC) and the Federal National Mortgage Association (FNMA). Following the initial reports regarding these practices, we conducted an internal review of our foreclosure procedures. Based upon our review, we believe that PNC has systems designed to ensure that no foreclosure proceeds unless the loan is genuinely in default.

Similar to other banks, however, we identified issues regarding some of our foreclosure practices. Accordingly, after implementing a delay in pursuing individual foreclosures, we have been moving forward or are in the process of moving forward in most jurisdictions on such matters under procedures designed to address as appropriate any documentation issues. We are also proceeding with new foreclosures under enhanced procedures designed as part of this review to minimize the risk of errors related to the processing of documentation in foreclosure cases.

 

 

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The Federal Reserve and the OCC, together with the FDIC and others, conducted a publicly-disclosed interagency horizontal review of residential mortgage servicing operations at PNC and thirteen other federally regulated mortgage servicers. As a result of that review, in April 2011 PNC entered into a consent order with the Federal Reserve and PNC Bank N.A. entered into a consent order with the OCC. Collectively, these consent orders describe certain foreclosure-related practices and controls that the regulators found to be deficient and require PNC and PNC Bank to, among other things, develop and implement plans and programs to enhance PNC’s residential mortgage servicing and foreclosure processes, retain an independent consultant to review certain residential mortgage foreclosure actions, take certain remedial actions, and oversee compliance with the orders and the new plans and programs. The two orders do not resolve any other federal or state governmental, legislative or regulatory authority investigations, which may result in significant additional actions, penalties or other remedies, and they do not foreclose the potential for civil money penalties from the bank regulators.

For additional information, please see Note 16 Legal Proceedings and Note 17 Commitments and Guarantees in the Notes To Consolidated Financial Statements in this Report and our Current Report on Form 8-K dated April 14, 2011.

PNC’S PARTICIPATION IN SELECT GOVERNMENT PROGRAMS

Information on these programs is provided in Item 7 of our 2010 Form 10-K.

KEY FACTORS AFFECTING FINANCIAL PERFORMANCE

Our financial performance is substantially affected by several external factors outside of our control including the following:

   

General economic conditions, including the speed and stamina of the moderate economic recovery in general and on our customers in particular,

   

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

   

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

   

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

   

Customer demand for other products and services,

   

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

   

The impact of the extensive reforms enacted in the Dodd-Frank legislation and other legislative, regulatory and administrative initiatives, including those outlined above, and

   

The impact of market credit spreads on asset valuations.

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

   

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

   

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

   

Revenue growth,

   

A sustained focus on expense management,

   

Managing the distressed assets portfolio and other impaired assets,

   

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

   

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

   

Prudent risk and capital management related to our efforts to return to our desired moderate risk profile,

   

Actions we take within the capital and other financial markets, and

   

The impact of legal and regulatory contingencies.

SALE OF PNC GLOBAL INVESTMENT SERVICING

On July 1, 2010, we sold PNC Global Investment Servicing Inc. (GIS), a leading provider of processing, technology and business intelligence services to asset managers, broker-dealers and financial advisors worldwide, for $2.3 billion in cash pursuant to a definitive agreement entered into on February 2, 2010. The pretax gain recorded in the third quarter of 2010 related to this sale was $639 million, or $328 million after taxes.

Results of operations of GIS through March 31, 2010 are presented as income from discontinued operations, net of income taxes, on our Consolidated Income Statement in this Report. Once we entered into the sales agreement, GIS was no longer a reportable business segment. See Note 2 Divestiture in our Notes To Consolidated Financial Statements in this Report.

INCOME STATEMENT HIGHLIGHTS

   

Strong results for the first quarter reflected pretax earnings from continuing operations of $1.1 billion, compared with $.9 billion for the first quarter of 2010.

   

Net interest income for the first three months of 2011 was $2.2 billion and the net interest margin was 3.94%, compared with $2.4 billion and 4.24% for the first three months of 2010. The decreases compared with the prior year quarter were attributable to lower purchase accounting accretion, soft loan demand and the low interest rate environment partially offset by lower funding costs.

   

Noninterest income of $1.5 billion for the first quarter of 2011 increased from $1.4 billion in the prior year first quarter.

 

 

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The provision for credit losses declined to $421 million for the first three months of 2011 from $751 million for the first three months of 2010 driven by overall credit quality improvement and continuation of actions to reduce exposure levels.

   

Noninterest expense totaled $2.1 billion for the first quarter of both 2011 and 2010.

CREDIT QUALITY HIGHLIGHTS

   

Improvement in overall credit quality continued in the first quarter of 2011. Nonperforming assets decreased $43 million to $5.3 billion at March 31, 2011 compared with December 31, 2010. Accruing loans past due of $1.9 billion were relatively unchanged from December 31, 2010. The allowance for loan and lease losses was $4.8 billion, or 3.19% of total loans and 108% of nonperforming loans, as of March 31, 2011.

BALANCE SHEET HIGHLIGHTS

   

Total loans were $149 billion at March 31, 2011 and $151 billion at December 31, 2010. Growth in commercial loans of $1.4 billion during the quarter was offset by declines in commercial real estate loans of $.8 billion and residential mortgage loans of $.7 billion. Loans and commitments originated and renewed totaled approximately $27 billion in the first quarter, including $.9 billion of small business loans.

   

Total deposits were $182 billion at March 31, 2011 and $183 billion at December 31, 2010. Transaction deposits of $135 billion were essentially stable compared with December 31, 2010. Higher cost retail certificates of deposit continued to decline with a reduction of $1.5 billion, or 4%, in the first quarter.

   

PNC’s high quality balance sheet was core funded with a loan to deposit ratio of 82% at March 31, 2011 and a strong bank liquidity position to support growth.

   

PNC’s strong capital levels were reflected in its Tier 1 common capital ratio which increased to 10.3% at March 31, 2011 from 9.8% at December 31, 2010.

   

PNC reached a definitive agreement in January 2011 to acquire 19 branches and approximately $390 million of deposits from BankAtlantic Bancorp, Inc. located in the Tampa, Florida area. The transaction has received regulatory approval and is expected to close in June 2011, subject to customary closing conditions.

Our Consolidated Income Statement and Consolidated Balance Sheet Review sections of this Financial Review describe in greater detail the various items that impacted our results for the first three months of 2011 and 2010.

AVERAGE CONSOLIDATED BALANCE SHEET HIGHLIGHTS

Various seasonal and other factors impact our period-end balances whereas average balances are generally more

indicative of underlying business trends apart from the impact of acquisitions, divestitures and consolidations of variable interest entities.

The Consolidated Balance Sheet Review section of this Financial Review provides information on changes in selected Consolidated Balance Sheet categories at March 31, 2011 compared with December 31, 2010.

Total average assets were $262.6 billion for the first three months of 2011 compared with $267.1 billion for the first three months of 2010. Average interest-earning assets were $224.1 billion for the first three months of 2011, compared with $227.0 billion in the first three months of 2010. In both comparisons, the declines were primarily driven by an $8.6 billion decrease in average total loans partially offset by a $5.5 billion increase in average total investment securities. The overall decline in average loans reflected soft customer loan demand, loan repayments, dispositions and net charge-offs. The increase in total investment securities reflected net investments of excess liquidity in short duration, high quality securities, primarily residential mortgage-backed securities.

The decrease in average total loans primarily reflected declines in commercial real estate of $4.9 billion and residential real estate of $3.9 billion, partially offset by a $.8 billion increase in commercial loans. Commercial real estate loans declined due to loan sales, paydowns, and charge-offs. The decrease in residential real estate was impacted by portfolio management activities, paydowns and net charge-offs. Commercial loans increased due to a combination of new volume, improved utilization and new Market Street commitments. Loans represented 67% of average interest-earning assets for the first three months of 2011 and 70% of average interest-earning assets for the first three months of 2010.

Average securities available for sale increased $4.8 billion, to $55.4 billion, in the first quarter of 2011 compared with the first quarter of 2010. Average residential mortgage-backed agency securities increased $7.2 billion and other debt securities increased $2.1 billion in the comparison while residential mortgage-backed non-agency securities declined $2.2 billion and commercial mortgage-backed securities decreased $2.1 billion. The impact of purchases of high quality agency residential mortgage-backed securities and diversifiable other debt was partially offset by the natural run-off from paydowns of other security types.

Average securities held to maturity increased $.8 billion, to $6.7 billion, in the first three months of 2011 compared with the first three months of 2010. An increase of $2.1 billion in commercial mortgage-backed securities more than offset a $1.2 billion decrease in asset-backed securities in the comparison. Purchases of commercial mortgage-backed securities during the first quarter of 2011 outpaced the effect of paydowns of other security types.

 

 

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Total investment securities comprised 28% of average interest-earning assets for the first three months of 2011 and 25% for the first three months of 2010.

Average noninterest-earning assets totaled $38.5 billion in the first three months of 2011 compared with $40.2 billion in the first three months of 2010. The decline reflected a decrease in average goodwill and other intangible assets.

Average total deposits were $180.8 billion for the first quarter of 2011 compared with $183.1 billion for the first quarter of 2010. Average deposits declined from the prior year period primarily as a result of decreases in retail certificates of deposit and other time deposits, which were partially offset by increases in money market balances, demand and other noninterest-bearing deposits. Growing core checking deposits as a lower-cost funding source and as the cornerstone product to build customer relationships is the primary objective of our deposit strategy. Furthermore, core checking accounts are critical to our strategy of expanding our payment business. Total deposits at March 31, 2011 were $182.0 billion compared with $183.4 billion at December 31, 2010 and are further discussed within the Consolidated Balance Sheet Review section of this Report.

Average total deposits represented 69% of average total assets for both the first three months of 2011 and 2010.

Average transaction deposits were $132.6 billion for the first three months of 2011 compared with $125.2 billion for the first three months of 2010. The ongoing planned reduction of high-cost and primarily nonrelationship certificates of deposit is part of our overall deposit strategy that is focused on growing demand and other transaction deposits as the cornerstone product of customer relationships and a lower-cost, stable funding source.

Average borrowed funds were $38.4 billion for the first quarter of 2011 compared with $42.3 billion for the first quarter of 2010. Maturities of Federal Home Loan Bank (FHLB) borrowings drove the decline compared with the first quarter of 2010. Total borrowed funds at March 31, 2011 were $35.0 billion compared with $39.5 billion at December 31, 2010 and are further discussed within the Consolidated Balance Sheet Review section of this Financial Review. In addition, the Liquidity Risk Management portion of the Risk Management section of this Financial Review includes additional information regarding our sources and uses of borrowed funds.

BUSINESS SEGMENT HIGHLIGHTS

Total business segment earnings were $639 million for the first three months of 2011 and $659 million for the first three months of 2010. Highlights of results for the first three months of 2011 and 2010 are included below. The Business Segments Review section of this Financial Review includes a Results of Business-Summary table and further analysis of our business

segment results over these periods including presentation differences from Note 18 Segment Reporting in our Notes To Consolidated Financial Statements of this Report.

We provide a reconciliation of total business segment earnings to PNC consolidated income from continuing operations before noncontrolling interests as reported on a GAAP basis in Note 18 Segment Reporting in our Notes To Consolidated Financial Statements of this Report

Retail Banking

Retail Banking incurred a loss of $18 million for the quarter compared with earnings of $24 million for the year ago quarter. Earnings declined from the prior year quarter as lower revenues resulting from the impact of Regulation E rules related to overdraft fees and a low interest rate environment were partially offset by a lower provision for credit losses. Retail Banking continued to maintain its focus on growing customers and deposits, improving customer and employee satisfaction, investing in the business for future growth, and disciplined expense management during this period of market and economic uncertainty.

Corporate & Institutional Banking

Corporate & Institutional Banking earned $432 million in the first quarter of 2011 compared with $368 million in the first quarter of 2010. The increase in earnings was due to a decrease in the provision for credit losses, somewhat offset by declines in net interest income and revenue from commercial mortgage banking activities. We continued to focus on adding new clients and increased our cross selling to serve our clients’ needs, particularly in the western markets, and remained committed to strong expense discipline.

Asset Management Group

Asset Management Group earned $43 million in the first quarter of 2011 compared with $39 million in the first quarter of 2010. Assets under administration were $219 billion as of March 31, 2011. Earnings for the first quarter of 2011 reflected a benefit from the provision for credit losses compared with the provision for the first quarter of 2010. The business maintained its focus on new client acquisition and client asset growth during the quarter.

Residential Mortgage Banking

Residential Mortgage Banking earned $71 million in the first quarter of 2011 compared with $78 million in the first quarter of 2010. Earnings declined from the prior year first quarter primarily as a result of a higher provision for credit losses, lower servicing fees, lower net interest income and higher noninterest expense offset partially by increased loans sales revenue and higher net economic hedging gains on mortgage servicing rights.

BlackRock

Our BlackRock business segment earned $86 million in the first three months of 2011 and $77 million in the first three

 

 

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months of 2010. Higher earnings at BlackRock for the first quarter of 2011 compared to the first quarter of 2010 were due to the effect of growth in base and performance fees as well as BlackRock Solutions ® and advisory fees.

Distressed Assets Portfolio

This business segment consists primarily of assets acquired with acquisitions and had earnings of $25 million for the first three months of 2011 compared with $73 million in the first three months of 2010. The decline was driven by a decrease in net interest income, partially offset by a lower provision for credit losses and an increase in noninterest income.

Other

“Other” reported earnings of $193 million for the three months of 2011 compared with a net loss of $11 million for the first three months of 2010. The increase in earnings over the first quarter of 2010 primarily reflected the impact of integration costs incurred in the 2010 period, the reversal of a portion of an indemnification liability for certain Visa litigation in the first quarter of 2011 and higher net gains on sales of securities net of other-than-temporary impairments (OTTI) in the first quarter of 2011.

 

 

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CONSOLIDATED INCOME STATEMENT REVIEW

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

Net income for the first three months of 2011 was $832 million compared with $671 million for the first three months of 2010. Total revenue for the first three months of 2011 was $3.6 billion compared with $3.8 billion for the three months of 2010. The decline in total revenue in the comparison reflected lower net interest income in 2011.

NET INTEREST INCOME AND NET INTEREST MARGIN

 

     Three months ended
March 31
 
Dollars in millions    2011     2010  

Net interest income

   $ 2,176     $ 2,379  

Net interest margin

     3.94     4.24

Changes in net interest income and margin result from the interaction of the volume and composition of interest-earning assets and related yields, interest-bearing liabilities and related rates paid, and noninterest-bearing sources of funding. See the Statistical Information (Unaudited) – Average Consolidated Balance Sheet And Net Interest Analysis section of this Report for additional information.

The decrease in net interest income and net interest margin compared with the first quarter of 2010 was attributable to lower purchase accounting accretion, soft loan demand and the low interest rate environment partially offset by lower funding costs.

The net interest margin was 3.94% for the first three months of 2011 and 4.24% for the first three months of 2010. The following factors impacted the comparison:

   

A 50 basis point decrease in the yield on interest-earning assets. The yield on loans, the largest portion of our earning assets, decreased 41 basis points.

   

These factors were partially offset by a 21 basis point decline in the rate accrued on interest-bearing liabilities. The rate accrued on interest-bearing deposits, the largest component, decreased 26 basis points.

We expect that our purchase accounting accretion will decrease by as much as $700 million for full year 2011 compared with 2010. Excluding the impact of this factor, we expect our net interest income to increase for full year 2011 by $100 million or more. Overall, we also expect that our net interest margin will decline for full year 2011 compared with 2010.

NONINTEREST INCOME

Summary

Noninterest income totaled $1.5 billion for the first three months of 2011, compared with $1.4 billion for the first three months of 2010.

Noninterest income in the first quarter of 2011 increased $71 million compared with the first quarter of 2010 due to higher residential mortgage fees, higher net gains on sales of securities net of OTTI and a decrease in repurchase reserves partially offset by lower corporate service fees and a decline in service charges on deposits primarily from the impact of Regulation E rules pertaining to overdraft fees.

Additional Analysis

Asset management revenue increased $4 million to $263 million in the first three months of 2011 compared with the first three months of 2010. The increase in the comparisons was driven by higher equity markets, successful client retention, growth in new clients and strong sales performance. Assets under management at March 31, 2011 totaled $110 billion compared with $105 billion at March 31, 2010. Higher equity earnings from our BlackRock investment also contributed to the improved first quarter results.

For the first quarter of 2011, consumer services fees totaled $311 million compared with $296 million in the first quarter of 2010. The increase in fees reflected higher volume-related transaction fees, such as debit cards and credit cards.

Corporate services revenue totaled $217 million in the first three months of 2011 and $268 million in the first three months of 2010. Commercial mortgage servicing revenue declined due to higher impairment charges and lower ancillary fee income. Corporate services fees include the noninterest component of treasury management fees, which continued to be a strong contributor to revenue.

Residential mortgage revenue totaled $195 million in the first quarter of 2011 and $147 million in the first quarter of 2010. Higher loan sales revenue and net economic hedging gains on mortgage servicing rights drove the increase over the first quarter of 2010.

Service charges on deposits totaled $123 million for the first three months of 2011 and $200 million for the first three months of 2010. The decline resulted primarily from the impact of Regulation E rules pertaining to overdraft fees.

Net gains on sales of securities totaled $37 million for the first quarter of 2011 and $90 million for the first quarter of 2010. The net credit component of OTTI of securities recognized in earnings was a loss of $34 million in the first quarter of 2011, compared with a loss of $116 million in the first quarter of 2010.

 

 

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Other noninterest income totaled $343 million for the first three months of 2011 compared with $240 million for the first three months of 2010. The increase was driven by several individually insignificant items.

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

Looking to full year 2011, we see momentum in our fee-based revenues resulting from client growth and depth in our expanded franchise. At the same time, we will see the continued impact of ongoing regulatory reforms. Excluding the expected incremental negative impact of two aspects of anticipated regulatory changes on fees related to Regulation E and interchange rates of approximately $400 million for full year 2011 as further discussed in the Retail Banking portion of the Business Segments Review section of this Report, we expect noninterest income for full year 2011 to increase in the low-to-mid single digits (in terms of percentages) compared with 2010.

PRODUCT REVENUE

In addition to credit and deposit products for commercial customers, Corporate & Institutional Banking offers other services, including treasury management, commercial real estate, and capital markets-related products and services, that are marketed by several businesses primarily to commercial customers.

Treasury management revenue, which includes fees as well as net interest income from customer deposit balances, totaled $301 million for the first three months of 2011 and $296 million for the first three months of 2010.

Revenue from capital markets-related products and services totaled $139 million in the first quarter of 2011 compared with $161 million in the first quarter of 2010. The decrease was due to a number of large underwriting transactions and loan sale activity in the first quarter a year ago which did not recur, which were partially offset by increased derivatives client revenue and reduced impact of credit risk on customer derivative position values

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

Commercial mortgage banking activities resulted in revenue of $41 million in the first three months of 2011 compared with $115 million in the first three months of 2010. This decline was due to a reduction in the value of commercial mortgage servicing rights largely driven by higher loan prepayment rates and lower interest rates, and lower ancillary commercial mortgage servicing fees.

PROVISION FOR CREDIT LOSSES

The provision for credit losses totaled $421 million for the first three months of 2011 compared with $751 million for the first three months of 2010. The significant decline from the first three months of 2010 was driven by overall credit quality improvement and continuation of actions to reduce exposure levels.

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

We anticipate an overall improvement in credit migration for full year 2011 and a continued reduction in our nonperforming loans assuming modest GDP growth. As a result, we expect that our full year 2011 provision for credit losses will be at least $800 million less than our full year 2010 provision for credit losses assuming budgeted loan growth projections.

NONINTEREST EXPENSE

Noninterest expense was $2.1 billion for the first three months of both 2011 and 2010. Integration costs included in noninterest expense totaled $102 million in the first quarter of 2010.

Apart from the possible impact of the legal and regulatory contingencies disclosed in our 2010 Form 10-K and this Report, we expect that total noninterest expense for full year 2011 will be less than total noninterest expense for full year 2010. The magnitude of the decline will be dependent upon the pace of our investment in business growth opportunities.

EFFECTIVE TAX RATE

The effective tax rate was 27.0% in the first quarter of 2011 compared with 27.9% in the first quarter of 2010. We anticipate that the effective tax rate will remain approximately the same for the remainder of 2011.

 

 

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CONSOLIDATED BALANCE SHEET REVIEW

SUMMARIZED BALANCE SHEET DATA

 

In millions    Mar. 31
2011
     Dec. 31
2010
 

Assets

       

Loans

   $ 149,387      $ 150,595  

Investment securities

     60,992        64,262  

Cash and short-term investments

     9,242        10,437  

Loans held for sale

     2,980        3,492  

Goodwill and other intangible assets

     10,764        10,753  

Equity investments

     9,595        9,220  

Other, net

     16,418        15,525  

Total assets

   $ 259,378      $ 264,284  

Liabilities

       

Deposits

   $ 181,990      $ 183,390  

Borrowed funds

     34,996        39,488  

Other

     8,675        8,568  

Total liabilities

     225,661        231,446  

Total shareholders’ equity

     31,132        30,242  

Noncontrolling interests

     2,585        2,596  

Total equity

     33,717        32,838  

Total liabilities and equity

   $ 259,378      $ 264,284  

The summarized balance sheet data above is based upon our Consolidated Balance Sheet in this Report.

The decline in total assets at March 31, 2011 compared with December 31, 2010 was primarily due to lower investment securities.

An analysis of changes in selected balance sheet categories follows.

LOANS

A summary of the major categories of loans outstanding follows. Outstanding loan balances reflect unearned income, unamortized discount and premium, and purchase discounts and premiums totaling $2.6 billion at March 31, 2011 and $2.7 billion at December 31, 2010. The balances do not include future accretable net interest (i.e., the difference between the undiscounted expected cash flows and the recorded investment in the loan) on the purchased impaired loans.

Loans decreased $1.2 billion, or 1%, as of March 31, 2011 compared with December 31, 2010. Growth in commercial loans of $1.4 billion was offset by declines of $.8 billion in commercial real estate loans, $.7 billion of residential real estate loans and $.6 billion of home equity loans compared with year end. Commercial loans increased due to a combination of new volume, improved utilization and new Market Street commitments. Commercial real estate loans declined due to loan sales, paydowns, and charge-offs. The decrease in residential real estate was impacted by portfolio management activities, paydowns and net charge-offs. Home

equity loans declined due to increased paydowns in the first quarter of 2011 as well as lower refinancing activity.

Loans represented 58% of total assets at March 31, 2011 and 57% at December 31, 2010. Commercial lending represented 54% of the loan portfolio at March 31, 2011 and 53% at December 31, 2010. Consumer lending represented 46% at March 31, 2011 and 47% at December 31, 2010.

Commercial real estate loans represented 7% of total assets at both March 31, 2011 and December 31, 2010.

Details Of Loans

 

In millions   Mar. 31
2011
    Dec. 31
2010
 

Commercial

     

Retail/wholesale

  $ 10,665     $ 9,901  

Manufacturing

    9,805       9,334  

Service providers

    8,690       8,866  

Real estate related (a)

    8,040       7,500  

Financial services

    5,034       4,573  

Health care

    3,839       3,481  

Other

    10,529       11,522  

Total commercial

    56,602       55,177  

Commercial real estate

     

Real estate projects

    11,581       12,211  

Commercial mortgage

    5,552       5,723  

Total commercial real estate

    17,133       17,934  

Equipment lease financing

    6,215       6,393  

TOTAL COMMERCIAL LENDING (b)

    79,950       79,504  

Consumer

     

Home equity

     

Lines of credit

    23,001       23,473  

Installment

    10,655       10,753  

Residential real estate

     

Residential mortgage

    14,602       15,292  

Residential construction

    731       707  

Credit card

    3,707       3,920  

Other consumer

     

Education

    9,041       9,196  

Automobile

    3,156       2,983  

Other

    4,544       4,767  

TOTAL CONSUMER LENDING

    69,437       71,091  

Total loans

  $ 149,387     $ 150,595  
(a) Includes loans to customers in the real estate and construction industries.
(b) Construction loans with interest reserves, and A Note/B Note restructurings are not significant to PNC.

Total loans above include purchased impaired loans of $7.5 billion, or 5% of total loans, at March 31, 2011, and $7.8 billion, or 5% of total loans, at December 31, 2010.

We are committed to providing credit and liquidity to qualified borrowers. Total loan originations and new commitments and renewals totaled $27 billion for the first three months of 2011.

 

 

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

Commercial lending is the largest category and is the most sensitive to changes in assumptions and judgments underlying the determination of the allowance for loan and lease losses (ALLL). This estimate also considers other relevant factors such as:

   

Actual versus estimated losses,

   

Regional and national economic conditions,

   

Business segment and portfolio concentrations,

   

Industry conditions,

   

The impact of government regulations, and

   

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

Higher Risk Loans

Our loan portfolio includes certain loans deemed to be higher risk and therefore more likely to result in credit losses. We established specific and pooled reserves on the total commercial

lending category of $2.5 billion at March 31, 2011. This commercial lending reserve included what we believe to be adequate and appropriate loss coverage on the higher risk commercial loans in the total commercial portfolio. The commercial lending reserve represented 52% of the total ALLL of $4.8 billion at that date. The remaining 48% of ALLL pertained to the total consumer lending category. This category of loans is more homogenous in nature and has certain characteristics that can be assessed at a total portfolio level in terms of loans representing higher risk. We do not consider government insured/government guaranteed loans to be higher risk as we do not believe these loans will result in a significant loss because of their structure. Additional information regarding our higher risk loans is included in Note 5 Asset Quality and Allowances for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit in our Notes To Consolidated Financial Statements included in this Report.

Information related to purchased impaired loans, purchase accounting accretion and accretable net interest recognized during the first three months of 2011 and 2010 follows.

 

 

Valuation of Purchased Impaired Loans

 

     March 31, 2011     December 31, 2010  
Dollars in billions    Balance     Net
Investment
    Balance      Net
Investment
 

Commercial and commercial real estate loans:

           

Unpaid principal balance

   $ 1.6       $ 1.8       

Purchased impaired mark

     (.3       (.4     

Recorded investment

     1.3         1.4       

Allowance for loan losses

     (.3       (.3     

Net investment

     1.0       63     1.1        61

Consumer and residential mortgage loans:

           

Unpaid principal balance

     7.6         7.9       

Purchased impaired mark

     (1.4       (1.5     

Recorded investment

     6.2         6.4       

Allowance for loan losses

     (.6       (.6     

Net investment

     5.6       74     5.8        73

Total purchased impaired loans:

           

Unpaid principal balance

     9.2         9.7       

Purchased impaired mark

     (1.7       (1.9     

Recorded investment

     7.5         7.8       

Allowance for loan losses

     (.9 )(a)        (.9     

Net investment

   $ 6.6       72   $ 6.9        71
(a) Impairment reserves of $.9 billion at March 31, 2011 reflect impaired loans with further credit quality deterioration since acquisition. This deterioration was more than offset by the cash received to date in excess of recorded investment of $.8 billion and the net reclassification to accretable net interest, to be recognized over time, of $1.3 billion.

 

The unpaid principal balance of purchased impaired loans declined from $9.7 billion at December 31, 2010 to $9.2 billion at March 31, 2011 due to amounts determined to be uncollectible, payoffs and disposals. The remaining purchased impaired mark at March 31, 2011 was $1.7 billion which was a decline from $1.9 billion at December 31, 2010. The net investment of $6.9 billion at December 31, 2010 declined 4% to $6.6 billion at March 31, 2011 primarily due to payoffs, disposals and further impairment partially offset by accretion during 2011. At March 31, 2011, our largest individual

purchased impaired loan had a recorded investment of $22 million.

We currently expect to collect total cash flows of $8.8 billion on purchased impaired loans, representing the $6.6 billion net investment at March 31, 2011 and the accretable net interest of $2.2 billion shown in the Accretable Net Interest-Purchased Impaired Loans table that follows. These represent the net future cash flows on purchased impaired loans, as contractual interest will be reversed.

 

 

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Purchase Accounting Accretion

 

     Three months ended
March 31,
 
In millions    2011     2010  

Non-impaired loans

   $ 68     $ 112  

Impaired loans

     160       265  

Reversal of contractual interest on impaired loans

     (106     (134

Net impaired loans

     54       131  

Securities

     9       11  

Deposits

     100       167  

Borrowings

     (31     (56

Total

   $ 200     $ 365  

In addition to the amounts in the table above, cash received in excess of recorded investment from sales or payoffs of impaired commercial loans (cash recoveries) totaled $81 million for the first quarter of 2011 and $75 million for the first quarter of 2010. We do not expect this level of cash recoveries to be sustainable.

Remaining Purchase Accounting Accretion

 

In billions    Mar. 31
2011
    Dec. 31
2010
 

Non-impaired loans

   $ 1.1     $ 1.2  

Impaired loans

     2.2       2.2  

Total loans (gross)

     3.3       3.4  

Securities

     .2       .1  

Deposits

     .4       .5  

Borrowings

     (1.0     (1.1

Total

   $ 2.9     $ 2.9  

Accretable Net Interest – Purchased Impaired Loans

 

In billions    2011     2010  

January 1

   $ 2.2     $ 3.5  

Accretion (including cash recoveries)

     (.3     (.3

Net reclassifications to accretable from non-accretable

     .3       .5  

Disposals

             (.1

March 31

   $ 2.2     $ 3.6  

Net unfunded credit commitments are comprised of the following:

Net Unfunded Credit Commitments

 

In millions    March 31,
2011
     December 31,
2010
 

Commercial / commercial real estate (a)

   $ 60,150      $ 59,256  

Home equity lines of credit

     19,161        19,172  

Consumer credit card and other unsecured lines

     14,832        14,725  

Other

     2,638        2,652  

Total

   $ 96,781      $ 95,805  
(a) Less than 3% of these amounts at each date relate to commercial real estate.

Commitments to extend credit represent arrangements to lend funds or provide liquidity subject to specified contractual conditions. Commercial commitments reported above exclude syndications, assignments and participations, primarily to financial institutions, totaling $16.3 billion at March 31, 2011 and $16.7 billion at December 31, 2010.

Unfunded liquidity facility commitments and standby bond purchase agreements totaled $229 million at March 31, 2011 and $458 million at December 31, 2010 and are included in the preceding table primarily within the “Commercial / commercial real estate” category.

In addition to credit commitments, our net outstanding standby letters of credit totaled $10.2 billion at March 31, 2011 and $10.1 billion at December 31, 2010. Standby letters of credit commit us to make payments on behalf of our customers if specified future events occur.

 

 

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INVESTMENT SECURITIES

Details of Investment Securities

 

In millions    Amortized
Cost
     Fair
Value
 

March 31, 2011

       

SECURITIES AVAILABLE FOR SALE

       

Debt securities

       

US Treasury and government agencies

   $ 5,119      $ 5,229  

Residential mortgage-backed

       

Agency

     29,519        29,469  

Non-agency

     7,876        7,171  

Commercial mortgage-backed

       

Agency

     1,305        1,325  

Non-agency

     1,998        2,079  

Asset-backed

     3,005        2,864  

State and municipal

     2,254        2,234  

Other debt

     3,748        3,816  

Corporate stocks and other

     340        340  

Total securities available for sale

   $ 55,164      $ 54,527  

SECURITIES HELD TO MATURITY

       

Debt securities

       

Commercial mortgage-backed (non-agency)

   $ 4,169      $ 4,310  

Asset-backed

     2,287        2,320  

Other debt

     9        10  

Total securities held to maturity

   $ 6,465      $ 6,640  

December 31, 2010

       

SECURITIES AVAILABLE FOR SALE

       

Debt securities

       

US Treasury and government agencies

   $ 5,575      $ 5,710  

Residential mortgage-backed

       

Agency

     31,697        31,720  

Non-agency

     8,193        7,233  

Commercial mortgage-backed

       

Agency

     1,763        1,797  

Non-agency

     1,794        1,856  

Asset-backed

     2,780        2,582  

State and municipal

     1,999        1,957  

Other debt

     3,992        4,077  

Corporate stocks and other

     378        378  

Total securities available for sale

   $ 58,171      $ 57,310  

SECURITIES HELD TO MATURITY

       

Debt securities

       

Commercial mortgage-backed (non-agency)

   $ 4,316      $ 4,490  

Asset-backed

     2,626        2,676  

Other debt

     10        11  

Total securities held to maturity

   $ 6,952      $ 7,177  

The carrying amount of investment securities totaled $61.0 billion at March 31, 2011, a decrease of $3.3 billion, or 5%, from $64.3 billion at December 31, 2010. The decline resulted from principal payments and net sales of primarily agency mortgage-backed securities and government agency securities. Investment securities represented 24% of total assets at both March 31, 2011 and December 31, 2010.

We evaluate our portfolio of investment securities in light of changing market conditions and other factors and, where appropriate, take steps intended to improve our overall positioning. We consider the portfolio to be well-diversified and of high quality. US Treasury and government agencies, agency residential mortgage-backed securities and agency commercial mortgage-backed securities collectively represented 59% of the investment securities portfolio at March 31, 2011.

At March 31, 2011, the securities available for sale portfolio included a net unrealized loss of $637 million, which represented the difference between fair value and amortized cost. The comparable amount at December 31, 2010 was a net unrealized loss of $861 million. The fair value of investment securities is impacted by interest rates, credit spreads, market volatility and liquidity conditions. The fair value of investment securities generally decreases when interest rates increase and vice versa. In addition, the fair value generally decreases when credit spreads widen and vice versa.

The improvement in the net unrealized pretax loss compared with December 31, 2010 was primarily due to improved liquidity in non-agency residential mortgage-backed securities markets. Net unrealized gains and losses in the securities available for sale portfolio are included in shareholders’ equity as accumulated other comprehensive income or loss from continuing operations, net of tax.

Unrealized gains and losses on available for sale securities do not impact liquidity or risk-based capital. However, reductions in the credit ratings of these securities would have an impact on the determination of risk-weighted assets which could reduce our regulatory capital ratios. In addition, the amount representing the credit-related portion of OTTI on available for sale securities would reduce our earnings and regulatory capital ratios.

The expected weighted-average life of investment securities (excluding corporate stocks and other) was 4.8 years at March 31, 2011 and 4.7 years at December 31, 2010.

We estimate that, at March 31, 2011, the effective duration of investment securities was 3.4 years for an immediate 50 basis points parallel increase in interest rates and 3.3 years for an immediate 50 basis points parallel decrease in interest rates. Comparable amounts at December 31, 2010 were 3.1 years and 2.9 years, respectively.

 

 

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

 

     March 31, 2011  
     Agency     Non-agency         
Dollars in millions    Residential
Mortgage-Backed
Securities
    Commercial
Mortgage-Backed
Securities
    Residential
Mortgage-Backed
Securities
    Commercial
Mortgage-Backed
Securities
    Asset-Backed
Securities
 

Fair Value – Available for Sale

   $ 29,469     $ 1,325     $ 7,171     $ 2,079     $ 2,864  

Fair Value – Held to Maturity

                             4,310       2,320  

Total Fair Value

   $ 29,469     $ 1,325     $ 7,171     $ 6,389     $ 5,184  

% of Fair Value:

                

By Vintage

                

2011

     11     7       1    

2010

     38     25       2     7

2009

     17     33       3     14

2008

     5     4           13

2007

     8     4     18     9     10

2006

     5     7     24     30     12

2005 and earlier

     16     20     58     55     14

Not Available

                                     30

Total

     100     100     100     100     100

By Credit Rating

                

Agency

     100     100          

AAA

           5     81     80

AA

           3     6     1

A

           3     7    

BBB

           5     4     1

BB

           9     1    

B

           14         4

Lower than B

           60         12

No rating

                     1     1     2

Total

     100     100     100     100     100

By FICO Score

                

>720

           56         3

<720 and >660

           35         9

<660

                 3

No FICO score

                     9             85

Total

                     100             100

 

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

We also consider the severity of the impairment and the length of time that the security has been impaired in our assessment. Results of the periodic assessment are reviewed by a cross-functional senior management team representing Asset & Liability Management, Finance, and Market Risk

Management. The senior management team considers the results of the assessments, as well as other factors, in determining whether the impairment is other-than-temporary.

We recognize the credit portion of OTTI charges in current earnings for those debt securities where we do not intend to sell and believe we will not be required to sell the securities prior to expected recovery. The noncredit portion of OTTI is included in accumulated other comprehensive loss.

We recognized OTTI for the first three months of 2011 and 2010 as follows:

 

 

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Other-Than-Temporary Impairments

 

     Three months ended
March 31
 
In millions        2011             2010      

Credit portion of OTTI losses (a)

      

Non-agency residential mortgage-backed

   $ 28     $ 73  

Asset-backed

     5       43  

Other debt

     1          

Total credit portion of OTTI losses

     34       116  

Noncredit portion of OTTI losses
(recoveries) (b)

     (4     124  

Total OTTI losses

   $ 30     $ 240  
(a) Reduction of noninterest income in our Consolidated Income Statement.
(b) Included in Accumulated other comprehensive loss, net of tax, on our Consolidated Balance Sheet.

The following table summarizes net unrealized gains and losses (including the credit and noncredit portions of OTTI) recorded on non-agency residential and commercial mortgage-backed and other asset-backed securities, which represent our most significant categories of securities not backed by the US government or its agencies. A summary of all OTTI credit losses recognized for the first three months of 2011 by investment type is included in Note 7 Investment Securities in the Notes To Consolidated Financial Statements in this Report.

 

 

     March 31, 2011  
In millions    Residential Mortgage-
Backed Securities
    Commercial Mortgage-
Backed Securities
    

Asset-Backed

Securities

 

Available for Sale Securities (Non-Agency)

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

Credit Rating Analysis

                      

AAA

   $ 394      $ (12   $ 1,042      $ 37      $ 1,978      $ 7  

Other Investment Grade (AA, A, BBB)

     839        (26     885        36        42        (5

Total Investment Grade

     1,233        (38     1,927        73        2,020        2  

BB

     619        6       70        4          

B

     980        (102     7        4        206        (27

Lower than B

     4,297        (571                       606        (100

Total Sub-Investment Grade

     5,896        (667     77        8        812        (127

Total No Rating

     42                75                 28        (16

Total

   $ 7,171      $ (705   $ 2,079      $ 81      $ 2,860      $ (141

OTTI Analysis

                      

Investment Grade:

                      

OTTI has been recognized

   $ 109      $ (12               

No OTTI recognized to date

     1,124        (26   $ 1,927      $ 73      $ 2,020      $ 2  

Total Investment Grade

     1,233        (38     1,927        73        2,020        2  

Sub-Investment Grade:

                      

OTTI has been recognized

     3,807        (638             617        (126

No OTTI recognized to date

     2,089        (29     77        8        195        (1

Total Sub-Investment Grade

     5,896        (667     77        8        812        (127

No Rating:

                      

OTTI has been recognized

                    28        (16

No OTTI recognized to date

     42                75                             

Total No Rating

     42                75                 28        (16

Total

   $ 7,171      $ (705   $ 2,079      $ 81      $ 2,860      $ (141

Securities Held to Maturity (Non-Agency)

                      

Credit Rating Analysis

                      

AAA

          $ 4,119      $ 139      $ 2,148      $ 32  

Other Investment Grade (AA, A, BBB)

                      191        2        61        1  

Total Investment Grade

                      4,310        141        2,209        33  

BB

                    6       

B

                    2       

Lower than B

                                                    

Total Sub-Investment Grade

                                        8           

Total No Rating

                                        93           

Total

                    $ 4,310      $ 141      $ 2,310      $ 33  

 

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Residential Mortgage-Backed Securities

At March 31, 2011, our residential mortgage-backed securities portfolio was comprised of $29.5 billion fair value of US government agency-backed securities and $7.2 billion fair value of non-agency (private issuer) securities. The agency securities are generally collateralized by 1-4 family, conforming, fixed-rate residential mortgages. The non-agency securities are also generally collateralized by 1-4 family residential mortgages. The mortgage loans underlying the non-agency securities are generally non-conforming (i.e., original balances in excess of the amount qualifying for agency securities) and predominately have interest rates that are fixed for a period of time, after which the rate adjusts to a floating rate based upon a contractual spread that is indexed to a market rate (i.e., a “hybrid ARM”), or interest rates that are fixed for the term of the loan.

Substantially all of the non-agency securities are senior tranches in the securitization structure and at origination had credit protection in the form of credit enhancement, over-collateralization and/or excess spread accounts.

During the first quarter of 2011, we recorded OTTI credit losses of $28 million on non-agency residential mortgage-backed securities. As of March 31, 2011, $26 million of the credit losses related to securities rated below investment grade. As of March 31, 2011, the noncredit portion of OTTI losses recorded in accumulated other comprehensive loss for non-agency residential mortgage-backed securities totaled $650 million and the related securities had a fair value of $4 billion.

The fair value of sub-investment grade investment securities for which we have not recorded an OTTI credit loss as of March 31, 2011 totaled $2 billion, with unrealized net losses of $29 million. The results of our security-level assessments indicate that we will recover the entire cost basis of these securities. Note 7 Investment Securities in the Notes To Consolidated Financial Statements in this Report provides further detail regarding our process for assessing OTTI for these securities.

Commercial Mortgage-Backed Securities

The fair value of the non-agency commercial mortgage-backed securities portfolio was $6.4 billion at March 31, 2011 and consisted of fixed-rate, private-issuer securities collateralized by non-residential properties, primarily retail properties, office buildings, and multi-family housing. The agency commercial mortgage-backed securities portfolio was $1.3 billion fair value at March 31, 2011 consisting of multi-family housing. Substantially all of the securities are the most senior tranches in the subordination structure.

There were no OTTI credit losses on commercial mortgage-backed securities during the first quarter of 2011.

Asset-Backed Securities

The fair value of the asset-backed securities portfolio was $5.2 billion at March 31, 2011 and consisted of fixed-rate and floating-rate, private-issuer securities collateralized primarily by various consumer credit products, including residential mortgage loans, credit cards, automobile loans, and student loans. Substantially all of the securities are senior tranches in the securitization structure and have credit protection in the form of credit enhancement, over-collateralization and/or excess spread accounts.

We recorded OTTI credit losses of $5 million on asset-backed securities during first three months of 2011. All of the securities were collateralized by first and second lien residential mortgage loans and were rated below investment grade. As of March 31, 2011, the noncredit portion of OTTI losses recorded in accumulated other comprehensive loss for asset-backed securities totaled $142 million and the related securities had a fair value of $645 million.

For the sub-investment grade investment securities (available for sale and held to maturity) for which we have not recorded an OTTI loss through March 31, 2011, the remaining fair value was $203 million, with unrealized net losses of $1 million. The results of our security-level assessments indicate that we will recover the entire cost basis of these securities. Note 7 Investment Securities in the Notes To Consolidated Financial Statements in this Report provides further detail regarding our process for assessing OTTI for these securities.

If current housing and economic conditions were to worsen, if market volatility and illiquidity were to worsen, or if market interest rates were to increase appreciably, the valuation of our investment securities portfolio could continue to be adversely affected and we could incur additional OTTI credit losses that would impact our Consolidated Income Statement.

LOANS HELD FOR SALE

 

In millions   March 31
2011
     December 31
2010
 

Commercial mortgages at fair value

  $ 858      $ 877  

Commercial mortgages at lower of cost or market

    189        330  

Total commercial mortgages

    1,047        1,207  

Residential mortgages at fair value

    1,826        1,878  

Residential mortgages at lower of cost or market

    14        12  

Total residential mortgages

    1,840        1,890  

Other

    93        395  

Total

  $ 2,980      $ 3,492  

We stopped originating certain commercial mortgage loans designated as held for sale in 2008 and continue pursuing opportunities to reduce these positions at appropriate prices. We sold $16 million of commercial mortgage loans held for

 

 

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sale carried at fair value in the first three months of 2011 and sold $24 million in the first three months of 2010.

We recognized net gains of $13 million in the first three months of 2011 on the valuation and sale of commercial mortgage loans held for sale, net of hedges, compared with net gains of $9 million recognized in the first three months of 2010.

Residential mortgage loan origination volume was $3.2 billion in the first three months of 2011. Substantially all such loans were originated under agency or Federal Housing Administration (FHA) standards. We sold $3.4 billion of loans and recognized related gains of $84 million during the first three months of 2011. The comparable amounts for the first three months of 2010 were $1.9 billion and $39 million, respectively.

Interest income on loans held for sale was $69 million in the first three months of 2011, and $66 million in the first three months of 2010 and is included in Other interest income on our Consolidated Income Statement.

GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill and other intangible assets totaled $10.8 billion at both March 31, 2011 and December 31, 2010. See Note 9 Goodwill and Other Intangible Assets included in the Notes To Consolidated Financial Statements in this Report.

FUNDING AND CAPITAL SOURCES

Details Of Funding Sources

 

In millions    March 31
2011
     December 31
2010
 

Deposits

       

Money market

   $ 86,726      $ 84,581  

Demand

     47,786        50,069  

Retail certificates of deposit

     35,834        37,337  

Savings

     8,098        7,340  

Other time

     454        549  

Time deposits in foreign offices

     3,092        3,514  

Total deposits

     181,990        183,390  

Borrowed funds

       

Federal funds purchased and repurchase agreements

     4,079        4,144  

Federal Home Loan Bank borrowings

     5,020        6,043  

Bank notes and senior debt

     11,324        12,904  

Subordinated debt

     9,310        9,842  

Other

     5,263        6,555  

Total borrowed funds

     34,996        39,488  

Total

   $ 216,986      $ 222,878  

Total funding sources decreased $5.9 billion at March 31, 2011 compared with December 31, 2010.

Total deposits decreased $1.4 billion, or 1%, at March 31, 2011 compared with December 31, 2010. Interest-bearing deposits represented 73% of total deposits at both March 31, 2011 and December 31, 2010. Total borrowed funds decreased $4.5 billion since December 31, 2010. The decline from December 31, 2010 was primarily due to maturities of bank notes and senior debt, FHLB borrowings and other borrowings.

Capital

See 2011 Capital Actions in the Executive Summary section of this Financial Review for additional information regarding our April 2011 increase to PNC’s quarterly common stock dividend and our plans to purchase shares under PNC’s existing common stock repurchase program (described below) during the remainder of 2011.

We manage our capital position by making adjustments to our balance sheet size and composition, issuing debt, equity or hybrid instruments, executing treasury stock transactions, managing dividend policies and retaining earnings.

Total shareholders’ equity increased $.9 billion, to $31.1 billion, at March 31, 2011 compared with December 31, 2010 as retained earnings increased $.8 billion. Common shares outstanding were 526 million at both March 31, 2011 and December 31, 2010.

Our current common stock repurchase program permits us to purchase up to 25 million shares of PNC common stock on the open market or in privately negotiated transactions. This program will remain in effect until fully utilized or until modified, superseded or terminated. The extent and timing of share repurchases under this program will depend on a number of factors including, among others, market and general economic conditions, economic and regulatory capital considerations, alternative uses of capital, regulatory and contractual limitations, and the potential impact on our credit ratings. We did not purchase any shares in the first three months of 2011 under this program.

 

 

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Risk-Based Capital

 

Dollars in millions    March 31
2011
    December 31
2010
 

Capital components

      

Shareholders’ equity

      

Common

   $ 30,485     $ 29,596  

Preferred

     647       646  

Trust preferred capital securities

     2,908       2,907  

Noncontrolling interests

     1,348       1,351  

Goodwill and other intangible assets

     (9,008     (9,053

Eligible deferred income taxes on goodwill and other intangible assets

     419       461  

Pension, other postretirement benefit plan adjustments

     371       380  

Net unrealized securities losses, after-tax

     387       550  

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

     (454     (522

Other

     (224     (224

Tier 1 risk-based capital

     26,879       26,092  

Subordinated debt

     4,913       4,899  

Eligible allowance for credit losses

     2,694       2,733  

Total risk-based capital

   $ 34,486     $ 33,724  

Tier 1 common capital

      

Tier 1 risk-based capital

   $ 26,879     $ 26,092  

Preferred equity

     (647     (646

Trust preferred capital securities

     (2,908     (2,907

Noncontrolling interests

     (1,348     (1,351

Tier 1 common capital

   $ 21,976     $ 21,188  

Assets

      

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

   $ 213,281     $ 216,283  

Adjusted average total assets

     253,727       254,693  

Capital ratios

      

Tier 1 common

     10.3     9.8

Tier 1 risk-based

     12.6       12.1  

Total risk-based

     16.2       15.6  

Leverage

     10.6       10.2  

Federal banking regulators have stated that they expect all bank holding companies to have a level and composition of Tier 1 capital well in excess of the 4% regulatory minimum, and they have required the largest US bank holding companies, including PNC, to have a capital buffer sufficient to withstand losses and allow them to meet credit needs of their customers through the economic downturn. They have also stated their view that common equity should be the dominant form of Tier 1 capital. As a result, regulators are now emphasizing the Tier 1 common capital ratio in their evaluation of bank holding company capital levels, although this metric is not provided for in the regulations. We seek to manage our capital consistent with these regulatory principles, and believe that our March 31, 2011 capital levels were aligned with them.

Dodd-Frank requires the Federal Reserve Board to establish capital requirements that would, among other things, eliminate the Tier 1 treatment of trust preferred securities following a phase-in period expected to begin in 2013. Accordingly, PNC will evaluate its alternatives, including the potential for early redemption of some or all of its trust preferred securities, based on such considerations it may consider relevant, including dividend rates, the specifics of the future capital requirements, capital market conditions and other factors. PNC is also subject to replacement capital covenants with respect to certain of its trust preferred securities as discussed in Note 13 Capital Securities of Subsidiary Trusts and Perpetual Trust Securities in Item 8 of our 2010 Form 10-K.

Our Tier 1 common capital ratio was 10.3% at March 31, 2011, compared with 9.8% at December 31, 2010. Our Tier 1 risk-based capital ratio increased 50 basis points to 12.6% at March 31, 2011 from 12.1% at December 31, 2010. Increases in both ratios were attributable to retention of earnings and a decline in risk-weighted assets in 2011.

At March 31, 2011, PNC Bank, N.A., our domestic bank subsidiary, was considered “well capitalized” based on US regulatory capital ratio requirements. To qualify as “well-capitalized”, regulators currently require banks to maintain capital ratios of at least 6% for Tier 1 risk-based, 10% for total risk-based, and 5% for leverage, which are indicated on page 2 of this Report. We believe PNC Bank, N.A. will continue to meet these requirements during the remainder of 2011.

The access to, and cost of, funding for new business initiatives including acquisitions, the ability to engage in expanded business activities, the ability to pay dividends, the level of deposit insurance costs, and the level and nature of regulatory oversight depend, in part, on a financial institution’s capital strength.

 

 

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OFF-BALANCE SHEET ARRANGEMENTS AND VARIABLE INTEREST ENTITIES

We engage in a variety of activities that involve unconsolidated entities or that are otherwise not reflected in our Consolidated Balance Sheet that are generally referred to as “off-balance sheet arrangements.” Additional information on these types of activities is included in our 2010 Form 10-K and in the following sections of this Report:

   

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

   

Note 3 Loan Sale and Servicing Activities and Variable Interest Entities in the Notes To Consolidated Financial Statements,

   

Note 10 Capital Securities of Subsidiary Trusts and Perpetual Trust Securities in the Notes To Consolidated Financial Statements, and

   

Note 17 Commitments and Guarantees in the Notes To Consolidated Financial Statements.

PNC consolidates variable interest entities (VIEs) when we are deemed to be the primary beneficiary. The primary beneficiary of a VIE is determined to be the party that meets both of the following criteria: (1) has the power to make decisions that most significantly affect the economic performance of the VIE and (2) has the obligation to absorb losses or the right to receive benefits that in either case could potentially be significant to the VIE.

A summary of VIEs, including those that we have consolidated and those in which we hold variable interests but have not consolidated into our financial statements, as of March 31, 2011 and December 31, 2010 is included in Note 3 of this Report.

PNC Capital Trust E Trust Preferred Securities

In February 2008, PNC Capital Trust E issued $450 million of 7.75% Trust Preferred Securities due March 15, 2068 (the Trust E Securities). PNC Capital Trust E’s only assets are $450 million of 7.75% Junior Subordinated Notes due March 15, 2068 and issued by PNC (the JSNs). The Trust E Securities are fully and unconditionally guaranteed by PNC. We may, at our option, redeem the JSNs at 100% of their principal amount on or after March 15, 2013.

In connection with the closing of the Trust E Securities sale, we agreed that, if we have given notice of our election to defer interest payments on the JSNs or a related deferral period is continuing, then PNC would be subject during such period to restrictions on dividends and other provisions protecting the status of the JSN debenture holder similar to or in some ways more restrictive than those potentially imposed under the Exchange Agreements with Trust II and Trust III, as described in Note 13 Capital Securities of Subsidiary Trusts and Perpetual Trust Securities (Note 13) in our 2010 Form 10-K. PNC Capital Trusts C and D have similar protective provisions with respect to $500 million in principal amount of junior subordinated debentures. Also, in connection with the closing of the Trust E Securities sale, we entered into a replacement capital covenant, which is described in Note 13 in our 2010 Form 10-K.

Acquired Entity Trust Preferred Securities

As a result of the National City acquisition, we assumed obligations with respect to $2.4 billion in principal amount of junior subordinated debentures issued by the acquired entity. As a result of other prior acquisitions, we assumed obligations with respect to $158 million in principal amount of junior subordinated debentures issued by the acquired entities. As described in Note 13 in our 2010 Form 10-K, during 2010 we redeemed $81 million in principal amount related to the junior subordinated debentures issued by the acquired entities. Under the terms of the outstanding debentures, if there is an event of default under the debentures or PNC exercises its right to defer payments on the related trust preferred securities issued by the statutory trusts or there is a default under PNC’s guarantee of such payment obligations, PNC would be subject during the period of such default or deferral to restrictions on dividends and other provisions protecting the status of the debenture holders similar to or in some ways more restrictive than those potentially imposed under the Exchange Agreements with Trust II and Trust III, as described in Note 13 in our 2010 Form 10-K.

 

 

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FAIR VALUE MEASUREMENTS

In addition to the following, see Note 8 Fair Value in the Notes To Consolidated Financial Statements in this Report for further information regarding fair value.

Assets recorded at fair value represented 27% of total assets at both March 31, 2011 and December 31, 2010. Liabilities recorded at fair value represented 2% and 3% of total liabilities at March 31, 2011 and December 31, 2010, respectively.

The following table includes the assets and liabilities measured at fair value and the portion of such assets and liabilities that are classified within Level 3 of the valuation hierarchy.

 

     March 31, 2011     December 31, 2010  
In millions    Total Fair
Value
     Level 3     Total Fair
Value
     Level 3  

Assets

              

Securities available for sale

   $ 54,527      $ 8,610     $ 57,310      $ 8,583  

Financial derivatives

     5,076        50       5,757        77  

Residential mortgage loans held for sale

     1,826            1,878       

Trading securities

     2,254        60       1,826        69  

Residential mortgage servicing rights

     1,109        1,109       1,033        1,033  

Commercial mortgage loans held for sale

     858        858       877        877  

Equity investments

     1,457        1,457       1,384        1,384  

Customer resale agreements

     823            866       

Loans

     229        2       116        2  

Other assets

     915        455       853        403  

Total assets

   $ 69,074      $ 12,601     $ 71,900      $ 12,428  

Level 3 assets as a percentage of total assets at fair value

        18        17

Level 3 assets as a percentage of consolidated assets

              5              5

Liabilities

              

Financial derivatives

   $ 4,322      $ 476     $ 4,935      $ 460  

Trading securities sold short

     1,244            2,530       

Other liabilities

     3                6           

Total liabilities

   $ 5,569      $ 476     $ 7,471      $ 460  

Level 3 liabilities as a percentage of total liabilities at fair value

        9        6

Level 3 liabilities as a percentage of consolidated liabilities

              <1              <1

 

The majority of Level 3 assets represent non-agency residential mortgage-backed and asset-backed securities in the available for sale securities portfolio for which there was a lack of observable market activity.

During the first three months of 2011, no significant transfers of assets or liabilities between the hierarchy levels occurred.

 

 

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BUSINESS SEGMENTS REVIEW

We have six reportable business segments:

   

Retail Banking

   

Corporate & Institutional Banking

   

Asset Management Group

   

Residential Mortgage Banking

   

BlackRock

   

Distressed Assets Portfolio

Once we entered into an agreement to sell GIS, it was no longer a reportable business segment. We sold GIS on July 1, 2010.

Business segment results, including inter-segment revenues, and a description of each business are included in Note 18 Segment Reporting included in the Notes To Consolidated Financial Statements of this Report. Certain amounts included in this Financial Review differ from those amounts shown in Note 18 primarily due to the presentation in this Financial Review of business net interest revenue on a taxable-equivalent basis.

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

Assets receive a funding charge and liabilities and capital receive a funding credit based on a transfer pricing

methodology that incorporates product maturities, duration and other factors.

Capital is intended to cover unexpected losses and is assigned to our business segments using our risk-based economic capital model, including consideration of the goodwill and other intangible assets at those business segments, as well as the diversification of risk among the business segments. We have revised certain capital allocations among our business segments, including amounts for prior periods. PNC’s total capital did not change as a result of these adjustments for any periods presented.

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

Total business segment financial results differ from total consolidated results from continuing operations before noncontrolling interests, which itself excludes the earnings and revenue attributable to GIS through March 31, 2010 that is reflected in discontinued operations. The impact of these differences is reflected in the “Other” category. “Other” for purposes of this Business Segments Review and the Business Segment Highlights in the Executive Summary includes residual activities that do not meet the criteria for disclosure as a separate reportable business, such as gains or losses related to BlackRock transactions including LTIP share distributions and obligations, integration costs, asset and liability management activities including net securities gains or losses and certain trading activities, exited businesses, equity management activities, alternative investments, intercompany eliminations, most corporate overhead, and differences between business segment performance reporting and financial statement reporting (GAAP), including the presentation of net income attributable to noncontrolling interests.

 

 

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Results Of Businesses – Summary

(Unaudited)

 

     Income (Loss)     Revenue      Average Assets (a)  
Three months ended March 31 - in millions    2011     2010     2011      2010      2011      2010  

Retail Banking

   $ (18   $ 24     $ 1,247      $ 1,359      $ 66,669      $ 68,354  

Corporate & Institutional Banking

     432       368       1,098        1,261        76,980        79,575  

Asset Management Group

     43       39       222        227        6,918        7,041  

Residential Mortgage Banking

     71       78       258        228        11,619        8,855  

BlackRock

     86       77       108        99        5,530        6,225  

Distressed Assets Portfolio

     25       73       245        330        14,101        19,507  

Total business segments

     639       659       3,178        3,504        181,817        189,557  

Other (b) (c)

     193       (11     453        259        80,737        77,591  

Income from continuing operations before noncontrolling interests (d)

   $ 832     $ 648     $ 3,631      $ 3,763      $ 262,554      $ 267,148  
(a) Period-end balances for BlackRock.
(b) For our segment reporting presentation in this Financial Review, “Other” for the first three months of 2010 included $113 million of pretax integration costs related to acquisitions.
(c) “Other” average assets include securities available for sale associated with asset and liability management activities.
(d) Amounts are presented on a continuing operations basis and therefore exclude the earnings, revenue, and assets of GIS for the first three months of 2010.

 

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RETAIL BANKING

(Unaudited)

 

Three months ended March 31

Dollars in millions, except as noted

  2011     2010  

INCOME STATEMENT

     

Net interest income

  $ 818     $ 869  

Noninterest income

     

Service charges on deposits

    117       195  

Brokerage

    53       53  

Consumer services

    228       208  

Other

    31       34  

Total noninterest income

    429       490  

Total revenue

    1,247       1,359  

Provision for credit losses

    276       339  

Noninterest expense

    1,001       975  

Pretax earnings (loss)

    (30     45  

Income taxes (benefit)

    (12     21  

Earnings (loss)

  $ (18   $ 24  

AVERAGE BALANCE SHEET

     

Loans

     

Consumer

     

Home equity

  $ 26,064     $ 26,821  

Indirect auto

    2,400       1,893  

Indirect other

    1,612       2,080  

Education

    9,101       8,060  

Credit cards

    3,731       4,079  

Other

    1,823       1,793  

Total consumer

    44,731       44,726  

Commercial and commercial real estate

    10,786       11,455  

Floor plan

    1,572       1,296  

Residential mortgage

    1,287       1,801  

Total loans

    58,376       59,278  

Goodwill and other intangible assets

    5,769       5,934  

Other assets

    2,524       3,142  

Total assets

  $ 66,669     $ 68,354  

Deposits

     

Noninterest-bearing demand

  $ 18,102     $ 16,776  

Interest-bearing demand

    20,920       19,212  

Money market

    40,382       39,699  

Total transaction deposits

    79,404       75,687  

Savings

    7,573       6,552  

Certificates of deposit

    35,364       45,614  

Total deposits

    122,341       127,853  

Other liabilities

    1,147       1,652  

Capital

    8,048       8,310  

Total liabilities and equity

  $ 131,536     $ 137,815  

PERFORMANCE RATIOS

     

Return on average capital

    (1 )%      1

Return on average assets

    (.11     .14  

Noninterest income to total revenue

    34       36  

Efficiency

    80       72  

OTHER INFORMATION (a)

     

Credit-related statistics:

     

Commercial nonperforming assets

  $ 301     $ 324  

Consumer nonperforming assets

    409       276  

Total nonperforming assets (b)

  $ 710     $ 600  

Impaired loans (c)

  $ 869     $ 1,013  

Commercial lending net charge-offs

  $ 67     $ 96  

Credit card lending net charge-offs

    68       96  

Consumer lending (excluding credit card) net charge-offs

    122       108  

Total net charge-offs

  $ 257     $ 300  

Commercial lending annualized net charge-off ratio

    2.20      3.05

Credit card lending annualized net charge-off ratio

    7.39      9.54

Consumer lending (excluding credit card) annualized net charge-off ratio

    1.17      1.03

Total annualized net charge-off ratio

    1.79      2.05

Other statistics:

     

ATMs

    6,660       6,467  

Branches (d)

    2,446       2,461  

At March 31

Dollars in millions, except as noted

  2011     2010  

OTHER INFORMATION (CONTINUED) (a)

               

Home equity portfolio credit statistics:

     

% of first lien positions (e)

    36     34

Weighted average loan-to-value ratios (e)

    73     73

Weighted average FICO scores (f)

    731       725  

Annualized net charge-off ratio

    1.28     .70

Loans 30 – 59 days past due

    .47     .44

Loans 60 – 89 days past due

    .31     .30

Loans 90 days past due

    .99     .85

Customer-related statistics:

     

Retail Banking checking relationships

    5,521,000       5,379,000  

Retail online banking active customers

    3,226,000       2,782,000  

Retail online bill payment active customers

    1,029,000       826,000  

Brokerage statistics:

     

Financial consultants (g)

    700       722  

Full service brokerage offices

    34       41  

Brokerage account assets (billions)

  $ 34     $ 33  
(a) Presented as of March 31 except for net charge-offs and annualized net charge-off ratios, which are for the three months ended.
(b) Includes nonperforming loans of $688 million at March 31, 2011 and $579 million at March 31, 2010.
(c) Recorded investment of purchased impaired loans related to acquisitions.
(d) Excludes certain satellite branches that provide limited products and/or services.
(e) Includes loans from acquired portfolios for which lien position and loan-to-value information was limited.
(f) Represents the most recent FICO scores we have on file.
(g) Financial consultants provide services in full service brokerage offices and traditional bank branches.

Retail Banking incurred a loss of $18 million for the quarter compared with earnings of $24 million for the year ago quarter. Earnings declined from the prior year quarter as lower revenues resulting from the impact of Regulation E rules related to overdraft fees and a low interest rate environment were partially offset by a lower provision for credit losses. Retail Banking continued to maintain its focus on growing customers and deposits, improving customer and employee satisfaction, investing in the business for future growth, and disciplined expense management during this period of market and economic uncertainty.

Highlights of Retail Banking’s performance for the first quarter of 2011 include the following:

   

In January, PNC reached a definitive agreement to acquire 19 branches and approximately $390 million of deposits from BankAtlantic Bancorp, Inc. All of the branches are located in the Tampa, Florida area. The transaction is expected to close in June 2011, subject to customary closing conditions. The transaction is expected to provide Retail Banking with the opportunity to establish a foothold in the Tampa area and to expand our branch presence in the Florida market.

   

Retail Banking launched a new checking account line-up and a new credit card suite during the first quarter. The new products are designed to provide more choices for customers.

   

Net new checking relationships grew 56,000 in the first quarter and 142,000 over the prior year, strong results reflecting gains in all of our markets. We are

 

 

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seeing strong retention and increasing acquisition in all of our markets.

   

Success in implementing Retail Banking’s deposit strategy resulted in growth in average demand deposits of $3.0 billion, or 8%, over the prior year.

   

Our investment in online banking capabilities continues to pay off. Active online bill payment and active online banking customers grew by 5% and 6%, respectively, during the first quarter of 2011. In a year-over-year comparison, active online bill payment grew 25% and active online banking customers grew 16%.

   

PNC’s branch footprint covers nearly one-third of the US population with a network of 2,446 branches and 6,660 ATM machines at March 31, 2011. We continue to invest in the branch network. In the first quarter of 2011, we opened 6 traditional branches, consolidated 30 branches, and had a net decrease of 13 ATMs.

Total revenue for the first quarter of 2011 was $1.2 billion compared with $1.4 billion for the first quarter of 2010. Net interest income of $818 million declined $51 million compared with the first quarter of 2010. Net interest income was negatively impacted by lower interest credits assigned to deposits, reflective of the rate environment, and benefited from higher demand deposits and increased education loans.

Noninterest income declined $61 million when compared with the first quarter of 2010. The decline was driven by lower overdraft fees resulting from Regulation E rules.

For 2011, Retail Banking revenue continues to be negatively impacted by the rules set forth in Regulation E related to overdraft fees and is expected to be negatively impacted by the potential limits related to interchange rates on debit card transactions (proposed in Dodd-Frank.) The incremental negative impact of these two aspects of regulatory reform on fees is estimated to be approximately $400 million in 2011 compared with 2010 if limits to interchange rates are implemented consistent with rules currently proposed by the Federal Reserve Board. Changes in the proposed interchange rules could impact this estimate. Further, this estimate does not include any additional impact to revenue of other or additional regulatory requirements. There could be other aspects of regulatory reform that further impact these or other areas of our business as regulatory agencies, including the new CFPB, issue proposed and final regulations pursuant to Dodd-Frank and other legislation. See additional information regarding legislative and regulatory developments in the Executive Summary section of this Financial Review.

The provision for credit losses was $276 million for the first quarter of 2011 compared with $339 million in the first quarter of 2010. Net charge-offs were $257 million for the first quarter of 2011 compared with $300 million in prior year first quarter. Improvements in credit quality are evident in the

credit card and small business portfolios. However, the home equity portfolio is challenged by trends reflecting an increase in bankruptcies, continued loan modifications, many of which resulted in troubled debt restructurings, and a longer foreclosure timeline.

Noninterest expense for the first three months of 2011 increased $26 million from the same period last year. The increase was driven by continued investment in the business.

Growing core checking deposits as a lower-cost funding source and as the cornerstone product to build customer relationships is the primary objective of our deposit strategy. Furthermore, core checking accounts are critical to our strategy of expanding our payments business. The deposit strategy of Retail Banking is to remain disciplined on pricing, target specific products and markets for growth, and focus on the retention and growth of balances for relationship customers.

In the first quarter of 2011, average total deposits decreased $5.5 billion, or 4%, compared with 2010.

   

Average demand deposits increased $3.0 billion, or 8%, over the same quarter in 2010. The increase was primarily driven by customer growth and customer preferences for liquidity.

   

Average money market deposits increased $683 million, or 2%, from the first three months of 2010. The increase was primarily due to core money market growth as customers generally prefer more liquid deposits in a low rate environment.

   

In the first three months of 2011, average certificates of deposit decreased $10.3 billion from the same period last year. This decline is expected to continue in 2011, although at a slower pace, due to the continued run-off of higher rate certificates of deposits.

Currently, we plan to maintain our focus on a relationship-based lending strategy that targets specific customer sectors (mass consumers, homeowners, students, small businesses and auto dealerships) and our moderate risk lending approach. In the first quarter of 2011, average total loans were $58.4 billion, a decrease of $902 million, or 2%, over the same quarter last year.

   

Average education loans grew $1.0 billion compared with the first three months of 2010, primarily due to portfolio purchases.

   

Average indirect auto loans increased $507 million over the first quarter of 2010. The increase was due to the expansion of our indirect sales force and product introduction to acquired markets, as well as overall increases in auto sales. The indirect other portfolio is primarily a run-off portfolio comprised of marine, RV, and other indirect loan products.

   

Average floor plan loans grew $276 million compared with the first quarter of 2010, primarily

 

 

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due to higher line utilization as dealers maintained higher inventory levels due to product availability and improved sales prospects.

   

Average credit card balances decreased $348 million over the first quarter of 2010. The decrease was primarily the result of weak consumer demand in response to the economic environment. This resulted in fewer active accounts generating balances coupled with increased paydowns on existing accounts.

   

Average home equity loans declined $757 million compared with the first three months of 2010. Consumer loan demand remained soft in the current

   

economic climate. The decline is driven by loan demand being outpaced by paydowns, refinancings, and charge-offs. Retail Banking’s home equity loan portfolio is relationship based, with 96% of the portfolio attributable to borrowers in our primary geographic footprint. The nonperforming assets and charge-offs that we have experienced are within our expectations given current market conditions.

   

Average commercial and commercial real estate loans declined $669 million compared with the first quarter of 2010. The decline was primarily due to loan demand being outpaced by refinancings, paydowns, and charge-offs.

 

 

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CORPORATE & INSTITUTIONAL BANKING

(Unaudited)

 

Three months ended March 31

Dollars in millions, except as noted

   2011     2010  

INCOME STATEMENT

      

Net interest income

   $ 799     $ 890  

Noninterest income

      

Corporate service fees

     187       242  

Other

     112       129  

Noninterest income

     299        371  

Total revenue

     1,098       1,261  

Provision for (recoveries of) credit losses

     (30     236  

Noninterest expense

     445       446  

Pretax earnings

     683       579  

Income taxes

     251       211  

Earnings

   $ 432     $ 368  

AVERAGE BALANCE SHEET

      

Loans

      

Commercial

   $ 33,194     $ 34,081  

Commercial real estate

     14,347       17,961  

Commercial – real estate related

     3,463       3,128  

Asset-based lending

     7,370       5,940  

Equipment lease financing

     5,540       5,320  

Total loans

     63,914        66,430  

Goodwill and other intangible assets

     3,484       3,795  

Loans held for sale

     1,341       1,410  

Other assets

     8,241       7,940  

Total assets

   $ 76,980     $ 79,575  

Deposits

      

Noninterest-bearing demand

   $ 27,843     $ 22,271  

Money market

     12,131       12,253  

Other

     6,057       7,610  

Total deposits

     46,031       42,134  

Other liabilities

     12,205       10,871  

Capital

     7,858       8,800  

Total liabilities and equity

   $ 66,094     $ 61,805  

Three months ended March 31

Dollars in millions, except as noted

   2011     2010  

PERFORMANCE RATIOS

      

Return on average capital

     22     17

Return on average assets

     2.28       1.88  

Noninterest income to total revenue

     27       29  

Efficiency

     41       35  

COMMERCIAL MORTGAGE SERVICING PORTFOLIO (in billions)

      

Beginning of period

   $ 266     $ 287  

Acquisitions/additions

     10       8  

Repayments/transfers

     (10     (13

End of period

   $ 266     $ 282  

OTHER INFORMATION

      

Consolidated revenue from: (a)

      

Treasury Management

   $ 301     $ 296  

Capital Markets

   $ 139     $ 161  

Commercial mortgage loans held for sale (b)

   $ 29     $ 27  

Commercial mortgage loan servicing (c)

     12       88  

Total commercial mortgage banking activities

   $ 41      $ 115  

Total loans (d)

   $ 64,368     $ 65,137  

Credit-related statistics:

      

Nonperforming assets (d) (e)

   $ 2,574     $ 3,343  

Impaired loans (d) (f)

   $ 659     $ 1,033  

Net charge-offs

   $ 153     $ 271  

Net carrying amount of commercial mortgage servicing rights (d)

   $ 645     $ 921  
(a) Represents consolidated PNC amounts.
(b) Includes valuations on commercial mortgage loans held for sale and related commitments, derivative valuations, origination fees, gains on sale of loans held for sale and net interest income on loans held for sale.
(c) Includes net interest income and noninterest income from loan servicing and ancillary services.
(d) At March 31.
(e) Includes nonperforming loans of $2.4 billion at March 31, 2011 and $3.2 billion at March 31, 2010.
(f) Recorded investment of purchased impaired loans related to acquisitions.

Corporate & Institutional Banking earned $432 million in the first quarter of 2011 compared with $368 million in the first quarter of 2010. The increase in earnings was due to a decrease in the provision for credit losses, somewhat offset by declines in net interest income and revenue from commercial mortgage banking activities. We continued to focus on adding new clients and increased our cross selling to serve our clients’ needs, particularly in the western markets, and remained committed to strong expense discipline.

Highlights of Corporate & Institutional Banking performance include:

   

Added new clients at a record pace in 2010 and continued this momentum during the first quarter of 2011.

   

Loan commitments, primarily in our Middle Market and Business Credit segments, grew from the first quarter of 2010. Average loans grew over $1 billion from the fourth quarter of 2010.

 

 

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Cross sales of treasury management and capital markets products to customers in PNC’s western markets continued to be successful following the systems conversions. Sales in the first quarter of 2011 were ahead of target and were up compared with the first quarter last year.

   

Midland Loan Services, one of the leading third-party providers of servicing for the commercial real estate industry, received the highest U.S. servicer and special servicer ratings from Fitch Ratings and Standard & Poor’s and is in its 11th consecutive year of achieving these ratings.

   

Midland was the number one servicer of FNMA and FHLMC loans and was the second leading servicer of commercial and multifamily loans by volume as of December 31, 2010 according to Mortgage Bankers Association.

   

Mergers and Acquisitions Journal named Harris William & Co. Advisor of the Year in its March 2011 issue.

Net interest income for the first quarter of 2011 was $799 million, a decrease of $91 million from the first quarter of 2010, reflecting lower purchase accounting accretion, lower interest credits assigned to deposits and a decrease in average loans, partially offset by improved loan spreads and an increase in average deposits.

Corporate service fees were $187 million for the first three months of 2011, a decrease of $55 million from the first three months of 2010, primarily due to a reduction in the value of commercial mortgage servicing rights largely driven by higher loan prepayment rates and lower interest rates, and lower ancillary commercial mortgage servicing fees. The major components of corporate service fees are treasury management, corporate finance fees and commercial mortgage servicing revenue.

   

Our Treasury Management business, which is one of the top providers in the country, continued to invest in markets, products and infrastructure as well as major initiatives such as healthcare. The healthcare initiative is designed to help provide our customers opportunities to reduce operating costs.

Other noninterest income was $112 million for the first three months of 2011 compared with $129 million in the first quarter of 2010 primarily due to a decline in underwriting revenues.

The provision for credit losses was a recovery of $30 million in the first quarter 2011 compared with a provision of $236 million in the first three months of 2010. The improvement reflected continued positive migration in portfolio credit quality along with lower loan levels. Net charge-offs for the first three months of 2011 of $153 million decreased $118 million or 44% compared with the 2010 period. The decline

was attributable primarily to the commercial real estate and equipment finance portfolios. Nonperforming assets declined across all portfolios for the fourth consecutive quarter.

Noninterest expense was $445 million in the first three months of 2011 and was flat compared to the same period a year ago. Lower compensation costs due to the sale of a duplicative agency servicing operation were offset by higher credit-related costs.

Average loans were $63.9 billion for the first quarter of 2011 compared with $66.4 billion in the first quarter of 2010. The decrease in average loans of $2.5 billion or 4% compared with 2010 was driven by exits of certain client relationships combined with lower utilization rates.

   

PNC Real Estate provides commercial real estate and real-estate related lending and is one of the industry’s top providers of both conventional and affordable multifamily financing. Commercial real estate loans declined in the first three months of 2011 compared with the first three months of 2010 due to loan sales, paydowns and charge-offs.

   

PNC Business Credit is one of the top asset-based lenders in the country. It expanded its operations with the acquisition of an asset-based lending group in the United Kingdom which was completed in November 2010. Total loans acquired were approximately $300 million. Loan commitments and loan utilization rates increased throughout 2010 and into the first quarter of 2011.

   

PNC Equipment Finance is the 6th largest bank-affiliated leasing company with $9 billion in equipment finance assets. Average loans and leases declined slightly in the first quarter 2011 compared with the first quarter of 2010 due to runoff and sales of non-strategic portfolios, which offset portfolio acquisitions and improved origination volumes within our middle market customer base.

Average deposits were $46.0 billion for the first quarter of 2011, an increase of $3.9 billion, or 9%, compared with the first three months of 2010. Our customers have continued to move balances to noninterest-bearing demand deposits to maintain liquidity.

The commercial mortgage servicing portfolio was $266 billion at March 31, 2011 compared with $282 billion at March 31, 2010. The decrease was primarily the result of the sale of a duplicative agency servicing operation, a non-core business, in the second quarter of 2010.

See the additional revenue discussion regarding treasury management, capital markets-related products and services, and commercial mortgage banking activities in the Product Revenue section of the Consolidated Income Statement Review.

 

 

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ASSET MANAGEMENT GROUP

(Unaudited)

 

Three months ended March 31

Dollars in millions, except as noted

   2011     2010  

INCOME STATEMENT

      

Net interest income

   $ 60     $ 63  

Noninterest income

     162       164  

Total revenue

     222       227  

Provision for (recoveries of) credit losses

     (6     9  

Noninterest expense

     160       156  

Pretax earnings

     68       62  

Income taxes

     25       23  

Earnings

   $ 43     $ 39  

AVERAGE BALANCE SHEET

      

Loans

      

Consumer

   $ 4,054     $ 3,993  

Commercial and commercial real estate

     1,503       1,442  

Residential mortgage

     715       963  

Total loans

     6,272       6,398  

Goodwill and other intangible assets

     374       415  

Other assets

     272       228  

Total assets

   $ 6,918     $ 7,041  

Deposits

      

Noninterest-bearing demand

   $ 1,162     $ 1,228  

Interest-bearing demand

     2,291       1,699  

Money market

     3,597       3,217  

Total transaction deposits

     7,050       6,144  

Certificates of deposit and other

     677       818  

Total deposits

     7,727       6,962  

Other liabilities

     70       112  

Capital

     344       418  

Total liabilities and equity

   $ 8,141     $ 7,492  

PERFORMANCE RATIOS

      

Return on average capital

     51     38

Return on average assets

     2.52       2.25  

Noninterest income to total revenue

     73       72  

Efficiency

     72       69  

OTHER INFORMATION

      

Total nonperforming assets (a) (b)

   $ 74     $ 139  

Impaired loans (a) (c)

   $ 143     $ 191  

Total net charge-offs (recoveries)

   $ (11   $ 4  

Assets Under Administration (in billions) (a) (d)

      

Personal

   $ 102     $ 96  

Institutional

     117       113  

Total

   $ 219     $ 209  

Asset Type

      

Equity

   $ 120     $ 104  

Fixed Income

     64       59  

Liquidity/Other

     35       46  

Total

   $ 219     $ 209  

Discretionary assets under management

      

Personal

   $ 71     $ 69  

Institutional

     39       36  

Total

   $ 110     $ 105  

Asset Type

      

Equity

   $ 57     $ 51  

Fixed Income

     36       35  

Liquidity/Other

     17       19  

Total

   $ 110     $ 105  

Nondiscretionary assets under administration

      

Personal

   $ 31     $ 27  

Institutional

     78       77  

Total

   $ 109     $ 104  

Asset Type

      

Equity

   $ 63     $ 53  

Fixed Income

     28       24  

Liquidity/Other

     18       27  

Total

   $ 109     $ 104  
(a) As of March 31.
(b) Includes nonperforming loans of $69 million at March 31, 2011 and $132 million at March 31, 2010.
(c) Recorded investment of purchased impaired loans related to acquisitions.
(d) Excludes brokerage account assets.

Asset Management Group earned $43 million in the first quarter of 2011 compared with $39 million in the first quarter of 2010. Assets under administration were $219 billion as of March 31, 2011. Earnings for the first quarter of 2011 reflected a benefit from the provision for credit losses compared with the provision for the first quarter of 2010. The business maintained its focus on new client acquisition and client asset growth during the quarter.

Highlights of Asset Management Group’s performance during the first three months of 2011 include the following:

 

Substantially increased new client acquisition and year-over-year sales and also outperformed first quarter goals;

 

Focused hiring to drive growth across the footprint;

 

Piloted new financial reporting technology to clients in several markets, and

 

Continued signs of improvement in credit performance.

Assets under administration were $219 billion at March 31, 2011 compared with $209 billion at March 31, 2010. Discretionary assets under management were $110 billion at March 31, 2011 compared with $105 billion at March 31, 2010. The increase in the comparisons was driven by higher equity markets, successful client retention, growth in new clients and strong sales performance.

Total revenue for the first quarter of 2011 was $222 million compared with $227 million for the same period in 2010. Net interest income was $60 million for the first quarter of 2011 compared with $63 million in the first quarter of 2010. The decrease was attributable to lower loan yields and lower interest credits assigned to deposits reflective of the current low rate environment. Noninterest income of $162 million for the first three months of 2011 declined slightly from the prior year first quarter as the exit of acquisition-related noncore products mitigated solid growth in asset management fees from improved equity markets and strong sales performance.

Provision for credit losses was a benefit of $6 million in the first quarter of 2011 reflecting improved credit quality compared with provision of $9 million for the first quarter of 2010. A net recovery of $11 million was recognized for the first quarter compared with net charge-offs of $4 million in the first quarter of 2010.

Noninterest expense of $160 million in the first quarter of 2011 increased $4 million, or 3%, from the year ago first quarter. The increase was attributable to investments in the business to drive growth.

Average deposits for the quarter increased $765 million, or 11%, over the prior year first quarter. Average transaction deposits grew 15% compared with first quarter 2010 and were substantially offset by the strategic run off of higher rate certificates of deposit in the comparison. Average loan balances decreased $126 million, or 2%, from the prior year first quarter primarily due to the current economy.

 

 

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RESIDENTIAL MORTGAGE BANKING

(Unaudited)

 

Three months ended March 31

Dollars in millions, except as noted

   2011     2010  

INCOME STATEMENT

      

Net interest income

   $ 56     $ 74  

Noninterest income

      

Loan servicing revenue

      

Servicing fees

     50       69  

Net MSR hedging gains

     64       46  

Loan sales revenue

     84       39  

Other

     4          

Total noninterest income

     202       154  

Total revenue

     258       228  

Provision for (recoveries of) credit losses

     8       (16

Noninterest expense

     137       120  

Pretax earnings

     113       124  

Income taxes

     42       46  

Earnings

   $ 71     $ 78  

AVERAGE BALANCE SHEET

      

Portfolio loans

   $ 2,734     $ 2,820  

Loans held for sale

     1,802       974  

Mortgage servicing rights (MSR)

     1,048       1,264  

Other assets

     6,035       3,797  

Total assets

   $ 11,619     $ 8,855  

Deposits

   $ 1,587     $ 3,602  

Borrowings and other liabilities

     4,144       2,279  

Capital

     729       1,195  

Total liabilities and equity

   $ 6,460     $ 7,076  

PERFORMANCE RATIOS

      

Return on average capital

     39     26

Return on average assets

     2.48     3.57

Noninterest income to total revenue

     78     68

Efficiency

     53     53

RESIDENTIAL MORTGAGE SERVICING PORTFOLIO

      

(in billions)

      

Beginning of period

   $ 125     $ 145  

Acquisitions

     5      

Additions

     3       2  

Repayments/transfers

     (6     (6

End of period

   $ 127     $ 141  

Servicing portfolio statistics: (a)

      

Fixed rate

     90     89

Adjustable rate/balloon

     10     11

Weighted average interest rate

     5.53     5.79

MSR capitalized value (in billions)

   $ 1.1     $ 1.3  

MSR capitalization value (in basis points)

     88       90  

Weighted average servicing fee (in basis points)

     30       30  

OTHER INFORMATION

      

Loan origination volume (in billions)

   $ 3.2     $ 2.0  

Percentage of originations represented by:

      

Agency and government programs

     100     98

Refinance volume

     85     73

Total nonperforming assets (a) (b)

   $ 395     $ 418  

Impaired loans (a) (c)

   $ 158     $ 298  
(a) As of March 31
(b) Includes nonperforming loans of $101 million at March 31, 2011 and $239 million at March 31, 2010.
(c) Recorded investment of purchased impaired loans related to acquisitions.

Residential Mortgage Banking earned $71 million in the first quarter of 2011 compared with $78 million in the first quarter of 2010. Earnings declined from the prior year first quarter primarily as a result of a higher provision for credit losses, lower servicing fees, lower net interest income and higher noninterest expense offset partially by increased loans sales revenue and higher net economic hedging gains on mortgage servicing rights.

Residential Mortgage Banking overview:

   

Total loan originations were $3.2 billion for the first quarter of 2011 compared with $2.0 billion in the first quarter of 2010. Refinance application volume was up compared to first quarter 2010. Loans continue to be originated primarily through direct channels under FNMA, FHLMC and FHA/VA agency guidelines.

   

Investors may request PNC to indemnify them against losses on certain loans or to repurchase loans that they believe do not comply with applicable contractual loan origination covenants and representations and warranties we have made. At March 31, 2011, the liability for estimated losses on repurchase and indemnification claims for the Residential Mortgage Banking business segment was $124 million compared with $188 million at March 31, 2010. See Note 17 Commitments and Guarantees in the Notes To Consolidated Financial Statements of this Report for additional information.

   

Residential mortgage loans serviced for others totaled $127 billion at March 31, 2011 compared with $141 billion at March 31, 2010 as payoffs continued to outpace new direct loan origination volume.

   

Noninterest income was $202 million in the first quarter of 2011 compared with $154 million in the first quarter of 2010. The increase resulted from higher loan sales revenue driven by higher loan origination volume and higher net economic hedging gains on mortgage servicing rights.

   

Net interest income was $56 million in the first quarter of 2011 compared with $74 million in the first quarter of 2010. The decrease in the comparisons was primarily due to lower interest earned on escrow deposits.

   

Noninterest expense was $137 million in the first quarter of 2011 compared with $120 million in the first quarter of 2010. The increase from the prior year first quarter was driven by higher loan origination volume and higher foreclosure-related expenses.

   

The fair value of mortgage servicing rights was $1.1 billion at March 31, 2011 compared with $1.3 billion at March 31, 2010. The decline was due to lower mortgage rates at March 31, 2011 and a smaller mortgage servicing portfolio.

 

 

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BLACKROCK

(Unaudited)

Information related to our equity investment in BlackRock follows:

 

Three months ended March 31

Dollars in millions

   2011     2010  

Business segment earnings (a)

   $ 86     $ 77  

PNC’s economic interest in BlackRock (b)

     20     24
(a) Includes PNC’s share of BlackRock’s reported GAAP earnings and additional income taxes on those earnings incurred by PNC.
(b) At March 31.

 

In billions    Mar. 31
2011
     Dec. 31
2010
 

Carrying value of PNC’s investment in BlackRock (c)

   $ 5.1      $ 5.1  

Market value of PNC’s investment in BlackRock (d)

     7.2        6.9  
(c) The March 31, 2011 amount is comprised of our equity investment of $5,068 million and $22 million of goodwill and accumulated other comprehensive income related to our BlackRock investment. The comparable amounts at December 31, 2010 were $5,017 million and $37 million.
     PNC accounts for its investment in BlackRock under the equity method of accounting, exclusive of a related $1.8 billion deferred tax liability at both March 31, 2011 and December 31, 2010.
(d) Does not include liquidity discount.

PNC accounts for its BlackRock Series C Preferred Stock at fair value, which offsets the impact of marking-to-market the obligation to deliver these shares to BlackRock to help fund BlackRock LTIP programs. The fair value amount of the BlackRock Series C Preferred Stock is included on our Consolidated Balance Sheet in the caption Other assets. Additional information regarding the valuation of the BlackRock Series C Preferred Stock is included in Note 8 Fair Value in the Notes To Consolidated Financial Statements of this Report.

PNC accounts for its remaining investment in BlackRock under the equity method of accounting. Our percentage ownership of BlackRock common stock (approximately 25% at March 31, 2011) is higher than our overall share of BlackRock’s equity and earnings.

Our 2010 Form 10-K includes additional information about our investment in BlackRock, including BlackRock’s November 2010 secondary common stock offering and our sale of a portion of our shares of BlackRock common stock in that offering.

DISTRESSED ASSETS PORTFOLIO

(Unaudited)

 

Three months ended March 31

Dollars in millions, except as noted

  2011     2010  

INCOME STATEMENT

     

Net interest income

  $ 236     $ 342  

Noninterest income

    9       (12

Total revenue

    245       330  

Provision for credit losses

    152       165  

Noninterest expense

    53       48  

Pretax earnings

    40       117  

Income taxes

    15       44  

Earnings

  $ 25     $ 73  

AVERAGE BALANCE SHEET

     

Commercial Lending:

     

Commercial/Commercial real estate

  $ 1,582     $ 2,599  

Lease financing

    757       803  

Total commercial lending

    2,339       3,402  

Consumer Lending:

     

Consumer

    5,559       6,573  

Residential real estate

    6,332       8,190  

Total consumer lending

    11,891       14,763  

Total portfolio loans

    14,230       18,165  

Other assets

    (129     1,342  

Total assets

  $ 14,101     $ 19,507  

Deposits

    $ 85  

Other liabilities

  $ 159       55  

Capital

    1,371       1,734  

Total liabilities and equity

  $ 1,530     $ 1,874  

PERFORMANCE RATIOS

     

Return on average capital

    7     17

Return on average assets

    .72       1.52  

OTHER INFORMATION

     

Nonperforming assets (a) (b)

  $ 1,209     $ 1,777  

Impaired loans (a) (c)

  $ 5,685     $ 7,124  

Net charge-offs (d)

  $ 123     $ 111  

Annualized net charge-off ratio (d)

    3.51     2.48

LOANS (a)

     

Commercial Lending

     

Commercial/Commercial real estate

  $ 1,474     $ 2,641  

Lease financing

    695       806  

Total commercial lending

    2,169       3,447  

Consumer Lending

     

Consumer

    5,381       6,511  

Residential real estate

    6,325       8,105  

Total consumer lending

    11,706       14,616  

Total loans

  $ 13,875     $ 18,063  
(a) As of March 31.
(b) Includes nonperforming loans of $.9 billion at March 31, 2011 and $1.4 billion at March 31, 2010.
(c) Recorded investment of purchased impaired loans related to acquisitions. At March 31, 2011, this segment contained 76% of PNC’s purchased impaired loans.
(d) For the three months ended March 31.

This business segment consists primarily of assets acquired with acquisitions and had earnings of $25 million for the first three months of 2011 compared with $73 million in the first three months of 2010. The decline was driven by a decrease in

 

 

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net interest income, partially offset by a lower provision for credit losses and an increase in noninterest income.

Distressed Assets Portfolio overview:

   

Average loans declined to $14.2 billion in the first quarter of 2011 compared with $18.2 billion in the first quarter of 2010. The decline was impacted by portfolio management activities including loan sales, paydowns and net charge-offs.

   

Net interest income was $236 million in the first three months of 2011 compared with $342 million for the first three months of 2010. The decline was driven by lower purchase accounting accretion on impaired loans and a decline in average loan balances.

   

Noninterest income was $9 million for the first quarter of 2011 compared with a loss of $12 million for the first quarter of 2010. An increase in reserves for brokered home equity loan indemnification and repurchase obligations was recorded in the first quarter a year ago.

   

The provision for credit losses was $152 million in the first quarter of 2011 compared with $165 million in the first quarter of 2010. The decline was driven by improved credit performance within the mortgage and construction loan portfolios.

   

Noninterest expense for the first three months of 2011 was $53 million compared with $48 million in the first three months of 2010. The increase was driven by other real estate owned-related losses and expenses.

   

Nonperforming loans decreased $.5 billion, to $.9 billion, at March 31, 2011 compared with March 31, 2010. The consumer lending portfolio comprised 53% of the nonperforming loans at March 31, 2011. Nonperforming consumer loans decreased $.3 billion.

   

Net charge-offs were $123 million for the first quarter of 2011 and $111 million for the first quarter of 2010. The increase was driven by increased net charge-offs in the consumer lending portfolio.

Certain loans in this business segment may require special servicing given current loan performance and market conditions. Consequently, the business activities of this segment are focused on maximizing the value of the portfolio assigned to it while mitigating risk. Business intent drives the inclusion of assets in this business segment. Not all impaired loans are included in this business segment, nor are all of the loans included in this business segment considered impaired.

   

The $13.9 billion of loans held in this portfolio at March 31, 2011 are stated inclusive of a fair value adjustment on purchased impaired loans at acquisition. Taking the adjustment and the ALLL into account, the net carrying basis of this loan portfolio is 77% of customer outstandings.

   

Commercial Lending within the Distressed Assets Portfolio business segment is comprised of $1.5

   

billion in residential development assets (i.e. condominiums, townhomes, developed and undeveloped land) primarily acquired from National City and $.7 billion of performing cross-border leases. This commercial lending portfolio has declined 37% since March 31, 2010. For the residential development portfolio, a team of asset managers actively deploy workout strategies on this portfolio through reducing unfunded loan exposure, refinancing, customer payoffs, foreclosures and loan sales. The overall credit quality of this portfolio is considered to be moderately better at March 31, 2011 compared with the beginning of 2010 based upon continuing dispositions of credits, improved economic conditions and increased activity in several markets. The cross-border lease portfolio continues to demonstrate good credit quality.

   

The performance of the Consumer Lending portfolio is dependent upon economic growth, unemployment rates, the housing market recovery and the interest rate environment. The portfolio’s credit quality performance has stabilized through actions taken by management over the last two years. Approximately 76% of customers have been current with principal and interest payments for the past 12 months. Currently, the portfolio yields over 7%. Consumer Lending consists of residential real estate mortgages and consumer or brokered home equity loans.

   

Residential real estate mortgages are primarily legacy National City, originate for sale programs (now discontinued) and acquired portfolios. The residential real estate mortgage portfolio is composed of jumbo and ALT-A first lien mortgages, non-prime first and second lien mortgages and to a lesser extent, residential construction loans. We have implemented internal and external programs to proactively explore refinancing opportunities that would allow the borrower to qualify for a conforming mortgage loan which would be originated and sold by PNC or originated by a third-party originator. Also, loss mitigation programs have been developed to help manage risk and assist borrowers to maintain homeownership, when possible.

   

Home equity loans include second liens and brokered home equity lines of credit. We have implemented several modification programs to assist the loss mitigation teams that manage this risk. Additionally, we have initiated several voluntary and involuntary programs to reduce and/or block line availability on home equity lines of credit.

   

When loans are sold, investors may request PNC to indemnify them against losses or to repurchase loans that they believe do not comply with applicable contractual loan origination covenants and representations and warranties we have made. From 2005 to 2007, home equity loans were sold with such contractual provisions. At March 31, 2011, the

 

 

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liability for estimated losses on repurchase and indemnification claims for the Distressed Assets Portfolio business segment was $128 million. No additional reserves were recorded in the first quarter of 2011. See the Recourse and Repurchase Obligations section of this Financial Review and Note 17 Commitments and Guarantees in the Notes To Consolidated Financial Statements included in this Report for additional information.

CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS

Note 1 Accounting Policies in Part II, Item 8 of our 2010 Form 10-K and in the Notes To Consolidated Financial Statements included in Part I, Item 1 of this Report describe the most significant accounting policies that we use. Certain of these policies require us to make estimates or economic assumptions that may prove inaccurate or be subject to variations that may significantly affect our reported results and financial position for the period or in future periods.

We must use estimates, assumptions, and judgments when assets and liabilities are required to be recorded at, or adjusted to reflect, fair value.

Assets and liabilities carried at fair value inherently result in a higher degree of financial statement volatility. Fair values and the information used to record valuation adjustments for certain assets and liabilities are based on either quoted market prices or are provided by independent third-party sources, including appraisers and valuation specialists, when available. When such third-party information is not available, we estimate fair value primarily by using cash flow and other financial modeling techniques. Changes in underlying factors, assumptions, or estimates could materially impact our future financial condition and results of operations.

We discuss the following critical accounting policies and judgments under this same heading in Part II, Item 7 of our 2010 Form 10-K:

   

Fair Value Measurements

   

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

   

Estimated Cash Flows on Purchased Impaired Loans

   

Goodwill

   

Lease Residuals

   

Revenue Recognition

   

Residential Mortgage Servicing Rights

   

Income Taxes

Residential Mortgage Servicing Rights

In conjunction with the acquisition of National City, PNC acquired servicing rights for residential real estate loans. We have elected to measure these mortgage servicing rights (MSRs) at fair value. MSRs are established and valued using

discounted cash flow modeling techniques which require management to make estimates regarding future net servicing cash flows, taking into consideration actual and expected mortgage loan prepayment rates, discount rates, servicing costs, and other factors.

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

The fair value of residential MSRs and significant inputs to the valuation model as of March 31, 2011 are shown in the table below. The expected and actual rates of mortgage loan prepayments are the most significant factors driving the fair value. Management uses a third party model to estimate future loan prepayments. This model has been refined based on historical performance of PNC’s managed portfolio, as adjusted for current market conditions. Future interest rates are another important factor in the valuation of MSRs. Management utilizes market implied forward interest rates to estimate the future direction of mortgage and discount rates. The forward rates utilized are derived from the current yield curve for U.S. dollar interest rate swaps and are consistent with pricing of capital markets instruments. Changes in the shape and slope of the forward curve in future periods may result in volatility in the fair value estimate.

 

Dollars in millions    March 31,
2011
    December 31,
2010
 

Fair value

   $ 1,109     $ 1,033  

Weighted-average life (in years) (a)

     6.2       5.8  

Weighted-average constant prepayment rate (a)

     11.75     12.61

Spread over forward interest rate swap rates

     12.11     12.18
(a) Changes in weighted-average life and weighted-average constant prepayment rate reflect the cumulative impact of changes in rates, prepayment expectations and model changes.

A sensitivity analysis of the hypothetical effect on the fair value of MSRs for adverse changes in key assumptions is presented below. These sensitivities do not include the impact of the related hedging activities. Changes in fair value generally cannot be extrapolated because the relationship of the change in the assumption to the change in fair value may

 

 

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not be linear. Also, the effect of a variation in a particular assumption on the fair value of the MSRs is calculated independently without changing any other assumption. In reality, changes in one factor may result in changes in another (for example, changes in mortgage interest rates, which drive changes in prepayment rate estimates, could result in changes in the interest rate spread), which could either magnify or counteract the sensitivities.

 

Dollars in millions    March 31,
2011
     December 31,
2010
 

Prepayment rate:

     

Decline in fair value from 10% adverse change

   $ 48      $ 41  

Decline in fair value from 20% adverse change

   $ 93      $ 86  

Spread over forward interest rate swap rates:

     

Decline in fair value from 10% adverse change

   $ 47      $ 43  

Decline in fair value from 20% adverse change

   $ 90      $ 83  

Recent Accounting Pronouncements

See Note 1 Accounting Policies in the Notes to the Consolidated Financial Statements of this Report regarding the impact of the adoption of new accounting guidance issued by the Financial Accounting Standards Board.

STATUS OF QUALIFIED DEFINED BENEFIT PENSION PLAN

We have a noncontributory, qualified defined benefit pension plan (plan or pension plan) covering eligible employees. Benefits are determined using a cash balance formula where earnings credits are a percentage of eligible compensation. Pension contributions are based on an actuarially determined amount necessary to fund total benefits payable to plan participants. Consistent with our investment strategy, plan assets are primarily invested in equity investments and fixed income instruments. Plan fiduciaries determine and review the plan’s investment policy, which is described more fully in Note 14 Employee Benefit Plans in our 2010 Form 10-K.

We calculate the expense associated with the pension plan and the assumptions and methods that we use include a policy of reflecting trust assets at their fair market value. On an annual basis, we review the actuarial assumptions related to the pension plan. The primary assumptions used to measure pension obligations and costs are the discount rate, compensation increase and expected long-term return on assets. Among these, the compensation increase assumption does not significantly affect pension expense.

The discount rate used to measure pension obligations is determined by comparing the expected future benefits that will be paid under the plan with yields available on high quality corporate bonds of similar duration. In lower interest rate environments, the sensitivity of pension expense to the assumed discount rate increases. The impact on pension expense of a 0.5% decrease in discount rate in the current environment is $19 million. In contrast, the sensitivity to the same change in discount rate in a higher interest rate environment is less significant.

The expected long-term return on assets assumption also has a significant effect on pension expense. The expected return on plan assets is a long-term assumption established by considering historical and anticipated returns of the asset classes invested in by the pension plan and the asset allocation policy currently in place. For purposes of setting and reviewing this assumption, “long term” refers to the period over which the plan’s projected benefit obligations will be disbursed. We review this assumption at each measurement date and adjust it if warranted. Our selection process references certain historical data and the current environment, but primarily utilizes qualitative judgment regarding future return expectations. Accordingly, we generally do not change the assumption unless we modify our investment strategy or identify events that would alter our expectations of future returns.

To evaluate the continued reasonableness of our assumption, we examine a variety of viewpoints and data. Various studies have shown that portfolios comprised primarily of US equity securities have returned approximately 10% annually over long periods of time, while US debt securities have returned approximately 6% annually over long periods. Application of these historical returns to the plan’s allocation ranges for equities and bonds produces a result between 7.25% and 8.75% and is one point of reference, among many other factors, that is taken into consideration. We also examine the plan’s actual historical returns over various periods. Recent experience is considered in our evaluation with appropriate consideration that, especially for short time periods, recent returns are not reliable indicators of future returns. While annual returns can vary significantly (rates of return for 2010, 2009, and 2008 were +14.87%, +20.61%, and -32.91%, respectively), the selected assumption represents our estimated long-term average prospective returns.

Acknowledging the potentially wide range for this assumption, we also annually examine the assumption used by other companies with similar pension investment strategies, so that we can ascertain whether our determinations markedly differ from others. In all cases, however, this data simply informs our process, which places the greatest emphasis on our qualitative judgment of future investment returns, given the conditions existing at each annual measurement date.

 

 

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As more fully described in our 2010 Form 10-K, the expected long-term return on plan assets for determining net periodic pension cost for 2011 is 7.75%, down from 8.00% in 2010.

Under current accounting rules, the difference between expected long-term returns and actual returns is accumulated and amortized to pension expense over future periods. Each one percentage point difference in actual return compared with our expected return causes expense in subsequent years to change by up to $9 million as the impact is amortized into results of operations.

The table below reflects the estimated effects on pension expense of certain changes in annual assumptions, using 2011 estimated expense as a baseline.

 

Change in Assumption (a)    Estimated
Increase to 2011
Pension
Expense
(In  millions)
 

.5% decrease in discount rate

   $ 19  

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

   $ 19  

.5% increase in compensation rate

   $ 3  
(a) The impact is the effect of changing the specified assumption while holding all other assumptions constant.

We currently estimate a pretax pension expense of $11 million in 2011 compared with pretax expense of $46 million in 2010. This year-over-year expected reduction is primarily due to the amortization impact of the favorable 2010 investment returns as compared with the expected long-term return assumption, which has been established by considering the time over which the Plan’s obligations are expected to be paid.

Our pension plan contribution requirements are not particularly sensitive to actuarial assumptions. Investment performance has the most impact on contribution requirements and will drive the amount of permitted contributions in future years. Also, current law, including the provisions of the Pension Protection Act of 2006, sets limits as to both minimum and maximum contributions to the plan. We do not expect to be required by law to make any contributions to the plan during 2011.

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

RECOURSE AND REPURCHASE OBLIGATIONS

As discussed in Note 3 Loan Sale and Servicing Activities and Variable Interest Entities in our 2010 Form 10-K, PNC has sold commercial mortgage and residential mortgage loans directly or indirectly in securitizations and whole-loan sale transactions with continuing involvement. One form of continuing involvement includes certain recourse and loan repurchase obligations associated with the transferred assets in these transactions.

COMMERCIAL MORTGAGE RECOURSE OBLIGATIONS

We originate, close, and service certain commercial mortgage loans which are sold to FNMA under FNMA’s Delegated Underwriting and Servicing (DUS) program. We have similar arrangements with FHLMC.

Under these programs, we generally assume up to a one-third pari passu risk of loss on unpaid principal balances through a loss share arrangement. The unpaid principal balance outstanding of loans sold as a participant in these programs was $13.2 billion at both March 31, 2011 and December 31, 2010, and the potential maximum exposure under the loss share arrangements was $4.0 billion at both March 31, 2011 and December 31, 2010. We maintain a reserve based upon these potential losses. The reserve for losses under these programs totaled $56 million and $54 million as of March 31, 2011 and December 31, 2010, respectively, and is included in Other liabilities on our Consolidated Balance Sheet. If payment is required under these programs, we would not have a contractual interest in the collateral underlying the mortgage loans on which losses occurred, although the value of the collateral is taken into account in determining our share of such losses. Our exposure and activity associated with these recourse obligations are reported in the Corporate & Institutional Banking segment.

RESIDENTIAL MORTGAGE LOAN REPURCHASE OBLIGATIONS

While residential mortgage loans are sold on a non-recourse basis, we assume certain loan repurchase obligations associated with mortgage loans we have sold to investors. These loan repurchase obligations primarily relate to situations where PNC is alleged to have breached certain origination covenants and representations and warranties made to purchasers of the loans in the respective purchase and sale agreements. Residential mortgage loans covered by these loan repurchase obligations include first and second-lien mortgage loans we have sold through Agency securitizations, Non-Agency securitizations, and whole-loan sale transactions. As discussed in Note 3 in our 2010 Form 10-K, Agency securitizations consist of mortgage loans sale transactions with FNMA, FHLMC, and the Government National Mortgage Association (GNMA) program, while Non-Agency securitizations and whole-loan sale transactions consist of mortgage loans sale transactions with private investors. Our

 

 

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exposure and activity associated with these loan repurchase obligations is reported in the Residential Mortgage Banking segment. In addition, PNC’s residential mortgage loan repurchase obligations include certain brokered home equity loans/lines that were sold to private investors by National City prior to our acquisition. PNC is no longer engaged in the brokered home equity lending business, and our exposure under these loan repurchase obligations is reported in the Distressed Assets Portfolio segment.

Loan covenants and representations and warranties are established through loan sale agreements with various investors to provide assurance that PNC has sold loans to investors of sufficient investment quality. Key aspects of such covenants and representations and warranties include the loan’s compliance with any applicable loan criteria established by the investor, including underwriting standards, delivery of all required loan documents to the investor or its designated party, sufficient collateral valuation, and the validity of the lien securing the loan. As a result of alleged breaches of these contractual obligations, investors may request PNC to indemnify them against losses on certain loans or to repurchase loans.

Indemnifications for loss or loan repurchases typically occur when, after review of the claim, we agree insufficient evidence exists to dispute the investor’s claim that a breach of a loan covenant and representation and warranty has occurred, such breach has not been cured, and the effect of such breach is deemed to have had a material and adverse effect on the value of the transferred loan. Depending on the sale agreement and upon proper notice from the investor, we typically respond to such indemnification and repurchase requests within 60 days, although final resolution of the claim may take a longer period of time. With the exception of the sales agreements associated with the Agency securitizations, most sale agreements do not provide for penalties or other remedies if we do not respond timely to investor indemnification or repurchase requests.

Investor indemnification or repurchase claims are typically settled on an individual loan basis through make-whole payments or loan repurchases; however, on occasion we may negotiate pooled settlements with investors. The following table details the unpaid principal balance of our unresolved indemnification and repurchase claims at March 31, 2011 and December 31, 2010.

Analysis of Unresolved Asserted Indemnification and Repurchase Claims

 

In millions    Mar. 31,
2011
     Dec. 31,
2010
 

Residential mortgages:

       

Agency securitizations

   $ 166      $ 110  

Private investors (a)

     112        100  
 

Home equity loans/lines:

       

Private investors (b)

     210        299  

Total unresolved claims

   $ 488      $ 509  
(a) Activity relates to loans sold through Non-Agency securitization and whole-loan sale transactions.
(b) Activity relates to brokered home equity loans/lines sold through whole-loan sale transactions which occurred during 2005-2007.

To mitigate losses associated with indemnification and repurchase claims, we have established quality assurance programs designed to ensure loans sold meet specific underwriting and origination criteria provided for in the investor sale agreements. In addition, we investigate every investor claim on a loan by loan basis to determine the existence of a legitimate claim, and that all other conditions for indemnification or repurchase have been met prior to the settlement with an investor.

The table below details our indemnification and repurchase claim settlement activity during the first three months of 2011 and 2010. Any repurchased loan is appropriately considered in our nonperforming loan disclosures and statistics.

 

 

Analysis of Indemnification and Repurchase Claim Settlement Activity

 

     2011      2010  
Three months ended March 31 - In millions    Unpaid
Principal
Balance (a)
     Losses
Incurred (b)
     Fair Value of
Repurchased
Loans (c)
     Unpaid
Principal
Balance (a)
     Losses
Incurred (b)
     Fair Value of
Repurchased
Loans (c)
 

Residential mortgages (d):

                   

Agency securitizations

   $ 59      $ 29      $ 24      $ 91      $ 42      $ 32  

Private investors (e)

     21        5        6        44        26        16  
 

Home equity loans/lines:

                   

Private investors - Repurchases (f)

     22        22                 1        1           

Total indemnification and repurchase settlements

   $ 102      $ 56      $ 30      $ 136      $ 69      $ 48  
(a) Represents unpaid principal balance of loans at the indemnification or repurchase date.
(b) Represents both i) amounts paid for indemnification payments and ii) the difference between loan repurchase price and fair value of the loan at the repurchase date. These losses are charged to the indemnification and repurchase liability.
(c) Represents fair value of loans repurchased only as we have no exposure to changes in the fair value of loans or underlying collateral when indemnification payments are made to investors.
(d) Repurchase activity associated with insured loans, government-guaranteed loans, and loans repurchased through the exercise of our removal of account provision (ROAP) option are excluded from this table. Refer to Note 3 in the Notes To Consolidated Financial Statements in this Report for further discussion of ROAPs.
(e) Activity relates to loans sold through Non-Agency securitizations and whole-loan sale transactions.
(f) Activity relates to brokered home equity loans/lines sold through whole-loan sale transactions which occurred during 2005-2007.

 

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During 2010 and the first three months of 2011, unresolved and settled investor indemnification and repurchase claims were primarily related to one of the following alleged breaches in representations and warranties: 1) misrepresentation of income, assets or employment; 2) property evaluation or status issues (e.g., appraisal, title, etc.); or 3) underwriting guideline violations. During 2010, the frequency and timing of unresolved and settled investor indemnification and repurchase claims increased as a result of higher loan delinquencies which have been impacted by the deterioration in the overall economy and the prolonged weak residential housing sector. The increased volume of claims was also reflective of an industry trend where investors implemented certain strategies to aggressively reduce their exposure to losses on purchased loans. These same factors also contributed to the first quarter 2011 increase in the balance of unresolved indemnification and repurchase claims for residential mortgages. The year-over-year first quarter 2011 decline in indemnification and repurchase settlements for residential mortgages resulted primarily from higher claim rescission rates. Higher claim rescission rates also drove the first quarter 2011 decline in the balance of home equity loans/lines unresolved indemnification and repurchase claims. The year-over-year first quarter increase in home equity indemnification and repurchase settlements was attributed solely to the timing of when repurchases were executed.

For the first and second-lien mortgage balances of unresolved and settled claims contained in the tables above, a significant amount of these claims were associated with sold loans originated through correspondent lender and broker origination channels. For the home equity loans/lines sold portfolio, all unresolved and settled claims relate to loans originated through the broker origination channel. In certain instances when indemnification or repurchase claims are settled for these types of sold loans, we have recourse back to the correspondent lenders, brokers and other third-parties (e.g., contract underwriting companies, closing agents, appraisers, etc.). Depending on the underlying reason for the investor claim, we determine our ability to pursue recourse with these parties and file claims with them accordingly. Our historical recourse recovery rate has been insignificant as our efforts have been impacted by the inability of such parties to reimburse us for their recourse obligations (e.g., their capital availability or whether they remain in business) or contractual limitations that limit our ability to pursue recourse with these parties (e.g., loss caps, statutes of limitations, etc.). All of these factors are considered in the determination of our estimated indemnification and repurchase liability detailed below.

Origination and sale of residential mortgages is an ongoing business activity and, accordingly, management continually assesses the need for indemnification and repurchase liabilities pursuant to the associated investor sale agreements. We establish indemnification and repurchase liabilities for estimated losses on sold first and second-lien mortgages and

home equity loans/lines for which indemnification is expected to be provided or for loans that are expected to be repurchased. For the first and second-lien mortgage sold portfolio, we have established an indemnification and repurchase liability pursuant to investor sale agreements based on claims made and our estimate of future claims on a loan by loan basis. These relate primarily to loans originated during 2006-2008. For the home equity loans/lines sold portfolio, we have established indemnification and repurchase liabilities based upon this same methodology for loans sold during 2005-2007.

Indemnification and repurchase liabilities are initially recognized when loans are sold to investors and are subsequently evaluated for adequacy by management. Initial recognition and subsequent adjustments to the indemnification and repurchase liability for the first and second-lien mortgage sold portfolio are recognized in Residential mortgage revenue on the Consolidated Income Statement. Since PNC is no longer engaged in the brokered home equity lending business, only subsequent adjustments are recognized to the home equity loans/lines indemnification and repurchase liability. These adjustments are recognized in Other noninterest income on the Consolidated Income Statement.

Management’s subsequent evaluation of these indemnification and repurchase liabilities is based upon trends in indemnification and repurchase requests, actual loss experience, known and inherent risks in the underlying serviced loan portfolios, and current economic conditions. As part of its evaluation, management considers estimated loss projections over the life of the subject loan portfolio. At March 31, 2011 and December 31, 2010, the liability for estimated losses on indemnification and repurchase claims for residential mortgages totaled $124 million and $144 million, respectively. The indemnification and repurchase liability for home equity loans/lines was $128 million and $150 million at March 31, 2011 and December 31, 2010, respectively. These liabilities are included in Other liabilities on the Consolidated Balance Sheet.

The residential mortgages indemnification and repurchase liability declined during the first three months of 2011, reflecting lower actual repurchase and indemnification losses primarily driven by higher claim rescission rates. This decrease resulted despite higher levels of investor indemnification and repurchase claim activity as described above. The first quarter 2011 reduction in the home equity loans/lines indemnification and repurchase liability primarily resulted from loan repurchases.

We believe our indemnification and repurchase liabilities adequately reflect the estimated losses on anticipated investor indemnification and repurchase claims at March 31, 2011 and December 31, 2010. However, actual losses could be more or less than our established indemnification and repurchase liability. Factors that could affect our estimate include the

 

 

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timing and frequency of investor claims driven by investor strategies and behavior, our ability to successfully negotiate claims with investors, the housing markets which drive the estimates made for loan indemnification and repurchase losses, and other economic conditions. Accordingly, if we assumed an adverse change of 10% for the indemnification and repurchase claims, claim rescission rates, and indemnification and repurchase loss assumptions in our indemnification and repurchase liability model, this liability would increase to $296 million at March 31, 2011.

RISK MANAGEMENT

We encounter risk as part of the normal course of our business and we design risk management processes to help manage these risks.

The Risk Management section included in Part II, Item 7 of our 2010 Form 10-K describes our risk management philosophy, principles, governance and various aspects of our corporate-level risk management program. Additionally, our 2010 Form 10-K provides an analysis of our primary areas of risk: credit, operational, liquidity, and market, as well as a discussion of our use of financial derivatives as part of our overall asset and liability risk management process, and addresses historical performance in appropriate places within the Risk Management section of that report.

The following information updates our 2010 Form 10-K risk management disclosures.

CREDIT RISK MANAGEMENT

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

ASSET QUALITY OVERVIEW

Asset quality trends for the first quarter of 2011 were mostly positive and included the following:

   

First quarter 2011 net charge-offs declined significantly to $533 million, down 23% from first quarter 2010 net charge-offs of $691 million and 33% from fourth quarter 2010 net charge-offs of $791 million. First quarter 2011 net charge-offs represented the lowest quarterly level of net charge-offs since first quarter 2009.

   

Reflecting ongoing reductions in credit exposure and improvements in asset quality, the provision for credit losses declined for the third consecutive quarter. The ALLL has also been decreasing.

   

Due to the improvement in the economy, nonperforming loans declined $73 million to $4.4 billion as of March 31, 2011.

   

Overall loan delinquency levels have mostly stabilized or improved modestly due to the improving economy, especially in late stage delinquencies with accruing loans 90 days or more past due declining 10% from year-end 2010.

   

Commercial credit quality trends improved noticeably with levels of criticized commercial loan outstandings declining by approximately $1 billion or over 7% to $12.7 billion at March 31, 2011. See Note 5 Asset Quality and Allowances for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit in the Notes To Consolidated Financial Statements in this Report for additional information.

These positive trends were partially offset by the following:

   

Our ongoing loan modification efforts to assist homeowners and other borrowers continued to increase total trouble debt restructurings (TDRs). In particular, nonperforming TDRs increased to over 20% of total nonperforming loans. However, as the economy continues to improve, our loan modification efforts have begun to show signs of slowing.

   

Levels of other real estate owned (OREO) and foreclosed assets continued to increase modestly and now represent over 16% of total nonperforming assets. The majority of these assets are comprised of single family residential properties.

NONPERFORMING ASSETS AND LOAN DELINQUENCIES

Nonperforming Assets, including OREO and Foreclosed Assets

Nonperforming assets decreased $43 million from December 31, 2010, to March 31, 2011, remaining stable at approximately $5.3 billion. Nonperforming loans decreased $73 million to $4.4 billion while OREO and foreclosed assets increased $30 million to $865 million. The ratio of nonperforming assets to total loans and OREO and foreclosed assets was 3.50% for both March 31, 2011, and December 31, 2010. The ratio of nonperforming loans to total loans declined slightly, to 2.94%. The modest decrease in nonperforming loans from December 31, 2010, occurred across almost all loan classes, except for an increase in nonperforming commercial real estate loans and a small increase in nonperforming home equity loans. The increase in home equity loans was driven by increased levels of modifications that were determined to be TDRs.

At March 31, 2011, TDRs included in nonperforming loans increased to $882 million or 20% of total nonperforming loans compared to $784 million or 18% of nonperforming loans as of December 31, 2010. Within consumer nonperforming

 

 

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loans, residential real estate TDRs comprise approximately 37% of total residential real estate nonperforming loans at March 31, 2011, up modestly from 30% at December 31, 2010. Similarly, home equity TDRs comprise approximately 77% of home equity nonperforming loans at March 31, 2011, up slightly from 75% at December 31, 2010. The level of modifications that were determined to be TDRs in these portfolios is expected to result in elevated nonperforming loan levels for longer periods because TDRs remain in nonperforming status until a borrower has made at least six consecutive months of payments under the modified terms or ultimate resolution occurs. At March 31, 2011, our largest nonperforming asset was $33 million in the Accommodation and Food Services Industry and our average nonperforming loan associated with commercial lending was approximately $1 million. Our top ten nonperforming assets are all commercial loans and represent approximately 7% and 4% of total commercial nonperforming loans and total nonperforming assets, respectively, as of March 31, 2011.

Nonperforming Assets By Type

 

In millions    Mar. 31
2011
    Dec. 31
2010
 

Nonperforming loans

      

Commercial

      

Retail/wholesale

   $ 180     $ 197  

Manufacturing

     213       250  

Real estate related (a)

     277       263  

Financial services

     27       16  

Health care

     46       50  

Other industries

     460       477  

Total commercial

     1,203       1,253  

Commercial real estate

      

Real estate projects

     1,468       1,422  

Commercial mortgage

     416       413  

Total commercial real estate

     1,884       1,835  

Equipment lease financing

     41       77  

TOTAL COMMERCIAL LENDING

     3,128       3,165  

Consumer (b)

      

Home equity

     464       448  

Residential real estate

      

Residential mortgage

     726       764  

Residential construction

     46       54  

Other consumer

     29       35  

TOTAL CONSUMER LENDING

     1,265       1,301  

Total nonperforming loans

     4,393       4,466  

OREO and foreclosed assets

      

Other real estate owned (OREO)

     802       767  

Foreclosed and other assets

     63       68  

OREO and foreclosed assets

     865       835  

Total nonperforming assets

   $ 5,258     $ 5,301  

Amount of nonperforming loans current as to remaining principal and interest

   $ 906     $ 1,002  

Percentage of total nonperforming loans

     21     22

Amount of TDRs included in nonperforming loans

   $ 882     $ 784  

Percentage of total nonperforming loans

     20     18

Nonperforming loans to total loans

     2.94     2.97

Nonperforming assets to total loans, OREO and foreclosed assets

     3.50       3.50  

Nonperforming assets to total assets

     2.03       2.01  

Allowance for loan and lease losses to total nonperforming loans

     108       109  
(a) Includes loans related to customers in the real estate and construction industries.
(b) Excludes most consumer loans and lines of credit, not secured by residential real estate, which are charged off after 120 to 180 days past due and are not placed on nonperforming status.
 

 

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OREO and Foreclosed Assets

 

In millions    Mar. 31
2011
     Dec. 31
2010
 

Other real estate owned (OREO):

       

Residential properties

   $ 515      $ 482  

Residential development properties

     171        166  

Commercial properties

     116        119  

Total OREO

     802        767  

Foreclosed and other assets

     63        68  

OREO and foreclosed assets

   $ 865      $ 835  

Total OREO and foreclosed assets increased $30 million during the first quarter of 2011 from $835 million at December 31, 2010, to $865 million at March 31, 2011, which represents approximately 16% of total nonperforming assets. As of March 31, 2011, and December 31, 2010, approximately 60% and 58%, respectively, of our OREO and foreclosed assets are comprised of single family residential properties. The increase in the first quarter of 2011 was largely due to the resumption of foreclosures under enhanced procedures following the completion of a review of some of our foreclosure practices.

Change in Nonperforming Assets

 

In millions    2011     2010  

January 1

   $ 5,301     $ 6,316  

Transferred in

     1,143       1,774  

Charge-offs and valuation adjustments

     (390     (620

Principal activity including payoffs

     (380     (278

Asset sales and transfers to held for sale

     (178     (265

Returned to performing-TDRs

     (104     (217

Returned to performing-Other

     (134     (170

March 31

   $ 5,258     $ 6,540  

Loans held for sale and purchased impaired loans are excluded from nonperforming loans. Additionally, most consumer loans and lines of credit, not secured by residential real estate, are charged off after 120 to 180 days past due and as such are excluded from nonperforming status.

Purchased impaired loans are considered performing, even if contractually past due (or if we do not expect to receive payment in full based on the original contractual terms), as we are currently accreting interest income over the expected life of the loans. The accretable yield represents the excess of the expected cash flows on the loans at the measurement date over the recorded investment. Any decrease, other than for prepayments or interest rate decreases for variable rate notes, in the net present value of expected cash flows of individual commercial or pooled consumer purchased impaired loans would result in an impairment charge to the provision for loan losses in the period in which the change is deemed probable. Any increase in the net present value of expected cash flows of purchased impaired loans would first result in a recovery of previously recorded allowance for loan losses, to the extent applicable, and then an increase to accretable yield for the remaining life of the purchased impaired loans. Total

nonperforming loans and assets in the tables above are significantly lower than they would have been due to this accounting treatment for purchased impaired loans. This treatment also results in a lower ratio of nonperforming loans to total loans and a higher ratio of ALLL to nonperforming loans. We recorded purchased impaired loans at estimated fair value, including life of loan credit losses, of $12.7 billion at December 31, 2008. See Note 6 Purchased Impaired Loans in the Notes To Consolidated Financial Statements in this Report for additional information on these loans.

Loan Delinquencies

We regularly monitor the level of loan delinquencies and believe these levels to be a key indicator of loan portfolio asset quality. Measurement of delinquency and past due status are based on the contractual terms of each loan. Loans that are 30 days or more past due in terms of payment are considered delinquent. Loan delinquencies exclude loans held for sale, purchased impaired loans and loans that are government insured or guaranteed.

Total early stage loan delinquencies (accruing loans past due 30 to 89 days) increased by $50 million from December 31, 2010, to March 31, 2011, remaining relatively stable at approximately $1.4 billion. Commercial early stage delinquencies rose by $149 million from the prior quarter, mostly due to increases in commercial real estate, while consumer delinquencies fell by $99 million. The increase in commercial real estate early stage delinquencies was largely due to maturing loans in the first quarter of 2011 that were not repaid.

The improvement in consumer delinquencies was experienced across all loan classes.

Accruing loans past due 90 days or more are referred to as late stage delinquencies and are not included in nonperforming loans because they are well secured by collateral and in the process of collection. These loans declined approximately 10% from $542 million at December 31, 2010, to $486 million at March 31, 2011, reflecting improvement in commercial delinquency levels. The following tables display the delinquency status of our loans at March 31, 2011 and December 31, 2010. Additional information regarding accruing loans past due is included in Note 5 Asset Quality and Allowances for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit in the Notes To Consolidated Financial Statements in this Report.

Accruing Loans Past Due 30 To 59 Days

 

     Amount      Percent of Total
Outstandings
 
Dollars in millions    Mar. 31
2011
     Dec. 31
2010
     Mar. 31
2011
    Dec. 31
2010
 

Commercial

   $ 208      $ 251        .37     .45

Commercial real estate

     315        128        1.84       .71  

Equipment lease financing

     72        37        1.16       .58  

Residential real estate

     205        226        1.34       1.41  

Home equity

     146        159        .43       .47  

Credit card

     41        46        1.11       1.17  

Other consumer

     60        95        .36       .56  

Total

   $ 1,047      $ 942        .70       .62  
 

 

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Accruing Loans Past Due 60 To 89 Days

 

     Amount      Percent of Total
Outstandings
 
Dollars in millions    Mar. 31
2011
     Dec. 31
2010
     Mar. 31
2011
    Dec. 31
2010
 

Commercial

   $ 56      $ 92        .10     .17

Commercial real estate

     65        62        .38       .35  

Equipment lease financing

     5        2        .08       .03  

Residential real estate

     91        107        .59       .67  

Home equity

     96        91        .29       .26  

Credit card

     25        32        .67       .82  

Other consumer

     25        32        .15       .19  

Total

   $ 363      $ 418        .24       .28  

Accruing Loans Past Due 90 Days Or More

 

     Amount      Percent of Total
Outstandings
 
Dollars in millions    Mar. 31
2011
     Dec. 31
2010
     Mar. 31
2011
    Dec. 31
2010
 

Commercial

   $ 49      $ 59        .09     .11

Commercial real estate

     6        43        .04       .24  

Equipment lease financing

        1          .02  

Residential real estate

     174        160        1.13       1.00  

Home equity

     165        174        .49       .51  

Credit card

     65        77        1.75       1.96  

Other consumer

     27        28        .16       .16  

Total

   $ 486      $ 542        .33       .36  

Our Special Asset Committee closely monitors loans that are not included in the nonperforming or accruing past due categories and for which we are uncertain about the borrower’s ability to comply with existing repayment terms over the next six months. These loans totaled $523 million at March 31, 2011 and $574 million at December 31, 2010.

LOAN MODIFICATIONS AND TROUBLED DEBT RESTRUCTURINGS

Consumer Loan Modifications

We modify loans under government and PNC-developed programs based upon our commitment to help eligible homeowners and borrowers avoid foreclosure, where appropriate. Initially, a borrower is evaluated for a modification under a government program. If a borrower does not qualify under a government program, the borrower is then evaluated under a PNC program. Our programs utilize both temporary and permanent modifications and typically reduce the interest rate, extend the term and/or defer or forgive principal. Temporary and permanent modifications under programs involving a contractual change to loan terms are substantially all classified as TDRs, regardless of the period of time for which the modified terms apply, as discussed in more detail below.

A temporary modification, with a term between three and 60 months, involves a change in original loan terms for a period

of time and reverts to the original loan terms as of a specific date or the occurrence of an event, such as a failure to pay in accordance with the terms of the modification. Typically, these modifications are for a period of up to 24 months after which the interest rate reverts to the original loan rate. A permanent modification, with a term greater than 60 months, is a modification in which the terms of the original loan are changed, but could revert back to the original loan terms. Permanent modifications primarily include the government-created Home Affordable Modification Program (HAMP) or PNC-developed HAMP-like modification programs.

For consumer loan programs (e.g., residential mortgages, home equity loans and lines), we will enter into a temporary modification when the borrower has indicated a temporary hardship and a willingness to bring current the delinquent loan balance. Examples of this situation often include delinquency due to illness or death in the family, or a loss of employment. Permanent modifications are entered into when it is confirmed that the borrower does not possess the income necessary to continue making loan payments at the current amount, but our expectation is that payments at lower amounts can be made.

Residential mortgage and home equity loans and lines have been modified with changes in contractual terms for up to 60 months, although the majority involve periods of three to 24 months. The change in terms may include a reduced interest rate and/or an extension of the amortization period.

We also monitor the success rates and delinquency status of our loan modification programs to assess their effectiveness in serving our customers’ needs while mitigating credit losses. The following tables provide the number of accounts and unpaid principal balance of modified consumer real estate related loans as well as the number of accounts and unpaid principal balance of modified loans that were 60 days or more past due as of six months, nine months and twelve months after the modification date.

Bank-Owned Consumer Real Estate Related Loan Modifications

 

    March 31, 2011     December 31, 2010  
Dollars in millions   Number of
Accounts
    Unpaid
Principal
Balance
    Number of
Accounts
    Unpaid
Principal
Balance
 

Conforming Mortgages

         

Permanent Modifications

    5,892     $ 1,099       5,517     $ 1,137  

Non-Prime Mortgages

         

Permanent Modifications

    3,740       482       3,405       441  

Residential Construction

         

Permanent Modifications

    984       467       470       235  

Home Equity

         

Temporary Modifications

    13,479       1,216       12,643       1,151  

Permanent Modifications

    189       19       163       17  

Total Home Equity

    13,668       1,235       12,806       1,168  

Total Bank-Owned Consumer Real Estate Related Loan Modifications

    24,284     $ 3,283       22,198     $ 2,981  
 

 

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Bank-Owned Consumer Real Estate Related Loan Modifications Re-Default by Vintage

 

     Six Months     Nine Months     12 Months         

March 31, 2011

Dollars in millions

   Number of
Accounts
Re-defaulted
    

% of

Vintage
Re-defaulted

    Number of
Accounts
Re-defaulted
    

% of

Vintage
Re-defaulted

    Number of
Accounts
Re-defaulted
    

% of

Vintage
Re-defaulted

    Unpaid
Principal
Balance
 

Permanent Modifications

                   

Conforming Mortgages

                   

Third Quarter 2010

     529        26.3             $ 88.7  

Second Quarter 2010

     354        23.7       446        29.9          74.1  

First Quarter 2010

     306        22.9       462        34.6       519        38.8     77.4  

Fourth Quarter 2009

     224        25.4       306        34.7       392        44.4       57.0  

Non-Prime Mortgages

                   

Third Quarter 2010

     98        18.8                 15.8  

Second Quarter 2010

     106        24.0       117        26.5            17.5  

First Quarter 2010

     72        21.4       87        25.8       99        29.4       12.3  

Fourth Quarter 2009

     126        19.0       212        31.9       244        36.7       20.4  

Residential Construction (a)

                   

Third Quarter 2010

     20        7.1                 5.9  

Second Quarter 2010

     32        11.9       33        12.3            10.5  

First Quarter 2010

     5        12.8       6        15.4       5        12.8       3.2  

Home Equity (b)

                   

Third Quarter 2010

     1        7.7                

Second Quarter 2010

     2        12.5       4        25.0           

First Quarter 2010

     1        2.3       5        11.6       8        18.6      

Fourth Quarter 2009

                      1        8.3       3        25.0          

Temporary Modifications

                   

Home Equity

                   

Third Quarter 2010

     117        5.4             $ 10.1  

Second Quarter 2010

     168        7.7       197        9.0          14.2  

First Quarter 2010

     243        8.5       401        14.1       413        14.5     30.2  

Fourth Quarter 2009

     199        8.9       333        14.8       430        19.2       29.0  
(a) Amounts for fourth quarter 2009 are zero.
(b) The unpaid principal balance for permanent home equity modifications totals less than $1 million for each vintage.

 

In addition to temporary loan modifications, we may make available to a borrower a payment plan or a HAMP trial payment period. Under a payment plan or a HAMP trial payment period, there is no change to the loan’s contractual terms so the borrower remains legally responsible for payment of the loan under its original terms. A payment plan involves the borrower making payments that differ from the contractual payment amount for a short period of time, generally three months, during which time a borrower is brought current. Our motivation is to allow for repayment of an outstanding past due amount through payment of additional amounts over the short period of time. Due to the short term nature of the payment plan and the expectation that all contractual principal and interest will be collected, there is a minimal impact to the ALLL.

Under a HAMP trial payment period, we allow a borrower to demonstrate successful payment performance before contractually establishing an alternative payment amount. Subsequent to successful borrower performance under the trial payment period, we will change a loan’s contractual terms and the loan would be classified as a TDR and a nonperforming

loan. However, the borrower is often already delinquent at the time of participation in the HAMP trial payment period. As such, upon successful completion, there is not a significant increase in the ALLL. If the trial payment period is unsuccessful, the loan will be charged-off at the end of the trial payment period to its estimated fair value of the underlying collateral less costs to sell.

Residential conforming and certain residential construction loans have been permanently modified under HAMP or, if they do not qualify for a HAMP modification, under PNC- developed programs, which in some cases may operate similar to HAMP. These programs first require a reduction of the interest rate followed by an extension of term and, if appropriate, deferral or forgiveness of principal payments. As of March 31, 2011 and December 31, 2010, 1,188 accounts with a balance of $295 million and 1,027 accounts with a balance of $262 million, respectively, of residential real estate loans have been modified under HAMP and were still outstanding on our balance sheet. In October 2010, we signed a Service Provider Agreement for the government-sponsored Second Lien Modification Program and have begun modifying

 

 

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loans under this program. As of March 31, 2011, we have modified 11 accounts with a total balance of less than $1 million.

We do not re-modify a defaulted modified loan except for subsequent significant life events, as defined by the OCC. A re-modified loan continues to be classified as a TDR for the remainder of its term regardless of subsequent payment performance.

Commercial Loan Modifications

Modifications of terms for commercial loans are based on individual facts and circumstances. Commercial loan modifications may involve reduction of the interest rate, extension of the term of the loan and/or forgiveness of principal. Modified large commercial loans are usually already nonperforming prior to modification.

Beginning in 2010, we established certain commercial loan modification programs for small business loans, Small Business Administration loans, and investment real estate loans. As of March 31, 2011 and December 31, 2010, approximately $100 million and $88 million, respectively, in loan balances had been modified under these small business modification programs. None of these small business loan modifications have been determined to be TDRs.

Troubled Debt Restructurings

Loan modifications are evaluated and subject to classification as a TDR if the borrower is experiencing financial difficulty and we grant a concession to the borrower. TDRs typically result from our loss mitigation activities and could include rate reductions and/or principal forgiveness intended to minimize the economic loss and to avoid foreclosure or repossession of collateral. Purchased impaired loans are excluded from consideration as TDRs.

Troubled Debt Restructurings By Type

 

In millions    Mar. 31
2011
     Dec. 31
2010
 

Consumer lending:

       

Real estate-related

   $ 1,257      $ 1,087  

Credit card (a)

     314        331  

Other consumer

     4        4  

Total consumer lending

     1,575        1,422  

Total commercial lending

     260        236  

Total TDRs

   $ 1,835      $ 1,658  

Nonperforming status

   $ 882      $ 784  

Accrual status

     639        543  

Credit card (a)

     314        331  

Total TDRs

   $ 1,835      $ 1,658  
(a) Credit cards and certain consumer small business and other credit agreements whose terms have been modified primarily through interest rate reductions are also classified as TDRs. However, these loans are excluded from nonperforming loans since our policy is to exempt these loans from being placed on nonaccrual status as permitted by regulatory guidance. As such, generally under modified terms, these loans are directly charged off in the period that they become 120 to 180 days past due.

Total TDRs increased $177 million or 11% during the first quarter 2011 to $1.8 billion as of March 31, 2011. Of this total, nonperforming TDRs totaled $882 million, which represents approximately 20% of total nonperforming loans. However, as the economy continues to improve, our consumer real estate related loan modification efforts have begun to show signs of slowing.

TDRs that have returned to performing (accrual) status are excluded from nonperforming loans. These loans have demonstrated a period of at least six months of consecutive performance under the modified terms. These TDRs increased $96 million or 18% during the first quarter 2011 to $639 million as of March 31, 2011. This increase reflects the further seasoning and performance of the loan modification portfolio. Cumulatively, of the TDRs that have returned to performing status, approximately $46 million have subsequently re-defaulted and are no longer current under their modified terms.

ALLOWANCES FOR LOAN AND LEASE LOSSES AND UNFUNDED LOAN COMMITMENTS AND LETTERS OF CREDIT

We recorded $533 million in net charge-offs for the first quarter of 2011, compared to $691 million in the first quarter of 2010. This significantly lower level of total net charge-offs represents our lowest level of quarterly net charge-offs in two years. Commercial net charge-offs fell from $437 million in the first quarter of 2010 to $248 million in the first quarter of 2011. Consumer net charge-offs increased slightly from $254 million in the first quarter of 2010 to $285 million in the first quarter of 2011. This consumer increase was primarily due to higher net charge-offs in our home equity portfolio.

Loan Charge-Offs And Recoveries

 

Three months ended March 31

Dollars in millions

   Charge-
offs
     Recoveries      Net
Charge-
offs
     Percent
of
Average
Loans
 

2011

             

Commercial

   $ 179      $ 80      $ 99        .71

Commercial real estate

     158        14        144        3.33  

Equipment lease financing

     14        9        5        .32  

Residential real estate

     58        1        57        1.49  

Home equity

     140        10        130        1.57  

Credit card

     74        6        68        7.21  

Other consumer

     51        21        30        .73  

Total

   $ 674      $ 141      $ 533        1.44  

2010

             

Commercial

   $ 273      $ 65      $ 208        1.52

Commercial real estate

     238        33        205        3.71  

Equipment lease financing

     36        12        24        1.59  

Residential real estate

     38           38        .79  

Home equity

     73        10        63        .71  

Credit card

     100        5        95        9.51  

Other consumer

     69        11        58        1.51  

Total

   $ 827      $ 136      $ 691        1.77  
 

 

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Total net charge-offs are significantly lower than they would have been otherwise due to the accounting treatment for purchased impaired loans. This treatment also results in a lower ratio of net charge-offs to average loans. Customer balances related to these purchased impaired loans were reduced by the fair value adjustments of $9.2 billion as of December 31, 2008. See Note 6 Purchased Impaired Loans in the Notes To Consolidated Financial Statements in this Report for additional information on net charge-offs related to these loans.

We maintain an ALLL to absorb losses from the loan portfolio and determine this allowance based on quarterly assessments of the estimated probable credit losses incurred in the loan portfolio. While we make allocations to specific loans and pools of loans, the total reserve is available for all loan and lease losses. Although quantitative modeling factors as discussed below are constantly changing as the financial strength of the borrower and overall economic conditions change, there were no significant changes during the first quarter of 2011 to the methodology we follow to determine our ALLL.

We establish specific allowances for loans considered impaired using methods prescribed by GAAP. All impaired loans are subject to individual analysis, except leases and large groups of smaller-balance homogeneous loans which may include, but are not limited to, credit card, residential mortgage, and consumer installment loans. Specific allowances for individual loans are determined by our Special Asset Committee based on an analysis of the present value of expected future cash flows from the loans discounted at their effective interest rate, observable market price, or the fair value of the underlying collateral.

Allocations to commercial loan classes (pool reserve methodology) are assigned to pools of loans as defined by our business structure and are based on internal probability of default and loss given default credit risk ratings. Key elements of the pool reserve methodology include:

   

Probability of Default (PD), which is primarily based on historical default analyses and is derived from the borrower’s internal PD credit risk rating;

   

Exposure at Default (EAD), which is derived from historical default data; and

   

Loss Given Default (LGD), which is based on historical loss data, collateral value and other structural factors that may affect our ultimate ability to collect on the loan and is derived from the loan’s internal LGD credit risk rating.

As more fully described in Part II, Item 7 of our 2010 Form 10-K, our pool reserve methodology is sensitive to changes in key risk parameters such as PDs, LGDs and EADs. In general, a given change in any of the major risk parameters will have a corresponding change in the pool reserve allocations for

non-impaired commercial loans. Our commercial loans are the largest category of credits and are most sensitive to changes in the key risk parameters and pool reserve loss rates. Additionally, other factors such as the rate of migration in the severity of problem loans will contribute to the final pool reserve allocations.

The majority of the commercial portfolio is secured by collateral, including loans to asset-based lending customers that continue to show demonstrably lower loss given default. Further, the large investment grade or equivalent portion of the loan portfolio has performed well and has not been subject to significant deterioration. Additionally, guarantees on loans greater than $1 million and owner guarantees for small business loans do not significantly impact our ALLL.

Allocations to consumer loan classes are based upon a roll-rate model based on statistical relationships, calculated from historical data that estimate the movement of loan outstandings through the various stages of delinquency and ultimately charge-off. In general, the estimated rates at which loan outstandings roll from one stage of delinquency to another are dependent on various factors such as FICO credit scores, loan-to-value ratios, the current economic environment, and geography.

The ALLL is significantly lower than it would have been otherwise due to the accounting treatment for purchased impaired loans. This treatment also results in a lower ratio of ALLL to total loans. Loan loss reserves on the purchased impaired loans were not carried over on the date of acquisition. In addition, these loans were recorded net of $9.2 billion of fair value adjustments as of December 31, 2008. As of March 31, 2011, we have established reserves of $876 million for purchased impaired loans.

A portion of the ALLL related to qualitative and measurement factors has been assigned to loan categories based on the relative specific and pool allocation amounts to provide coverage for specific and pool reserve methodologies. These factors include, but are not limited to, the following:

   

industry concentrations and conditions;

   

credit quality trends;

   

recent loss experience in particular sectors of the portfolio;

   

changes in risk selection and underwriting standards; and

   

timing of available information.

In addition to the ALLL, we maintain an allowance for unfunded loan commitments and letters of credit. We report this allowance as a liability on our Consolidated Balance Sheet. We determine this amount using estimates of the probability of the ultimate funding and losses related to those credit exposures. This methodology is very similar to the one we use for determining the adequacy of our ALLL.

 

 

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We refer you to Note 5 Asset Quality and Allowances for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit for further information on key asset quality indicators that we use to evaluate our portfolio and establish the allowances.

Allowance for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit

 

Dollars in millions    2011     2010  

January 1

   $ 4,887     $ 5,072  

Total net charge-offs

     (533     (691

Provision for credit losses

     421       751  

Adoption of ASU 2009-17, Consolidations

       141  

Acquired allowance adjustments

       2  

Net change in allowance for unfunded loan commitments and letters of credit

     (16     44  

March 31

   $ 4,759     $ 5,319  

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

     1.44     1.77

Allowance for loan and lease losses to total loans

     3.19       3.38  

Commercial lending net charge-offs

   $ (248   $ (437

Consumer lending net charge-offs

     (285     (254

Total net charge-offs

   $ (533   $ (691

Net charge-offs to average loans

      

Commercial lending

     1.25     2.11

Consumer lending

     1.65       1.38  

The provision for credit losses totaled $421 million for the first quarter of 2011 compared to $751 million for the first quarter of 2010. This decrease in provision reflected reductions in overall credit exposure, changes in loan portfolio composition as well as the improvement in asset quality over the past year. For the first quarter of 2011, the provision for commercial credit losses declined by $266 million or 68% from the first quarter of 2010. Similarly, the provision for consumer credit losses decreased $64 million or 18% from the first quarter of 2010. Correspondingly, the level of ALLL has also been decreasing.

The portion of the ALLL allocated to commercial nonperforming loans was 26% at March 31, 2011 and 28% at December 31, 2010. Approximately 77% of total nonperforming loans are secured by collateral which would be expected to reduce credit losses and require less reserves in the event of default.

The allowance allocated to purchased impaired loans and consumer loans and lines of credit not secured by residential real estate, which are both excluded from nonperforming loans, was $1.3 billion and $1.4 billion at March 31, 2011, and December 31, 2010, respectively. Excluding these balances, the allowance as a percent of nonperforming loans was 79% and 77% as of March 31, 2011 and December 31, 2010, respectively.

See Note 5 Asset Quality and Allowances for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit and Note 6 Purchased Impaired Loans in the Notes To Consolidated Financial Statements of this Report regarding changes in the ALLL and in the allowance for unfunded loan commitments and letters of credit.

CREDIT DEFAULT SWAPS

From a credit risk management perspective, we buy and sell credit loss protection via the use of credit derivatives. When we buy loss protection by purchasing a credit default swap (CDS), we pay a fee to the seller, or CDS counterparty, in return for the right to receive a payment if a specified credit event occurs for a particular obligor or reference entity. We purchase CDSs to mitigate the risk of economic loss on a portion of our loan exposures.

We also sell loss protection to mitigate the net premium cost and the impact of fair value accounting on the CDS in cases where we buy protection to hedge the loan portfolio. These activities represent additional risk positions rather than hedges of risk.

We approve counterparty credit lines for all of our CDS activities. Counterparty credit lines are approved based on a review of credit quality in accordance with our traditional credit quality standards and credit policies. The credit risk of our counterparties is monitored in the normal course of business. In addition, all counterparty credit lines are subject to collateral thresholds and exposures above these thresholds are secured.

CDSs are included in the “Derivatives not designated as hedging instruments under GAAP” table in the Financial Derivatives section of this Risk Management discussion.

LIQUIDITY RISK MANAGEMENT

Liquidity risk has two fundamental components. The first is the potential loss if we were unable to meet our funding requirements at a reasonable cost. The second is the potential inability to operate our businesses because adequate contingent liquidity is not available in a stressed environment. We manage liquidity risk at the bank and parent company levels to help ensure that we can obtain cost-effective funding to meet current and future obligations under both normal “business as usual” and stressful circumstances and to help ensure that we maintain an appropriate level of contingent liquidity.

Spot and forward funding gap analyses are the primary metrics used to measure and monitor bank liquidity risk. Funding gaps represent the difference in projected sources of liquidity available to offset projected uses. We calculate funding gaps for the overnight, thirty-day, ninety-day, one hundred eighty-day and one-year time intervals. Risk limits are established within our Liquidity Risk Policy. Management’s Asset and Liability Committee regularly reviews compliance with the established limits.

 

 

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Parent company liquidity guidelines are designed to help ensure that sufficient liquidity is available to meet our parent company obligations over the succeeding 24-month period. Risk limits for parent company liquidity are established within our Enterprise Capital Management Policy. The Board of Directors’ Risk Committee regularly reviews compliance with the established limits.

Bank Level Liquidity – Uses

Obligations requiring the use of liquidity can generally be characterized as either contractual or discretionary. At the bank level, primary contractual obligations include funding loan commitments, satisfying deposit withdrawal requests and maturities and debt service related to bank borrowings. We also maintain adequate bank liquidity to meet future potential loan demand and provide for other business needs, as necessary.

As of March 31, 2011, there were approximately $3.9 billion of bank borrowings with maturities of less than one year.

Bank Level Liquidity – Sources

Our largest source of bank liquidity on a consolidated basis is the deposit base that comes from our retail and commercial businesses. Liquid assets and unused borrowing capacity from a number of sources are also available to maintain our liquidity position. Borrowed funds come from a diverse mix of short and long-term funding sources.

At March 31, 2011, our liquid assets consisted of short-term investments (Federal funds sold, resale agreements, trading securities, and interest-earning deposits with banks) totaling $5.9 billion and securities available for sale totaling $54.5 billion. Of our total liquid assets of $60.4 billion, we had $24.6 billion pledged as collateral for borrowings, trust, and other commitments. The level of liquid assets fluctuates over time based on many factors, including market conditions, loan and deposit growth and active balance sheet management.

In addition to the customer deposit base, which has historically provided the single largest source of relatively stable and low-cost funding and liquid assets, the bank also obtains liquidity through the issuance of traditional forms of funding including long-term debt (senior notes and subordinated debt and FHLB advances) and short-term borrowings (Federal funds purchased, securities sold under repurchase agreements, commercial paper issuances, and other short-term borrowings).

PNC Bank, N.A. has the ability to offer up to $20 billion in senior and subordinated unsecured debt obligations with maturities of more than nine months. Through March 31, 2011, PNC Bank, N.A. had issued $6.9 billion of debt under this program. Total senior and subordinated debt declined to $4.9 billion at March 31, 2011 from $5.5 billion at December 31, 2010 due to maturities.

PNC Bank, N.A. is a member of the FHLB-Pittsburgh and as such has access to advances from FHLB-Pittsburgh secured generally by residential mortgage and other mortgage-related loans. At March 31, 2011, our unused secured borrowing capacity was $15.2 billion with FHLB-Pittsburgh. Total FHLB borrowings declined to $5.0 billion at March 31, 2011 from $6.0 billion at December 31, 2010 due to maturities.

PNC Bank, N.A. has the ability to offer up to $3.0 billion of its commercial paper. As of March 31, 2011, there were no issuances outstanding under this program. Commercial paper included in Other borrowed funds on our Consolidated Balance Sheet is issued by Market Street as described in Off-Balance Sheet Arrangements and Variable Interest Entities in this Financial Review.

PNC Bank, N.A. can also borrow from the Federal Reserve Bank of Cleveland’s (Federal Reserve Bank) discount window to meet short-term liquidity requirements. The Federal Reserve Bank, however, is not viewed as the primary means of funding our routine business activities, but rather as a potential source of liquidity in a stressed environment or during a market disruption. These potential borrowings are secured by securities and commercial loans. At March 31, 2011, our unused secured borrowing capacity was $25.0 billion with the Federal Reserve Bank.

Parent Company Liquidity – Uses

Obligations requiring the use of liquidity can generally be characterized as either contractual or discretionary. The parent company’s contractual obligations consist primarily of debt service related to parent company borrowings and funding non-bank affiliates. Additionally, the parent company maintains adequate liquidity to fund discretionary activities such as paying dividends to PNC shareholders, share repurchases, and acquisitions.

See 2011 Capital Actions in the Executive Summary section of this Financial Review for additional information regarding our April 2011 increase to PNC’s quarterly common stock dividend and our plans to purchase shares under PNC’s existing common stock repurchase plan during the remainder of 2011.

As of March 31, 2011, there were approximately $1.7 billion of parent company borrowings with maturities of less than one year.

Parent Company Liquidity – Sources

The principal source of parent company liquidity is the dividends it receives from its subsidiary bank, which may be impacted by the following:

   

Bank-level capital needs,

   

Laws and regulations,

   

Corporate policies,

   

Contractual restrictions, and

   

Other factors.

 

 

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The amount available for dividend payments by PNC Bank, N.A. to the parent company without prior regulatory approval was approximately $1.9 billion at March 31, 2011. There are statutory and regulatory limitations on the ability of national banks to pay dividends or make other capital distributions or to extend credit to the parent company or its non-bank subsidiaries. See Note 21 Regulatory Matters in the Notes To Consolidated Financial Statements in Part II, Item 8 of our 2010 Form 10-K for a further discussion of these limitations. Dividends may also be impacted by the bank’s capital needs and by contractual restrictions. We provide additional information on certain contractual restrictions under the “PNC Capital Trust E Trust Preferred Securities” and “Acquired Entity Trust Preferred Securities” sections of the Off-Balance Sheet Arrangements And Variable Interest Entities section of this Financial Review and in Note 13 Capital Securities of Subsidiary Trusts and Perpetual Trust Securities in the Notes To Consolidated Financial Statements in Part II, Item 8 of our 2010 Form 10-K.

In addition to dividends from PNC Bank, N.A., other sources of parent company liquidity include cash and short-term investments, as well as dividends and loan repayments from other subsidiaries and dividends or distributions from equity investments. As of March 31, 2011, the parent company had approximately $5.4 billion in funds available from its cash and short-term investments.

We can also generate liquidity for the parent company and PNC’s non-bank subsidiaries through the issuance of debt securities and equity securities, including certain capital securities, in public or private markets and commercial paper.

We have effective shelf registration statements pursuant to which we can issue additional debt and equity securities, including certain hybrid capital instruments. Total senior and subordinated debt and hybrid capital instruments was $15.8 billion at March 31, 2011 compared with $17.3 billion at December 31, 2010.

The parent company, through its subsidiary PNC Funding Corp, has the ability to offer up to $3.0 billion of commercial paper to provide additional liquidity. As of March 31, 2011, there were no issuances outstanding under this program.

Note 18 Equity in Part II, Item 8 of our 2010 Form 10-K describes the December 31, 2008 issuance of 75,792 shares of our Fixed Rate Cumulative Perpetual Preferred Shares, Series N (Series N Preferred Stock), related issuance discount and the issuance of a related common stock warrant to the US Treasury under the TARP Capital Purchase Program. In

addition, Note 18 in our 2010 Form 10-K describes our February 2010 redemption of the Series N Preferred Stock, the acceleration of the accretion of the remaining issuance discount on the Series N Preferred Stock in the first quarter of 2010 (and a corresponding reduction in retained earnings of $250 million in the first quarter of 2010), and the exchange by the US Treasury of the TARP warrant into warrants sold by the US Treasury in a secondary public offering. These common stock warrants will expire December 31, 2018.

Status of Credit Ratings

The cost and availability of short- and long-term funding, as well as collateral requirements for certain derivative instruments, is influenced by debt ratings.

In general, rating agencies base their ratings on many quantitative and qualitative factors, including capital adequacy, liquidity, asset quality, business mix, level and quality of earnings, and the current legislative and regulatory environment, including implied government support. In addition, rating agencies themselves have been subject to scrutiny arising from the financial crisis and could make or be required to make substantial changes to their ratings policies and practices, particularly in response to legislative and regulatory changes, including as a result of provisions in Dodd-Frank. Potential changes in the legislative and regulatory environment and the timing of those changes could impact our ratings, which as noted above, could impact our liquidity and financial condition. A decrease, or potential decrease, in credit ratings could impact access to the capital markets and/or increase the cost of debt, and thereby adversely affect liquidity and financial condition.

Credit ratings as of March 31, 2011 for PNC and PNC Bank, N.A. follow:

 

    Moody’s     Standard &
Poor’s
    Fitch  

The PNC Financial Services Group, Inc.

                       

Senior debt

    A3        A        A+   

Subordinated debt

    Baa1        A-        A   

Preferred stock

    Baa3        BBB        A   
 

PNC Bank, N.A.

       

Subordinated debt

    A3        A        A   

Long-term deposits

    A2        A+        AA-   

Short-term deposits

    P-1        A-1        F1+   

Commitments

The following tables set forth contractual obligations and various other commitments as of March 31, 2011 representing required and potential cash outflows.

 

 

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Contractual Obligations

 

           Payment Due By Period  
March 31, 2011 – in millions   Total     Less than
one year
    One to
three
years
    Four to
five
years
    After five
years
 

Remaining contractual maturities of time deposits (a)

  $ 39,380     $ 30,182     $ 7,025     $ 1,435     $ 738  

Borrowed funds (a)

    34,996       11,420       8,319       4,820       10,437  

Minimum annual rentals on noncancellable leases

    2,386       329       567       405       1,085  

Nonqualified pension and postretirement benefits

    572       69       123       117       263  

Purchase obligations (b)

    651       272       261       111       7  

Total contractual cash obligations

  $ 77,985     $ 42,272     $ 16,295     $ 6,888     $ 12,530  
(a) Includes purchase accounting adjustments.
(b) Includes purchase obligations for goods and services covered by noncancellable contracts and contracts including cancellation fees.

At March 31, 2011, the liability for uncertain tax positions, excluding associated interest and penalties, was $294 million. This liability represents an estimate of tax positions that we have taken in our tax returns which ultimately may not be sustained upon examination by taxing authorities. Since the ultimate amount and timing of any future cash settlements cannot be predicted with reasonable certainty, this estimated liability has been excluded from the contractual obligations table. See Note 15 Income Taxes in the Notes To Consolidated Financial Statements of this Report for additional information.

Our contractual obligations totaled $84.6 billion at December 31, 2010. The decline in the comparison is primarily attributable to the maturities of borrowed funds.

Other Commitments (a)

 

           Amount Of Commitment Expiration
By Period
 
March 31, 2011 – in millions   Total
Amounts
Committed
    Less
than one
year
    One to
three
years
    Four to
five
years
    After
five
years
 

Net unfunded credit commitments

  $ 96,781     $ 51,816     $ 35,543     $ 9,149     $ 273  

Standby letters of credit (b)

    10,173       4,505       4,929       641       98  

Reinsurance agreements (c)

    4,894       1,262       130       65       3,437  

Other commitments (d)

    708       359       238       98       13  

Total commitments

  $ 112,556     $ 57,942     $ 40,840     $ 9,953     $ 3,821  
(a) Other commitments are funding commitments that could potentially require performance in the event of demands by third parties or contingent events. Loan commitments are reported net of syndications, assignments and participations.
(b) Includes $7.1 billion of standby letters of credit that support remarketing programs for customers’ variable rate demand notes.
(c) Reinsurance agreements are with third-party insurers related to insurance sold to our customers.
(d) Includes unfunded commitments related to private equity investments of $300 million and other investments of $9 million which are not on our Consolidated Balance Sheet. Also includes commitments related to tax credit investments of $364 million and other direct equity investments of $35 million which are included in Other liabilities on our Consolidated Balance Sheet.

MARKET RISK MANAGEMENT OVERVIEW

Market risk is the risk of a loss in earnings or economic value due to adverse movements in market factors such as interest rates, credit spreads, foreign exchange rates, and equity prices. We are exposed to market risk primarily by our involvement in the following activities, among others:

   

Traditional banking activities of taking deposits and extending loans,

   

Equity and other investments and activities whose economic values are directly impacted by market factors, and

   

Trading in fixed income products, equities, derivatives, and foreign exchange, as a result of customer activities and underwriting.

We have established enterprise-wide policies and methodologies to identify, measure, monitor, and report market risk. Market Risk Management provides independent oversight by monitoring compliance with these limits and guidelines, and reporting significant risks in the business to the Risk Committee of the Board.

MARKET RISK MANAGEMENT – INTEREST RATE RISK

Interest rate risk results primarily from our traditional banking activities of gathering deposits and extending loans. Many factors, including economic and financial conditions, movements in interest rates, and consumer preferences, affect the difference between the interest that we earn on assets and the interest that we pay on liabilities and the level of our noninterest-bearing funding sources. Due to the repricing term mismatches and embedded options inherent in certain of these products, changes in market interest rates not only affect expected near-term earnings, but also the economic values of these assets and liabilities.

Asset and Liability Management centrally manages interest rate risk within limits and guidelines set forth in our risk management policies approved by management’s Asset and Liability Committee and the Risk Committee of the Board.

Sensitivity results and market interest rate benchmarks for the first quarters of 2011 and 2010 follow:

 

 

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Interest Sensitivity Analysis

 

      First
Quarter
2011
    First
Quarter
2010
 

Net Interest Income Sensitivity Simulation

      

Effect on net interest income in first year from gradual interest rate change over following 12 months of:

      

100 basis point increase

     1.1     1.3

100 basis point decrease (a)

     (.9 )%      (2.1 )% 

Effect on net interest income in second year from gradual interest rate change over the preceding 12 months of:

      

100 basis point increase

     3.4     1.3

100 basis point decrease (a)

     (3.4 )%      (6.3 )% 

Duration of Equity Model (a)

      

Base case duration of equity (in years):

            (1.7

Key Period-End Interest Rates

      

One-month LIBOR

     .24     .25

Three-year swap

     1.47     1.81
(a) Given the inherent limitations in certain of these measurement tools and techniques, results become less meaningful as interest rates approach zero.

In addition to measuring the effect on net interest income assuming parallel changes in current interest rates, we routinely simulate the effects of a number of nonparallel interest rate environments. The following Net Interest Income Sensitivity to Alternative Rate Scenarios table reflects the percentage change in net interest income over the next two 12-month periods assuming (i) the PNC Economist’s most likely rate forecast, (ii) implied market forward rates, and (iii) a Two-Ten Slope decrease (a 200 basis point decrease between two-year and ten-year rates superimposed on current base rates) scenario.

Net Interest Income Sensitivity to Alternative Rate Scenarios (First Quarter 2011)

 

      PNC
Economist
    Market
Forward
    Two-Ten
Slope
 

First year sensitivity

     .2         .1

Second year sensitivity

     1.1     2.1     (.4 )% 

All changes in forecasted net interest income are relative to results in a base rate scenario where current market rates are assumed to remain unchanged over the forecast horizon.

When forecasting net interest income, we make assumptions about interest rates and the shape of the yield curve, the volume and characteristics of new business, and the behavior of existing on- and off-balance sheet positions. These assumptions determine the future level of simulated net interest income in the base interest rate scenario and the other interest rate scenarios presented in the above table. These simulations assume that as assets and liabilities mature, they are replaced or repriced at then current market rates. We also consider forward projections of purchase accounting accretion when forecasting net interest income.

The following graph presents the yield curves for the base rate scenario and each of the alternate scenarios one year forward.

LOGO

The first quarter 2011 interest sensitivity analyses indicate that our Consolidated Balance Sheet is positioned to benefit from an increase in interest rates. We believe that we have the deposit funding base and balance sheet flexibility to adjust, where appropriate and permissible, to changing interest rates and market conditions.

MARKET RISK MANAGEMENT – TRADING RISK

Our trading activities are primarily customer-driven trading in fixed income securities, derivatives, and foreign exchange contracts. They also include the underwriting of fixed income and equity securities.

We use value-at-risk (VaR) as the primary means to measure and monitor market risk in trading activities. The Risk Committee of the Board establishes an enterprise-wide VaR limit on our trading activities.

During the first three months of 2011, our VaR ranged between $1.8 million and $3.8 million, averaging $3.1 million. During the first three months of 2010, our VaR ranged between $5.9 million and $8.8 million, averaging $7.1 million.

To help ensure the integrity of the models used to calculate VaR for each portfolio and enterprise-wide, we use a process known as backtesting. The backtesting process consists of comparing actual observations of trading-related gains or losses against the VaR levels that were calculated at the close of the prior day. Over a typical business cycle, we would expect an average of two to three instances a year in which actual losses exceeded the prior day VaR measure at the enterprise-wide level. There were no such instances during the first three months of 2011 or 2010, as the trading markets have moved into a period of relatively low pricing volatility.

 

 

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The following graph shows a comparison of enterprise-wide trading-related gains and losses against prior day VaR for the period.

LOGO

Total trading revenue was as follows:

Trading Revenue

 

Three months ended March 31

In millions

   2011      2010  

Net interest income

   $ 11      $ 16  

Noninterest income

     50        58  

Total trading revenue

   $ 61      $ 74  

Securities underwriting and trading (a)

   $ 16      $ 40  

Foreign exchange

     17        22  

Financial derivatives and other

     28        12  

Total trading revenue (b)

   $ 61      $ 74  
(a) Includes changes in fair value for certain loans accounted for at fair value.
(b) Product trading revenue includes related hedged activity.

Trading revenue excludes the impact of economic hedging activities, which relate primarily to residential mortgage servicing rights, and residential and held-for-sale commercial real estate loans.

Trading revenue for the first quarter of 2011 decreased $13 million compared with the first quarter of 2010 primarily due to lower underwriting revenues, which were partially offset by increased derivative client sales and reduced impact of credit risk on customer derivative position values.

MARKET RISK MANAGEMENT – EQUITY AND OTHER INVESTMENT RISK

Equity investment risk is the risk of potential losses associated with investing in both private and public equity markets. In addition to extending credit, taking deposits, and underwriting and trading financial instruments, we make and manage direct investments in a variety of transactions, including management buyouts, recapitalizations, and growth financings in a variety of industries. We also have investments in affiliated and non-affiliated funds that make similar investments in private equity and in debt and equity-oriented hedge funds. The economic and/or book value of these investments and other assets such as loan servicing rights are directly affected by changes in market factors.

The primary risk measurement for equity and other investments is economic capital. Economic capital is a common measure of risk for credit, market and operational risk. It is an estimate of the worst-case value depreciation over

a one year horizon to a level commensurate with a financial institution with an A rating by the credit rating agencies. Given the illiquid nature of many of these types of investments, it can be a challenge to determine their fair values. Market Risk Management and Finance provide independent oversight of the valuation process.

Various PNC business units manage our equity and other investment activities. Our businesses are responsible for making investment decisions within the approved policy limits and associated guidelines.

A summary of our equity investments follows:

 

In millions    Mar. 31
2011
     Dec. 31
2010
 

BlackRock

   $ 5,068      $ 5,017  

Tax credit investments

     2,304        2,054  

Private equity

     1,446        1,375  

Visa

     456        456  

Other

     321        318  

Total

   $ 9,595      $ 9,220  

BlackRock

PNC owned approximately 36 million common stock equivalent shares of BlackRock equity at March 31, 2011, accounted for under the equity method. The primary risk measurement, similar to other equity investments, is economic capital. The Business Segments Review section of this Financial Review includes additional information about BlackRock.

Tax Credit Investments

Included in our equity investments are tax credit investments which are mostly accounted for under the equity method. These investments, as well as equity investments held by consolidated partnerships, totaled $2.3 billion at March 31, 2011 and $2.1 billion at December 31, 2010.

Private Equity

The private equity portfolio is an illiquid portfolio comprised of equity and mezzanine investments that vary by industry, stage and type of investment.

Private equity investments carried at estimated fair value totaled $1.4 billion at both March 31, 2011 and December 31, 2010. As of March 31, 2011, $794 million was invested directly in a variety of companies and $652 million was invested indirectly through various private equity funds. Included in direct investments are investment activities of two private equity funds that are consolidated for financial reporting purposes. The noncontrolling interests of these funds totaled $255 million as of March 31, 2011. The indirect private equity funds are not redeemable, but PNC receives distributions over the life of the partnership from liquidation of the underlying investments by the investee.

 

 

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Our unfunded commitments related to private equity totaled $300 million at March 31, 2011 compared with $319 million at December 31, 2010.

Visa

At March 31, 2011, our investment in Visa Class B common shares totaled approximately 23 million shares. In March 2011, Visa funded $400 million to their litigation escrow account and reduced the conversion ratio of Visa B to A shares. We consequently recognized our estimated $38 million share of the $400 million as a reduction of our previously established indemnification liability and a reduction of noninterest expense. Our indemnification liability included on our Consolidated Balance Sheet at March 31, 2011 totaled $32 million. Our ultimate exposure to the specified Visa litigation may be different than this amount.

As of March 31, 2011, we had recognized $456 million of our Visa ownership, which we acquired with National City, on our Consolidated Balance Sheet. Based on the March 31, 2011 closing price of $73.62 for the Visa Class A shares, the market value of our investment was $837 million. The Visa Class B common shares we own generally will not be transferable, except under limited circumstances, until they can be converted into shares of the publicly traded class of stock, which cannot happen until the settlement of all of the specified litigation. It is expected that Visa will continue to adjust the conversion ratio of Visa Class B to Class A shares in connection with any settlements in excess of any amounts then in escrow for that purpose and will also reduce the conversion ratio to the extent that it adds any funds to the escrow in the future.

Note 17 Commitments and Guarantees in our Notes To Consolidated Financial Statements of this Report has further information on our Visa indemnification obligation.

Other Investments

We also make investments in affiliated and non-affiliated funds with both traditional and alternative investment strategies. The economic values could be driven by either the fixed-income market or the equity markets, or both. At March 31, 2011, other investments totaled $321 million compared with $318 million at December 31, 2010. We recognized net gains related to these investments of $15 million during the first three months of 2011 compared with $17 million during the first three months of 2010.

Given the nature of these investments, if market conditions affecting their valuation were to worsen, we could incur future losses.

Our unfunded commitments related to other investments totaled $9 million at March 31, 2011 and $11 million at December 31, 2010.

Financial Derivatives

We use a variety of financial derivatives as part of the overall asset and liability risk management process to help manage interest rate, market and credit risk inherent in our business activities. Substantially all such instruments are used to manage risk related to changes in interest rates. Interest rate and total return swaps, interest rate caps and floors, swaptions, options, forwards and futures contracts are the primary instruments we use for interest rate risk management. We also enter into derivatives with customers to facilitate their risk management activities.

Financial derivatives involve, to varying degrees, interest rate, market and credit risk. For interest rate swaps and total return swaps, options and futures contracts, only periodic cash payments and, with respect to options, premiums are exchanged. Therefore, cash requirements and exposure to credit risk are significantly less than the notional amount on these instruments.

Further information on our financial derivatives is presented in Note 1 Accounting Policies in our Notes To Consolidated Financial Statements under Part II, Item 8 of our 2010 Form 10-K and in Note 12 Financial Derivatives in the Notes To Consolidated Financial Statements in this Report, which is incorporated here by reference.

Not all elements of interest rate, market and credit risk are addressed through the use of financial or other derivatives, and such instruments may be ineffective for their intended purposes due to unanticipated market changes, among other reasons.

 

 

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The following table provides the notional or contractual amounts and estimated net fair value of financial derivatives at March 31, 2011 and December 31, 2010.

Financial Derivatives

 

     March 31, 2011     December 31, 2010  
In millions    Notional/
Contractual
Amount
     Estimated
Net Fair
Value
    Notional/
Contractual
Amount
     Estimated
Net Fair
Value
 

Derivatives designated as hedging instrument under GAAP

            

Interest rate contracts (a)

            

Asset rate conversion

            

Receive fixed swaps

   $ 15,546      $ 284     $ 14,452      $ 332  

Pay fixed swaps

     2,160        24       1,669        12  

Liability rate conversion

            

Receive fixed swaps

     9,803        717       9,803        834  

Forward purchase commitments

     700        4       2,350        (8

Total interest rate risk management

     28,209        1,029       28,274        1,170  

Total derivatives designated as hedging instruments (b)

   $ 28,209      $ 1,029     $ 28,274      $ 1,170  

Derivatives not designated as hedging instruments under GAAP

            

Derivatives used for residential mortgage banking activities:

            

Interest rate contracts

            

Swaps

   $ 92,278      $ 156     $ 83,421      $ 63  

Futures

     52,913          51,699       

Future options

     18,200        8       31,250        21  

Swaptions

     8,930        103       11,040        28  

Commitments related to residential mortgage assets

     13,250        20       16,652        47  

Total residential mortgage banking activities

   $ 185,571      $ 287     $ 194,062      $ 159  

Derivatives used for commercial mortgage banking activities:

            

Interest rate contracts

            

Swaps

   $ 1,747      $ (37   $ 1,744      $ (41

Commitments related to commercial mortgage assets

     608        1       1,228        5  

Credit contracts

            

Credit default swaps

     215        8       210        8  

Total commercial mortgage banking activities

   $ 2,570      $ (28   $ 3,182      $ (28

Derivatives used for customer-related activities:

            

Interest rate contracts

            

Swaps

   $ 92,802      $ (93   $ 92,248      $ (104

Caps/floors

            

Sold (c)

     3,639        (16     3,207        (15

Purchased

     3,052        18       2,528        14  

Swaptions

     2,115        8       2,165        13  

Futures

     2,379          2,793       

Commitments related to residential mortgage assets

     1,347        1       738       

Foreign exchange contracts (c)

     9,930        (10     7,913        (6

Equity contracts (c)

     339        (4     334        (3

Credit contracts

            

Risk participation agreements

     3,003        1       2,738        3  

Other contracts

     340                            

Total customer-related

   $ 118,946      $ (95   $ 114,664      $ (98

Derivatives used for other risk management activities:

            

Interest rate contracts

            

Swaps

   $ 818      $ 4     $ 3,021      $ 6  

Swaptions

          100        4  

Futures

     294          298       

Commitments related to residential mortgage assets

     340        1       1,100        1  

Foreign exchange contracts

     31        (4     32        (4

Credit contracts

            

Credit default swaps

     543        7       551        8  

Other contracts (c) (d)

     209        (447     209        (396

Total other risk management

   $ 2,235      $ (439   $ 5,311      $ (381

Total derivatives not designated as hedging instruments

   $ 309,322      $ (275   $ 317,219      $ (348

Total Gross Derivatives

   $ 337,531      $ 754     $ 345,493      $ 822  
(a) The floating rate portion of interest rate contracts is based on money-market indices. As a percent of notional amount, 59% were based on 1-month LIBOR and 41% on 3-month LIBOR at March 31, 2011 compared with 58% and 42%, respectively, at December 31, 2010.
(b) Fair value amount includes net accrued interest receivable of $123 million at March 31, 2011 and $132 million at December 31, 2010.
(c) The increases in the negative fair values from December 31, 2010 to March 31, 2011 for interest rate contracts, foreign exchange, equity contracts and other contracts were due to the changes in fair values of the existing contracts along with new contracts entered into during the first three months of 2011 and contracts terminated.
(d) Includes PNC’s obligation to fund a portion of certain BlackRock LTIP programs.

 

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INTERNAL CONTROLS AND DISCLOSURE CONTROLS AND PROCEDURES

As of March 31, 2011, we performed an evaluation under the supervision and with the participation of our management, including the Chairman and Chief Executive Officer and the Executive Vice President and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures and of changes in our internal control over financial reporting.

Based on that evaluation, our Chairman and Chief Executive Officer and our Executive Vice President and Chief Financial Officer concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities and Exchange Act of 1934, as amended) were effective as of March 31, 2011, and that there has been no change in PNC’s internal control over financial reporting that occurred during the first quarter of 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

GLOSSARY OF TERMS

Accretable net interest (Accretable yield) – The excess of cash flows expected to be collected on a purchased impaired loan over the carrying value of the loan. The accretable net interest is recognized into interest income over the remaining life of the loan using the constant effective yield method.

Adjusted average total assets – Primarily comprised of total average quarterly (or annual) assets plus (less) unrealized losses (gains) on investment securities, less goodwill and certain other intangible assets (net of eligible deferred taxes).

Annualized – Adjusted to reflect a full year of activity.

Assets under management – Assets over which we have sole or shared investment authority for our customers/clients. We do not include these assets on our Consolidated Balance Sheet.

Basis point – One hundredth of a percentage point.

Cash recoveries – Cash recoveries used in the context of purchased impaired loans represent cash payments from customers that exceeded the recorded investment of the designated impaired loan.

Charge-off – Process of removing a loan or portion of a loan from our balance sheet because it is considered uncollectible. We also record a charge-off when a loan is transferred from portfolio holdings to held for sale by reducing the loan carrying amount to the fair value of the loan, if fair value is less than carrying amount.

Common shareholders’ equity to total assets – Common shareholders’ equity divided by total assets. Common shareholders’ equity equals total shareholders’ equity less the liquidation value of preferred stock.

Credit derivatives – Contractual agreements, primarily credit default swaps, that provide protection against a credit event of one or more referenced credits. The nature of a credit event is established by the protection buyer and protection seller at the inception of a transaction, and such events include bankruptcy, insolvency and failure to meet payment obligations when due. The buyer of the credit derivative pays a periodic fee in return for a payment by the protection seller upon the occurrence, if any, of a credit event.

Credit spread – The difference in yield between debt issues of similar maturity. The excess of yield attributable to credit spread is often used as a measure of relative creditworthiness, with a reduction in the credit spread reflecting an improvement in the borrower’s perceived creditworthiness.

Derivatives – Financial contracts whose value is derived from changes in publicly traded securities, interest rates, currency exchange rates or market indices. Derivatives cover a wide assortment of financial contracts, including but not limited to forward contracts, futures, options and swaps.

Duration of equity – An estimate of the rate sensitivity of our economic value of equity. A negative duration of equity is associated with asset sensitivity (i.e., positioned for rising interest rates), while a positive value implies liability sensitivity (i.e., positioned for declining interest rates). For example, if the duration of equity is +1.5 years, the economic value of equity declines by 1.5% for each 100 basis point increase in interest rates.

Earning assets – Assets that generate income, which include: Federal funds sold; resale agreements; trading securities; interest-earning deposits with banks; loans held for sale; loans; investment securities; and certain other assets.

Economic capital – Represents the amount of resources that a business segment should hold to guard against potentially large losses that could cause insolvency. It is based on a measurement of economic risk, as opposed to risk as defined by regulatory bodies. The economic capital measurement process involves converting a risk distribution to the capital that is required to support the risk, consistent with our target credit rating. As such, economic risk serves as a “common currency” of risk that allows us to compare different risks on a similar basis.

Effective duration – A measurement, expressed in years, that, when multiplied by a change in interest rates, would approximate the percentage change in value of on- and off- balance sheet positions.

 

 

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Efficiency – Noninterest expense divided by total revenue.

Fair value – The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

FICO score – A credit bureau-based industry standard score created by Fair Isaac Co. which predicts the likelihood of borrower default. We use FICO scores both in underwriting and assessing credit risk in our consumer lending portfolio. Lower FICO scores indicate likely higher risk of default, while higher FICO scores indicate likely lower risk of default. FICO scores are updated on a periodic basis.

Foreign exchange contracts – Contracts that provide for the future receipt and delivery of foreign currency at previously agreed-upon terms.

Funds transfer pricing – A management accounting methodology designed to recognize the net interest income effects of sources and uses of funds provided by the assets and liabilities of a business segment. We assign these balances LIBOR-based funding rates at origination that represent the interest cost for us to raise/invest funds with similar maturity and repricing structures.

Futures and forward contracts – Contracts in which the buyer agrees to purchase and the seller agrees to deliver a specific financial instrument at a predetermined price or yield. May be settled either in cash or by delivery of the underlying financial instrument.

GAAP – Accounting principles generally accepted in the United States of America.

Interest rate floors and caps – Interest rate protection instruments that involve payment from the protection seller to the protection buyer of an interest differential, which represents the difference between a short-term rate (e.g., three-month LIBOR) and an agreed-upon rate (the strike rate) applied to a notional principal amount.

Interest rate swap contracts – Contracts that are entered into primarily as an asset/liability management strategy to reduce interest rate risk. Interest rate swap contracts are exchanges of interest rate payments, such as fixed-rate payments for floating-rate payments, based on notional principal amounts.

Intrinsic value – The amount by which the fair value of an underlying stock exceeds the exercise price of an option on that stock.

Investment securities – Collectively, securities available for sale and securities held to maturity.

Leverage ratio – Tier 1 risk-based capital divided by adjusted average total assets.

LIBOR – Acronym for London InterBank Offered Rate. LIBOR is the average interest rate charged when banks in the London wholesale money market (or interbank market) borrow unsecured funds from each other. LIBOR rates are used as a benchmark for interest rates on a global basis.

Loan-to-value ratio (LTV) – A calculation of a loan’s collateral coverage that is used both in underwriting and assessing credit risk in our lending portfolio. LTV is the sum total of loan obligations secured by collateral divided by the market value of that same collateral. Market values of the collateral are based on an independent valuation of the collateral. For example, an LTV of less than 90% is better secured and has less credit risk than an LTV of greater than or equal to 90%. Our real estate market values are updated on an annual basis but may be updated more frequently for select loans.

Loss Given Default (LGD) – An estimate of recovery based on collateral type, collateral value, loan exposure, or the guarantor(s) quality and guaranty type (full or partial). Each loan has its own LGD. The LGD risk rating measures the percentage of exposure of a specific credit obligation that we expect to lose if default occurs. LGD is net of recovery, through either liquidation of collateral or deficiency judgments rendered from foreclosure or bankruptcy proceedings. The LGD rating is updated with the same frequency as the borrower’s PD rating, and should be done more frequently than the PD if the collateral values and amounts change often.

Net interest income from loans and deposits – A management accounting assessment, using funds transfer pricing methodology, of the net interest contribution from loans and deposits.

Net interest margin – Annualized taxable-equivalent net interest income divided by average earning assets.

Nonaccretable difference – Contractually required payments receivable on a purchased impaired loan in excess of the cash flows expected to be collected.

Nondiscretionary assets under administration – Assets we hold for our customers/clients in a non-discretionary, custodial capacity. We do not include these assets on our Consolidated Balance Sheet.

Nonperforming assets – Nonperforming assets include non-accrual loans, certain non-accrual troubled debt restructured loans, OREO, foreclosed and other assets. We do not accrue interest income on assets classified as nonperforming.

Nonperforming loans – Loans for which we do not accrue interest income. Nonperforming loans include loans to commercial, commercial real estate, equipment lease

 

 

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financing, consumer (including loans and lines of credit secured by residential real estate), and residential real estate (including mortgages and construction) customers as well as certain non-accrual troubled debt restructured loans. Nonperforming loans do not include loans held for sale or OREO and foreclosed assets. Nonperforming loans do not include purchased impaired loans as we are currently accreting interest income over the expected life of the loans.

Notional amount – A number of currency units, shares, or other units specified in a derivative contract.

Operating leverage – The period to period dollar or percentage change in total revenue (GAAP basis) less the dollar or percentage change in noninterest expense. A positive variance indicates that revenue growth exceeded expense growth (i.e., positive operating leverage) while a negative variance implies expense growth exceeded revenue growth (i.e., negative operating leverage).

Options – Contracts that grant the purchaser, for a premium payment, the right, but not the obligation, to either purchase or sell the associated financial instrument at a set price during a specified period or at a specified date in the future.

Other real estate owned (OREO) – Foreclosed assets taken in settlement of troubled loans through surrender or foreclosure. Foreclosed assets include all assets received in full or partial satisfaction of a loan and include real and personal property, equity interests in corporations, partnerships, joint ventures, and beneficial interests in trusts. Premises that are no longer used in operations may also be included in real estate owned.

Other-than-temporary impairment (OTTI) – When the fair value of a security is less than its amortized cost basis, an assessment is performed to determine whether the impairment is other-than-temporary. If we intend to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, an other-than-temporary impairment is considered to have occurred. In such cases, an other-than-temporary impairment is recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. Further, if we do not expect to recover the entire amortized cost of the security, an other-than-temporary impairment is considered to have occurred. However for debt securities, if we do not intend to sell the security and it is not more likely than not that we will be required to sell the security before its recovery, the other-than-temporary loss is separated into (a) the amount representing the credit loss, and (b) the amount related to all other factors. The other-than-temporary impairment related to credit losses is recognized in earnings while the amount related to all other factors is recognized in other comprehensive income, net of tax.

 

Pretax, pre-provision earnings from continuing operations – Total revenue less noninterest expense, both from continuing operations.

Probability of Default (PD) – An internal risk rating that indicates the likelihood that a credit obligor will enter into default status.

Provision-adjusted net interest margin – Net interest margin less the ratio of the annualized provision for credit losses to average interest-earning assets.

Purchase accounting accretion – Accretion of the discounts and premiums on acquired assets and liabilities. The purchase accounting accretion is recognized in net interest income over the weighted average life of the financial instruments using the constant effective yield method.

Purchased impaired loans – Acquired loans determined to be credit impaired under FASB ASC 310-30 (AICPA SOP 03-3). Loans are determined to be impaired if there is evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected.

Recorded investment – The initial investment of a purchased impaired loan plus interest accretion and less any cash payments and writedowns to date. The recorded investment excludes any valuation allowance which is included in our allowance for loan and lease losses.

Recovery – Cash proceeds received on a loan that we had previously charged off. We credit the amount received to the allowance for loan and lease losses.

Residential development loans – Project-specific loans to commercial customers for the construction or development of residential real estate including land, single family homes, condominiums and other residential properties. This would exclude loans to commercial customers where proceeds are for general corporate purposes whether or not such facilities are secured.

Residential mortgage servicing rights hedge gains/(losses), net – We have elected to measure acquired or originated residential mortgage servicing rights (MSRs) at fair value under GAAP. We employ a risk management strategy designed to protect the economic value of MSRs from changes in interest rates. This strategy utilizes securities and a portfolio of derivative instruments to hedge changes in the fair value of MSRs arising from changes in interest rates. These financial instruments are expected to have changes in fair value which are negatively correlated to the change in fair value of the MSR portfolio. Net MSR hedge gains/(losses) represent the change in the fair value of MSRs, exclusive of changes due to time decay and payoffs, combined with the change in the fair value of the associated securities and derivative instruments.

 

 

 

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Return on average assets – Annualized net income divided by average assets.

Return on average capital – Annualized net income divided by average capital.

Return on average common shareholders’ equity – Annualized net income less preferred stock dividends, including preferred stock discount accretion and redemptions, divided by average common shareholders’ equity.

Risk-weighted assets – Computed by the assignment of specific risk-weights (as defined by the Board of Governors of the Federal Reserve System) to assets and off-balance sheet instruments.

Securitization – The process of legally transforming financial assets into securities.

Servicing rights – An intangible asset or liability created by an obligation to service assets for others. Typical servicing rights include the right to receive a fee for collecting and forwarding payments on loans and related taxes and insurance premiums held in escrow.

Swaptions – Contracts that grant the purchaser, for a premium payment, the right, but not the obligation, to enter into an interest rate swap agreement during a specified period or at a specified date in the future.

Taxable-equivalent interest – The interest income earned on certain assets is completely or partially exempt from Federal income tax. As such, these tax-exempt instruments typically yield lower returns than taxable investments. To provide more meaningful comparisons of yields and margins for all interest-earning assets, we use interest income on a taxable-equivalent basis in calculating average yields and net interest margins by increasing the interest income earned on tax-exempt assets to make it fully equivalent to interest income earned on other taxable investments. This adjustment is not permitted under GAAP on the Consolidated Income Statement.

Tier 1 common capital – Tier 1 risk-based capital, less preferred equity, less trust preferred capital securities, and less noncontrolling interests.

Tier 1 common capital ratio – Tier 1 common capital divided by period-end risk-weighted assets.

Tier 1 risk-based capital – Total shareholders’ equity, plus trust preferred capital securities, plus certain noncontrolling interests that are held by others; less goodwill and certain other intangible assets (net of eligible deferred taxes relating to taxable and nontaxable combinations), less equity investments in nonfinancial companies less ineligible servicing assets and less net unrealized holding losses on available for sale equity securities. Net unrealized holding gains on available for sale equity securities, net unrealized holding gains (losses) on available for sale debt securities and

net unrealized holding gains (losses) on cash flow hedge derivatives are excluded from total shareholders’ equity for Tier 1 risk-based capital purposes.

Tier 1 risk-based capital ratio – Tier 1 risk-based capital divided by period-end risk-weighted assets.

Total equity – Total shareholders’ equity plus noncontrolling interests.

Total return swap – A non-traditional swap where one party agrees to pay the other the “total return” of a defined underlying asset (e.g., a loan), usually in return for receiving a stream of LIBOR-based cash flows. The total returns of the asset, including interest and any default shortfall, are passed through to the counterparty. The counterparty is therefore assuming the credit and economic risk of the underlying asset.

Total risk-based capital – Tier 1 risk-based capital plus qualifying subordinated debt and trust preferred securities, other noncontrolling interest not qualified as Tier 1, eligible gains on available for sale equity securities and the allowance for loan and lease losses, subject to certain limitations.

Total risk-based capital ratio – Total risk-based capital divided by period-end risk-weighted assets.

Transaction deposits – The sum of interest-bearing money market deposits, interest-bearing demand deposits, and noninterest-bearing deposits.

Troubled debt restructuring – A restructuring of a loan whereby the lender for economic or legal reasons related to the borrower’s financial difficulties grants a concession to the borrower that the lender would not otherwise consider.

Value-at-risk (VaR) – A statistically-based measure of risk which describes the amount of potential loss which may be incurred due to severe and adverse market movements. The measure is of the maximum loss which should not be exceeded on 99 out of 100 days.

Watchlist – A list of criticized loans, credit exposure or other assets compiled for internal monitoring purposes. We define criticized exposure for this purpose as exposure with an internal risk rating of other assets especially mentioned, substandard, doubtful or loss.

Yield curve – A graph showing the relationship between the yields on financial instruments or market indices of the same credit quality with different maturities. For example, a “normal” or “positive” yield curve exists when long-term bonds have higher yields than short-term bonds. A “flat” yield curve exists when yields are the same for short-term and long-term bonds. A “steep” yield curve exists when yields on long-term bonds are significantly higher than on short-term bonds. An “inverted” or “negative” yield curve exists when short-term bonds have higher yields than long-term bonds.

 

 

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

We make statements in this Report, and we may from time to time make other statements, regarding our outlook or expectations for earnings, revenues, expenses, capital levels, liquidity levels, asset quality and/or other matters regarding or affecting PNC and its future business and operations that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Forward-looking statements are typically identified by words such as “believe,” “plan,” “expect,” “anticipate,” “intend,” “outlook,” “estimate,” “forecast,” “will,” “should,” “project,” “goal,” “see” and other similar words and expressions.

Forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time. Forward-looking statements speak only as of the date they are made. We do not assume any duty and do not undertake to update our forward-looking statements. Actual results or future events could differ, possibly materially, from those that we anticipated in our forward-looking statements, and future results could differ materially from our historical performance.

Our forward-looking statements are subject to the following principal risks and uncertainties. We provide greater detail regarding some of these factors in our 2010 Form 10-K and elsewhere in this Report, including in the Risk Factors and Risk Management sections of those reports. Our forward-looking statements may also be subject to other risks and uncertainties, including those discussed elsewhere in this Report or in our other filings with the SEC.

 

 

Our businesses and financial results are affected by business and economic conditions, both generally and specifically in the principal markets in which we operate. In particular, our businesses and financial results may be impacted by:

   

Changes in interest rates and valuations in the debt, equity and other financial markets.

   

Disruptions in the liquidity and other functioning of financial markets, including such disruptions in the markets for real estate and other assets commonly securing financial products.

   

Actions by the Federal Reserve and other government agencies, including those that impact money supply and market interest rates.

   

Changes in our customers’, suppliers’ and other counterparties’ performance in general and their creditworthiness in particular.

   

A slowing or failure of the moderate economic recovery that began in mid-2009 and continued throughout 2010 and into 2011.

   

Continued effects of the aftermath of recessionary conditions and the uneven spread of the positive impacts of the recovery on the economy in general

   

and our customers in particular, including adverse impact on loan utilization rates as well as delinquencies, defaults and customer ability to meet credit obligations.

   

Changes in levels of unemployment.

   

Changes in customer preferences and behavior, whether as a result of changing business and economic conditions, climate-related physical changes or legislative and regulatory initiatives, or other factors.

 

Turbulence in significant portions of the US and global financial markets could impact our performance, both directly by affecting our revenues and the value of our assets and liabilities and indirectly by affecting our counterparties and the economy generally.

 

We will be impacted by the extensive reforms provided for in the Dodd-Frank Act and ongoing reforms impacting the financial institutions industry generally. Further, as much of the Dodd-Frank Act will require the adoption of implementing regulations by a number of different regulatory bodies, the precise nature, extent and timing of many of these reforms and the impact on us is still uncertain.

 

Financial industry restructuring in the current environment could also impact our business and financial performance as a result of changes in the creditworthiness and performance of our counterparties and by changes in the competitive and regulatory landscape.

 

Our results depend on our ability to manage current elevated levels of impaired assets.

 

Given current economic and financial market conditions, our forward-looking financial statements are subject to the risk that these conditions will be substantially different than we are currently expecting. These statements are based on our current view that the moderate economic recovery that began in mid-2009 and continued throughout 2010 will transition into a self-sustaining economic expansion in 2011 pushing the unemployment rate lower amidst continued low interest rates.

 

Legal and regulatory developments could have an impact on our ability to operate our businesses or our financial condition or results of operations or our competitive position or reputation. Reputational impacts, in turn, could affect matters such as business generation and retention, our ability to attract and retain management, liquidity, and funding. These legal and regulatory developments could include:

   

Changes resulting from legislative and regulatory responses to the current economic and financial industry environment.

   

Other legislative and regulatory reforms, including broad-based restructuring of financial industry regulation (such as those under the Dodd-Frank Act)

 

 

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as well as changes to laws and regulations involving tax, pension, bankruptcy, consumer protection, and other aspects of the financial institution industry.

   

Unfavorable resolution of legal proceedings or other claims and regulatory and other governmental investigations or other inquiries. In addition to matters relating to PNC’s business and activities, such matters may also include proceedings, claims, investigations, or inquiries relating to pre-acquisition business and activities of acquired companies, such as National City. These matters may result in monetary judgments or settlements or other remedies, including fines, penalties, restitution or alterations in our business practices and in additional expenses and collateral costs.

   

The results of the regulatory examination and supervision process, including our failure to satisfy the requirements of agreements with governmental agencies.

   

Changes in accounting policies and principles.

   

Changes resulting from legislative and regulatory initiatives relating to climate change that have or may have a negative impact on our customers’ demand for or use of our products and services in general and their creditworthiness in particular.

   

Changes to regulations governing bank capital, including as a result of the Dodd-Frank Act and of the Basel III initiatives.

 

Our business and operating results are affected by our ability to identify and effectively manage risks inherent in our businesses, including, where appropriate, through the effective use of third-party insurance, derivatives, and capital management techniques, and by our ability to meet evolving regulatory capital standards.

 

The adequacy of our intellectual property protection, and the extent of any costs associated with obtaining rights in intellectual property claimed by others, can impact our business and operating results.

 

Our ability to anticipate and respond to technological changes can have an impact on our ability to respond to customer needs and to meet competitive demands.

 

Our ability to implement our business initiatives and strategies could affect our financial performance over the next several years.

 

Competition can have an impact on customer acquisition, growth and retention, as well as on our credit spreads and product pricing, which can affect market share, deposits and revenues.

 

Our business and operating results can also be affected by widespread disasters, terrorist activities or international hostilities, either as a result of the impact on the economy and capital and other financial markets generally or on us or on our customers, suppliers or other counterparties specifically.

 

Also, risks and uncertainties that could affect the results anticipated in forward-looking statements or from historical performance relating to our equity interest in BlackRock, Inc. are discussed in more detail in BlackRock’s filings with the SEC, including in the Risk Factors sections of BlackRock’s reports. BlackRock’s SEC filings are accessible on the SEC’s website and on or through BlackRock’s website at www.blackrock.com. This material is referenced for informational purposes only and should not be deemed to constitute a part of this Report.

We grow our business in part by acquiring from time to time other financial services companies, financial services assets and related deposits. Acquisitions present us with risks in addition to those presented by the nature of the business acquired. These include risks and uncertainties related both to the acquisition transactions themselves and to the integration of the acquired businesses into PNC after closing.

Acquisitions may be substantially more expensive to complete (including unanticipated costs incurred in connection with the integration of the acquired company) and the anticipated benefits (including anticipated cost savings and strategic gains) may be significantly harder or take longer to achieve than expected. Acquisitions may involve our entry into new businesses or new geographic or other markets, and these situations also present risks resulting from our inexperience in those new areas.

As a regulated financial institution, our pursuit of attractive acquisition opportunities could be negatively impacted due to regulatory delays or other regulatory issues. In addition, regulatory and/or legal issues relating to the pre-acquisition operations of an acquired business may cause reputational harm to PNC following the acquisition and integration of the acquired business into ours and may result in additional future costs or regulatory limitations arising as a result of those issues.

 

 

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Consolidated Income Statement

The PNC Financial Services Group, Inc.

 

In millions, except per share data    Three months ended
March 31
 
Unaudited    2011     2010  

Interest Income

    

Loans

   $ 1,884     $ 2,160  

Investment securities

     578       623  

Other

     121       122  

Total interest income

     2,583       2,905  

Interest Expense

    

Deposits

     182       281  

Borrowed funds

     225       245  

Total interest expense

     407       526  

Net interest income

     2,176       2,379  

Noninterest Income

    

Asset management

     263       259  

Consumer services

     311       296  

Corporate services

     217       268  

Residential mortgage

     195       147  

Service charges on deposits

     123       200  

Net gains on sales of securities

     37       90  

Other-than-temporary impairments

     (30     (240

Less: Noncredit portion of other-than-temporary impairments (a)

     4       (124

Net other-than-temporary impairments

     (34     (116

Other

     343       240  

Total noninterest income

     1,455       1,384  

Total revenue

     3,631       3,763  

Provision For Credit Losses

     421       751  

Noninterest Expense

    

Personnel

     989       956  

Occupancy

     193       187  

Equipment

     167       172  

Marketing

     40       50  

Other

     681       748  

Total noninterest expense

     2,070       2,113  

Income from continuing operations before income taxes and noncontrolling interests

     1,140       899  

Income taxes

     308       251  

Income from continuing operations before noncontrolling interests

     832       648  

Income from discontinued operations (net of income taxes of zero and $14)

             23  

Net income

     832       671  

Less: Net income (loss) attributable to noncontrolling interests

     (5     (5

Preferred stock dividends

     4       93  

Preferred stock discount accretion

             250  

Net income attributable to common shareholders

   $ 833     $ 333  

Basic Earnings Per Common Share

    

Continuing operations

   $ 1.59     $ .62  

Discontinued operations

             .05  

Net income

   $ 1.59     $ .67  

Diluted Earnings Per Common Share

    

Continuing operations

   $ 1.57     $ .61  

Discontinued operations

             .05  

Net income

   $ 1.57     $ .66  

Average Common Shares Outstanding

    

Basic

     524       498  

Diluted

     526       500  

 

(a) Included in accumulated other comprehensive income (loss).

See accompanying Notes To Consolidated Financial Statements.

 

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Consolidated Balance Sheet

The PNC Financial Services Group, Inc.

 

In millions, except par value

Unaudited

   March 31
2011
    December 31
2010
 

Assets

    

Cash and due from banks (includes $2 and $2 for VIEs) (a)

   $ 3,389     $ 3,297  

Federal funds sold and resale agreements (includes $823 and $866 measured at fair value) (b)

     2,240       3,704  

Trading securities

     2,254       1,826  

Interest-earning deposits with banks (includes $83 and $288 for VIEs) (a)

     1,359       1,610  

Loans held for sale (includes $2,684 and $2,755 measured at fair value) (b)

     2,980       3,492  

Investment securities (includes $110 and $192 for VIEs) (a)

     60,992       64,262  

Loans (includes $4,796 and $4,645 for VIEs) (includes $229 and $116 measured at fair value) (a) (b)

     149,387       150,595  

Allowance for loan and lease losses (includes $(128) and $(183) for VIEs) (a)

     (4,759     (4,887

Net loans

     144,628       145,708  

Goodwill

     8,146       8,149  

Other intangible assets

     2,618       2,604  

Equity investments (includes $1,332 and $1,177 for VIEs) (a)

     9,595       9,220  

Other (includes $741 and $676 for VIEs) (includes $447 and $396 measured at fair value) (a) (b)

     21,177       20,412  

Total assets

   $ 259,378     $ 264,284  

Liabilities

    

Deposits

    

Noninterest-bearing

   $ 48,707     $ 50,019  

Interest-bearing

     133,283       133,371  

Total deposits

     181,990       183,390  

Borrowed funds

    

Federal funds purchased and repurchase agreements

     4,079       4,144  

Federal Home Loan Bank borrowings

     5,020       6,043  

Bank notes and senior debt

     11,324       12,904  

Subordinated debt

     9,310       9,842  

Other (includes $3,397 and $3,354 for VIEs) (a)

     5,263       6,555  

Total borrowed funds

     34,996       39,488  

Allowance for unfunded loan commitments and letters of credit

     204       188  

Accrued expenses (includes $113 and $88 for VIEs) (a)

     3,078       3,188  

Other (includes $715 and $456 for VIEs) (a)

     5,393       5,192  

Total liabilities

     225,661       231,446  

Equity

    

Preferred stock (c)

    

Common stock – $5 par value

    

Authorized 800 shares, issued 536 and 536 shares

     2,682       2,682  

Capital surplus – preferred stock

     647       647  

Capital surplus – common stock and other

     12,056       12,057  

Retained earnings

     16,640       15,859  

Accumulated other comprehensive income (loss)

     (309     (431

Common stock held in treasury at cost: 10 and 10 shares

     (584     (572

Total shareholders’ equity

     31,132       30,242  

Noncontrolling interests

     2,585       2,596  

Total equity

     33,717       32,838  

Total liabilities and equity

   $ 259,378     $ 264,284  

 

(a) Amounts represent the assets or liabilities of consolidated variable interest entities (VIEs).
(b) Amounts represent items for which the Corporation has elected the fair value option.
(c) Par value less than $.5 million at each date.

See accompanying Notes To Consolidated Financial Statements.

 

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Consolidated Statement Of Cash Flows

The PNC Financial Services Group, Inc.

 

In millions    Three months ended March 31  
Unaudited    2011      2010  

Operating Activities

     

Net income

   $ 832      $ 671  

Adjustments to reconcile net income to net cash provided (used) by operating activities

     

Provision for credit losses

     421        751  

Depreciation and amortization

     279        226  

Deferred income taxes

     46        254  

Net gains on sales of securities

     (37      (90

Net other-than-temporary impairments

     34        116  

Undistributed earnings of BlackRock

     (55      (57

Net change in

     

Trading securities and other short-term investments

     (294      885  

Loans held for sale

     166        (218

Other assets

     (291      437  

Accrued expenses and other liabilities

     (411      (907

Other

     37        204  

Net cash provided (used) by operating activities

     727        2,272  

Investing Activities

     

Sales

     

Securities available for sale

     8,018        6,040  

Loans

     590        299  

Repayments/maturities

     

Securities available for sale

     1,590        1,815  

Securities held to maturity

     506        256  

Purchases

     

Securities available for sale

     (7,237      (9,154

Securities held to maturity

     (22      (527

Loans

     (417      (1,532

Net change in

     

Federal funds sold and resale agreements

     1,456        1,024  

Interest-earning deposits with banks

     251        3,881  

Loans

     458        3,251  

Other

     (80      264  

Net cash provided (used) by investing activities

     5,113        5,617  

(continued on following page)

 

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Consolidated Statement of Cash Flows

The PNC Financial Services Group, Inc.

(continued from previous page)

 

In millions   Three months ended March 31  
Unaudited   2011      2010  

Financing Activities

    

Net change in

    

Noninterest-bearing deposits

  $ (1,266    $ (559

Interest-bearing deposits

    (88      (2,527

Federal funds purchased and repurchase agreements

    (63      1,514  

Federal Home Loan Bank short-term borrowings

       (280

Other short-term borrowed funds

    (1,361      (1,149

Sales/issuances

    

Bank notes and senior debt

       1,991  

Other long-term borrowed funds

    2,201        1,303  

Common and treasury stock

    14        3,409  

Repayments/maturities

    

Federal Home Loan Bank long-term borrowings

    (1,023      (1,757

Bank notes and senior debt

    (1,525      (1,754

Subordinated debt

    (480      29  

Other long-term borrowed funds

    (2,068      (1,050

Preferred stock – TARP

       (7,579

Acquisition of treasury stock

    (33      (67

Preferred stock cash dividends paid

    (4      (93

Common stock cash dividends paid

    (52      (45

Net cash provided (used) by financing activities

    (5,748      (8,614

Net Increase (Decrease) In Cash And Due From Banks

    92        (725

Cash and due from banks at beginning of period

    3,297        4,288  

Cash and due from banks at end of period

  $ 3,389      $ 3,563  

Supplemental Disclosures

    

Interest paid

  $ 445      $ 515  

Income taxes paid

    265        308  

Income taxes refunded

    26        1  

Non-cash Investing and Financing Items

    

Transfer from (to) loans to (from) loans held for sale, net

    100        83  

Transfer from loans to foreclosed assets

    161        382  

See accompanying Notes To Consolidated Financial Statements.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

THE PNC FINANCIAL SERVICES GROUP, INC.

 

Business

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

PNC has businesses engaged in retail banking, corporate and institutional banking, asset management, and residential mortgage banking, providing many of its products and services nationally and others in PNC’s primary geographic markets located in Pennsylvania, Ohio, New Jersey, Michigan, Maryland, Illinois, Indiana, Kentucky, Florida, Virginia, Missouri, Delaware, Washington, D.C., and Wisconsin. PNC also provides certain products and services internationally.

NOTE 1 ACCOUNTING POLICIES

BASIS OF FINANCIAL STATEMENT PRESENTATION

Our consolidated financial statements include the accounts of the parent company and its subsidiaries, most of which are wholly owned, and certain partnership interests and variable interest entities.

We prepared these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (GAAP). We have eliminated intercompany accounts and transactions. We have also reclassified certain prior year amounts to conform with the 2011 presentation. These reclassifications did not have a material impact on our consolidated financial condition or results of operations.

See Note 2 Divestiture regarding our July 1, 2010 sale of PNC Global Investment Servicing Inc. The Consolidated Income Statement for the first three months of 2010 and related disclosures in the Notes To Consolidated Financial Statements reflect the global investment servicing business as discontinued operations.

In our opinion, the unaudited interim consolidated financial statements reflect all normal, recurring adjustments needed to present fairly our results for the interim periods. The results of operations for interim periods are not necessarily indicative of the results that may be expected for the full year or any other interim period.

When preparing these unaudited interim consolidated financial statements, we have assumed that you have read the audited consolidated financial statements included in our 2010 Annual Report on Form 10-K (2010 Form 10-K). Reference is made to Note 1 Accounting Policies in the 2010 Form 10-K for a detailed description of significant accounting policies.

There have been no significant changes to these policies in the first three months of 2011 other than as disclosed herein. These interim consolidated financial statements serve to update the 2010 Form 10-K and may not include all information and notes necessary to constitute a complete set of financial statements.

We have considered the impact on these consolidated financial statements of subsequent events.

USE OF ESTIMATES

We prepared these consolidated financial statements using financial information available at the time, which requires us to make estimates and assumptions that affect the amounts reported. Our most significant estimates pertain to our fair value measurements, allowances for loan and lease losses and unfunded loan commitments and letters of credit, purchased impaired loans, revenue recognition and valuation of residential mortgage servicing rights. Actual results may differ from the estimates and the differences may be material to the consolidated financial statements.

INVESTMENT IN BLACKROCK, INC.

We account for our investment in the common stock and Series B Preferred Stock of BlackRock (deemed to be in-substance common stock) under the equity method of accounting. The investment in BlackRock is reflected on our Consolidated Balance Sheet in Equity investments, while our equity in earnings of BlackRock is reported on our Consolidated Income Statement in Asset management revenue.

We also own 2.9 million shares of Series C Preferred Stock of BlackRock. Since these preferred shares are not deemed to be in substance common stock, we have elected to account for these preferred shares at fair value and the changes in fair value will offset the impact of marking-to-market the obligation to deliver these shares to BlackRock. Our investment in the BlackRock Series C Preferred Stock is included on our Consolidated Balance Sheet in Other assets.

As noted above, we mark-to-market our obligation to transfer BlackRock shares related to certain BlackRock long-term incentive plan (LTIP) programs. This obligation is classified as a derivative not designated as a hedging instrument under GAAP as disclosed in Note 12 Financial Derivatives.

NONPERFORMING ASSETS

Nonperforming assets include:

   

Nonaccrual loans,

   

Troubled debt restructurings, and

   

Foreclosed assets.

 

 

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Nonperforming loans are those loans that have deteriorated in credit quality to the extent that full collection of original contractual principal and interest is doubtful. When a loan is determined to be nonperforming (and as a result is impaired), the accrual of interest is ceased and the loan is classified as nonaccrual. The current year accrued and uncollected interest is reversed out of net interest income.

A loan acquired and accounted for under ASC Sub-Topic 310-30 – Loans and Debt Securities Acquired with Deteriorated Credit Quality is reported as an accruing loan and a performing asset.

We generally classify Commercial Lending (Commercial, Commercial Real Estate, and Equipment Lease Financing) loans as nonaccrual (and therefore nonperforming) when we determine that the collection of interest or principal is doubtful or when delinquency of interest or principal payments has existed for 90 days or more and the loans are not well-secured and in the process of collection. A loan is considered well-secured when the collateral in the form of liens on (or pledges of) real or personal property, including marketable securities, has a realizable value sufficient to discharge the debt in full, including accrued interest. Such factors that would lead to nonperforming status and subject to an impairment test would include, but are not limited to, the following:

   

Deterioration in the financial position of the borrower resulting in the loan moving from accrual to cash basis,

   

The collection of principal or interest is 90 days or more past due unless the asset is both well-secured and in the process of collection,

   

Reasonable doubt exists as to the certainty of the future debt service ability, whether 90 days have passed or not,

   

Customer has filed or will likely file for bankruptcy,

   

The bank advances additional funds to cover principal or interest,

   

We are in the process of liquidation of a commercial borrower, or

   

We are pursuing remedies under a guaranty.

We charge off commercial nonaccrual loans based on the facts and circumstances of the individual loans.

Additionally, in general, small business commercial term loans of less than $1 million and small business commercial revolving loans are placed on nonaccrual status at 90 days past due and charged off at 120 and 180 days past due, respectively.

Home equity installment loans and lines of credit, as well as residential real estate loans, that are well secured are classified as nonaccrual at 180 days past due. A consumer loan is considered well-secured when the collateral in the form of liens on (or pledges of) real or personal property, including marketable securities, have a realizable value sufficient to discharge the debt in full, including accrued interest.

Home equity installment loans and lines of credit and residential real estate loans that are not well secured and/or are in the process of collection are charged off at 180 days past due to the estimated fair value of the collateral less cost to sell. The remaining portion of the loan is placed on nonaccrual status.

Subprime mortgage loans for first liens with a loan-to-value (LTV) ratio of equal to or greater than 90% and second liens are classified as nonaccrual at 90 days past due. These loans are charged off as discussed above.

Most consumer loans and lines of credit, not secured by residential real estate, are charged off after 120 to 180 days past due. Generally, they are not placed on nonaccrual status as permitted by regulatory guidance.

If payment is received on a nonperforming loan, the payment is first applied to the past due principal; once this principal obligation has been fulfilled, payments are applied to recover any partial charge-off related to the impaired loan that might exist. Finally, if both past due principal and any partial charge-off have been recovered, then the payment will result in the recognition and recording of interest income. This process is followed for impaired loans with the exception of performing troubled debt restructurings (TDRs). Payments received on performing TDRs and other modified loans will be applied in accordance with the terms of the modified loan.

A loan is categorized as a TDR if a concession is granted due to deterioration in the financial condition of the borrower. TDRs may include certain modifications of terms of loans, receipts of assets from debtors in partial or full satisfaction of loans, or a combination thereof. Modified loans classified as TDRs are included in nonperforming loans until returned to performing status through the fulfilling of contractual terms for a reasonable period of time (generally 6 months).

See Note 5 Asset Quality and Allowances for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit for additional TDR information.

Nonperforming loans are generally not returned to performing status until the obligation is brought current and the borrower has performed in accordance with the contractual terms for a reasonable period of time and collection of the contractual principal and interest is no longer in doubt.

Foreclosed assets are comprised of any asset seized or property acquired through a foreclosure proceeding or acceptance of a deed-in-lieu of foreclosure. Other real estate owned is comprised principally of commercial real estate and residential real estate properties obtained in partial or total satisfaction of loan obligations. Following the obtaining of a foreclosure judgment, or in some jurisdictions the initiation of proceedings under a power of sale in the loan instruments, the property will be sold. When we acquire the deed, we transfer the loan to other real estate owned included in Other assets on our Consolidated Balance Sheet. Property obtained in satisfaction of a loan is recorded at the lower of recorded investment or estimated fair value less cost to sell. We estimate fair values primarily based on appraisals, when

 

 

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available, or quoted market prices on liquid assets. Anticipated recoveries and government guarantees are also considered in evaluating the potential impairment of loans at the date of transfer. If the estimated fair value less cost to sell is less than the recorded investment, a charge-off is recognized against the Allowance for loan and lease losses (ALLL).

Subsequently, foreclosed assets are valued at the lower of the amount recorded at acquisition date or estimated fair value less cost to sell. Valuation adjustments on these assets and gains or losses realized from disposition of such property are reflected in Other noninterest expense.

See Note 5 Asset Quality and Allowances for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit for additional information.

ALLOWANCE FOR LOAN AND LEASE LOSSES

We maintain the ALLL at a level that we believe to be adequate to absorb estimated probable credit losses incurred in the loan portfolio as of the balance sheet date. Our determination of the adequacy of the allowance is based on periodic evaluations of the loan and lease portfolios and other relevant factors. This evaluation is inherently subjective as it requires material estimates, all of which may be susceptible to significant change, including, among others:

   

Probability of default (PD),

   

Loss given default (LGD),

   

Exposure at date of default (EAD),

   

Amounts and timing of expected future cash flows,

   

Value of collateral, and

   

Qualitative factors such as changes in economic conditions that may not be reflected in historical results.

While our reserve methodologies strive to reflect all relevant risk factors, there continues to be uncertainty associated with, but not limited to, potential imprecision in the estimation process due to the inherent time lag of obtaining information and normal variations between estimates and actual outcomes. We provide additional reserves that are designed to provide coverage for losses attributable to such risks. The ALLL also includes factors which may not be directly measured in the determination of specific or pooled reserves. Such qualitative factors include:

   

Recent Credit quality trends,

   

Recent Loss experience in particular portfolios,

   

Recent Macro economic factors, and

   

Changes in risk selection and underwriting standards.

In determining the adequacy of the ALLL, we make specific allocations to impaired loans and allocations to portfolios of commercial and consumer loans. We also allocate reserves to provide coverage for probable losses incurred in the portfolio at the balance sheet date based upon current market conditions, which may not be reflected in historical loss data. While allocations are made to specific loans and pools of loans, the total reserve is available for all credit losses.

Nonperforming loans are considered impaired under ASC 310-Receivables and are allocated a specific reserve.

Specific reserve allocations are determined as follows:

   

For nonperforming loans greater than or equal to a defined dollar threshold and TDRs, specific reserves are based on an analysis of the present value of the loan’s expected future cash flows, the loan’s observable market price or the fair value of the collateral.

   

For nonperforming loans below the defined dollar threshold, the loans are aggregated for purposes of measuring specific reserve impairment using the applicable loan’s LGD percentage multiplied by the balance of the loans.

When applicable, this process is applied across all the loan classes in a similar manner. However, as previously discussed, certain consumer loans and lines of credit, not secured by residential real estate, are charged off instead of being classified as nonperforming.

Our credit risk management policies, procedures and practices are designed to promote sound and fair lending standards while achieving prudent credit risk management. We have policies, procedures and practices that address financial statement requirements, collateral review and appraisal requirements, advance rates based upon collateral types, appropriate levels of exposure, cross-border risk, lending to specialized industries or borrower type, guarantor requirements, and regulatory compliance.

See Note 5 Asset Quality and Allowances for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit for additional information.

ALLOWANCE FOR UNFUNDED LOAN COMMITMENTS AND LETTERS OF CREDIT

We maintain the allowance for unfunded loan commitments and letters of credit at a level we believe is adequate to absorb estimated probable losses related to these unfunded credit facilities. We determine the adequacy of the allowance based on periodic evaluations of the unfunded credit facilities, including an assessment of the probability of commitment usage, credit risk factors, and the terms and expiration dates of the unfunded credit facilities. The allowance for unfunded loan commitments and letters of credit is recorded as a liability on the Consolidated Balance Sheet. Net adjustments to the allowance for unfunded loan commitments and letters of credit are included in the provision for credit losses.

The reserve for unfunded loan commitments is estimated in a manner similar to the methodology used for determining reserves for similar funded exposures. However, there is one important distinction. This distinction lies in the estimation of the amount of these unfunded commitments that will become funded. This is determined using a cash conversion factor or

 

 

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loan equivalency factor, which is a statistical estimate of the amount of an unfunded commitment that will fund over a given period of time. Once the future funded amount is estimated, the calculation of the allowance follows similar methodologies to those employed for on-balance sheet exposure.

See Note 5 Asset Quality and Allowances for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit for additional information.

EARNINGS PER COMMON SHARE

Basic earnings per common share is calculated using the two-class method to determine income attributable to common shareholders. Unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are considered participating securities under the two-class method. Income attributable to common shareholders is then divided by the weighted-average common shares outstanding for the period.

Diluted earnings per common share is calculated under the more dilutive of either the treasury method or the two-class method. For the diluted calculation, we increase the weighted-average number of shares of common stock outstanding by the assumed conversion of outstanding convertible preferred stock and debentures from the beginning of the year or date of issuance, if later, and the number of shares of common stock that would be issued assuming the exercise of stock options and warrants and the issuance of incentive shares using the treasury stock method. These adjustments to the weighted-average number of shares of common stock outstanding are made only when such adjustments will dilute earnings per common share. See Note 13 Earnings Per Share for additional information.

RECENT ACCOUNTING PRONOUNCEMENTS

In April 2011, the FASB issued ASU 2011- 03 – Transfers and Servicing (Topic 860): Reconsideration of Effective Control for Repurchase Agreements. This ASU removes from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. Other criteria applicable to the assessment of effective control have not been changed by this ASU. ASU 2011-03 is effective for the first interim or annual period beginning on or after December 15, 2011 and should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The adoption of this new guidance is not expected to have a material effect on our results of operations or financial position.

In April 2011, the FASB issued ASU 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. The ASU clarifies when a loan modification constitutes a troubled debt

restructuring (TDR). This ASU (1) eliminates the sole use of the borrowers’ effective interest rate test to determine if a concession has occurred on the part of the creditor, (2) requires a modification with below market terms to be considered in determining classification as a TDR, (3) specifies that a borrower not currently in default may still be experiencing financial difficulty when payment default is “probable in the foreseeable future,” and (4) specifies that a delay in payment should be considered along with all other factors in determining classification as a TDR. The ASU guidance is effective for interim and annual periods beginning after June 15, 2011 and is to be applied retrospectively to the beginning of the annual period of adoption. We are currently evaluating the impact of this ASU.

In January 2010, the FASB issued ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820), Improving Disclosures About Fair Value Measurements. This ASU requires purchases, sales, issuances and settlements to be reported separately in the Level 3 fair value measurement rollforward beginning with the first quarter 2011 reporting. See Note 8 Fair Value for additional information.

In July 2010, the FASB issued ASU 2010-20 – Receivables (Topic 310) – Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. While the majority of the disclosures within this ASU were already required to be adopted and included in the 2010 Form 10-K, required disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. Comparative disclosures for earlier reporting periods that ended before initial adoption is encouraged. Comparative disclosures for those reporting periods ending after initial adoption are required. See Note 5 Asset Quality and Allowances for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit for additional information. The effective date for disclosures related to troubled debt restructurings required by ASU 2010-20 was deferred by ASU 2011-01 – Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20, which was issued in January 2011. The disclosures were deferred until the FASB had completed ASU 2011-02. The effective date of the TDR disclosures is now consistent with the effective date of ASU 2011-02.

NOTE 2 DIVESTITURE

SALE OF PNC GLOBAL INVESTMENT SERVICING

On July 1, 2010, we sold PNC Global Investment Servicing Inc. (GIS), a leading provider of processing, technology and business intelligence services to asset managers, broker-dealers and financial advisors worldwide, for $2.3 billion in cash pursuant to a definitive agreement entered into on February 2, 2010. This transaction resulted in a pretax gain of $639 million, net of transaction costs, in the third quarter of 2010. Results of operations of GIS through March 31, 2010

 

 

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are presented as Income from discontinued operations, net of income taxes, on our Consolidated Income Statement. As part of the sale agreement, PNC has agreed to provide certain transitional services on behalf of GIS until completion of related systems conversion activities. There were no assets or liabilities of GIS remaining at December 31, 2010.

NOTE 3 LOAN SALE AND SERVICING ACTIVITIES AND VARIABLE INTEREST ENTITIES

LOAN SALE AND SERVICING ACTIVITIES

We have transferred residential and commercial mortgage loans in securitization or sales transactions in which we have continuing involvement. These transfers have occurred through Agency securitization, Non-Agency securitization, and whole-loan sale transactions. Agency securitizations consist of securitization transactions with Federal National Mortgage Association (FNMA), Federal Home Loan Mortgage Corporation (FHLMC), and Government National Mortgage Association (GNMA) (collectively the Agencies). FNMA and FHLMC generally securitize our transferred loans into mortgage-backed securities for sale into the secondary market through special purpose entities (SPEs) they sponsor. We, as an authorized GNMA issuer/servicer, pool loans into mortgage-backed securities for sale into the secondary market. In Non-Agency securitizations, we have transferred loans into securitization SPEs. In other instances third-party investors

have purchased (in whole-loan sale transactions) and subsequently sold our loans into securitization SPEs. Third-party investors have also purchased our loans in whole-loan sale transactions. Securitization SPEs, which are legal entities that are utilized in the Agency and Non-Agency securitization transactions, are VIEs.

Our continuing involvement in the Agency securitizations, Non-Agency securitizations, and whole-loan sale transactions generally consists of servicing, repurchases of previously transferred loans and loss share arrangements, and, in limited circumstances, holding of mortgage-backed securities issued by the securitization SPEs. Refer to Note 3 Loan Sale and Servicing Activities and Variable Interest Entities in our 2010 Form 10-K for additional information regarding our continuing involvement in these transactions. In addition, further details of our repurchase and loss share obligations are contained in Note 17 Commitments and Guarantees.

Certain loans transferred to the Agencies contain removal of account provisions (ROAPs). Under these ROAPs, we hold an option to repurchase at par individual delinquent loans that meet certain criteria. When we have the unilateral ability to repurchase a delinquent loan, effective control over the loan has been regained and we recognize the loan and a corresponding liability on the balance sheet regardless of our intent to repurchase the loan. At March 31, 2011 and December 31, 2010, the balance of our ROAP asset and liability totaled $256 million and $336 million, respectively.

 

 

Certain Financial Information and Cash Flows Associated with Loan Sale and Servicing Activities

 

In millions    Residential
Mortgages
     Commercial
Mortgages (a)
    Home Equity
Loans/Lines (b)
 

FINANCIAL INFORMATION – March 31, 2011

         

Servicing portfolio (c)

   $ 127,246      $ 163,104     $ 5,894  

Carrying value of servicing assets (d)

     1,109        645       2  

Servicing advances

     503        450       6  

Servicing deposits

     2,052        3,379       43  

Repurchase and recourse obligations (e)

     124        56       128  

Carrying value of mortgage-backed securities held (f)

     2,143        1,871          

FINANCIAL INFORMATION – December 31, 2010

         

Servicing portfolio (c)

   $ 125,806      $ 162,514     $ 6,041  

Carrying value of servicing assets (d)

     1,033        665       2  

Servicing advances

     533        415       21  

Servicing deposits

     2,661        3,537       61  

Repurchase and recourse obligations (e)

     144        54       150  

Carrying value of mortgage-backed securities held (f)

     2,171        1,875          

 

In millions    Residential
Mortgages
    Commercial
Mortgages (a)
    Home Equity
Loans/Lines (b)
 

CASH FLOWS – Three months ended March 31, 2011

        

Sales of loans (g)

   $ 3,385     $ 483      

Repurchases of previously transferred loans (h)

     444       $ 22  

Contractual servicing fees received

     90       43       6  

Servicing advances recovered/(funded), net

     30       (35     15  

Cash flows on mortgage-backed securities held (f)

     151       97          

CASH FLOWS – Three months ended March 31, 2010

        

Sales of loans (g)

   $ 1,930     $ 342      

Repurchases of previously transferred loans (h)

     741       $ 1  

Contractual servicing fees received

     109       55       7  

Servicing advances recovered/(funded), net

     (114     (55     6  

Cash flows on mortgage-backed securities held (f)

     142       37          

 

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(a) Represents financial and cash flow information associated with both commercial mortgage loan transfer and servicing activities.
(b) These activities were part of an acquired brokered home equity business in which PNC is no longer engaged. See Note 17 Commitments and Guarantees for further information.
(c) For our continuing involvement with residential mortgages and home equity loan/line transfers, amount represents outstanding balance of loans transferred and serviced. For commercial mortgages, amount represents the portion of the overall servicing portfolio in which loans have been transferred by us or third parties to VIEs. It does not include loans serviced by us that were originated by third parties and have not been transferred to a VIE.
(d) See Note 8 Fair Value and Note 9 Goodwill and Other Intangible Assets for further information.
(e) Represents liability for our loss exposure associated with loan repurchases for breaches of representations and warranties for our Residential Mortgage Banking and Distressed Assets Portfolio segments, and our commercial mortgage loss share arrangements for our Corporate & Institutional Banking segment. See Note 17 Commitments and Guarantees for further information.
(f) Represents securities held where PNC transferred to and/or serviced loans for a securitization SPE and we hold securities issued by that SPE.
(g) There were no gains or losses recognized on the transaction date for sales of residential mortgage and certain commercial mortgage loans as these loans are recognized on the balance sheet at fair value. For transfers of commercial loans not recognized on the balance sheet at fair value, gains/losses recognized on sales of these loans were insignificant for the three months ended March 31, 2011 and March 31, 2010.
(h) Includes repurchases of insured loans, government guaranteed loans, and loans repurchased through the exercise of our ROAP option.

VARIABLE INTEREST ENTITIES (VIES)

As discussed in our 2010 Form 10-K, we are involved with various entities in the normal course of business that are deemed to be VIEs. The following provides a summary of VIEs, including those that we have consolidated and those in which we hold variable interests but have not consolidated into our financial statements as of March 31, 2011 and December 31, 2010.

Consolidated VIEs – Carrying Value (a)

 

March 31, 2011

In millions

  Market Street     Credit Card
Securitization Trust
    Tax Credit
Investments (b)
    Total  

Assets

               

Cash and due from banks

          $ 2     $ 2  

Interest-earning deposits with banks

      $ 79       4       83  

Investment securities

  $ 110               110  

Loans

    2,808       1,988           4,796  

Allowance for loan and lease losses

        (128         (128

Equity investments

            1,332       1,332  

Other assets

    375       8       358       741  

Total assets

  $ 3,293     $ 1,947     $ 1,696     $ 6,936  

Liabilities

               

Other borrowed funds

  $ 2,917     $ 364     $ 116     $ 3,397  

Accrued expenses

        34       79       113  

Other liabilities

    371               344       715  

Total liabilities

  $ 3,288     $ 398     $ 539     $ 4,225  

 

December 31, 2010

In millions

  Market Street     Credit Card
Securitization Trust
    Tax Credit
Investments (b)
     Total  

Assets

                

Cash and due from banks

          $ 2      $ 2  

Interest-earning deposits with banks

      $ 284       4        288  

Investment securities

  $ 192                192  

Loans

    2,520       2,125            4,645  

Allowance for loan and lease losses

        (183          (183

Equity investments

            1,177        1,177  

Other assets

    271       9       396        676  

Total assets

  $ 2,983     $ 2,235     $ 1,579      $ 6,797  

Liabilities

                

Other borrowed funds

  $ 2,715     $ 523     $ 116      $ 3,354  

Accrued expenses

        9       79        88  

Other liabilities

    268               188        456  

Total liabilities

  $ 2,983     $ 532     $ 383      $ 3,898  
(a) Amounts represent carrying value on PNC’s Consolidated Balance Sheet.
(b) Amounts primarily represent Low Income Housing Tax Credit (LIHTC) investments.

 

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Assets and Liabilities of Consolidated VIEs (a)

 

In millions   Aggregate
Assets
     Aggregate
Liabilities
 

March 31, 2011

        

Market Street

  $ 3,982      $ 3,986  

Credit Card Securitization Trust

    2,013        585  

Tax Credit Investments (b)

    1,705        576  
   

December 31, 2010

        

Market Street

  $ 3,584      $ 3,588  

Credit Card Securitization Trust

    2,269        1,004  

Tax Credit Investments (b)

    1,590        420  
(a) Amounts in this table differ from total assets and liabilities in the preceding “Consolidated VIEs – Carrying Value” table as amounts in the preceding table reflect the elimination of intercompany assets and liabilities.
(b) Amounts primarily represent LIHTC investments.

Non-Consolidated VIEs

 

In millions   Aggregate
Assets
    Aggregate
Liabilities
    PNC Risk
of Loss
    Carrying
Value of
Assets
    Carrying
Value of
Liabilities
 

March 31, 2011

                   

Tax Credit Investments (a)

  $ 4,248     $ 2,323     $ 877     $ 877  (c)    $ 351  (d) 

Commercial Mortgage-Backed Securitizations (b)

    78,144       78,144       2,074       2,074  (e)     

Residential Mortgage-Backed Securitizations (b)

    42,856       42,856       2,177       2,172  (e)      (d) 

Collateralized Debt Obligations

    18               1       (c)         

Total

  $ 125,266     $ 123,323     $ 5,129     $ 5,124     $ 356  

 

In millions   Aggregate
Assets
    Aggregate
Liabilities
    PNC Risk
of Loss
    Carrying
Value of
Assets
    Carrying
Value of
Liabilities
 

December 31, 2010

                   

Tax Credit Investments (a)

  $ 4,086     $ 2,258     $ 782     $ 782  (c)    $ 301  (d) 

Commercial Mortgage-Backed Securitizations (b)

    79,142       79,142       2,068       2,068  (e)     

Residential Mortgage-Backed Securitizations (b)

    42,986       42,986       2,203       2,199  (e)      (d) 

Collateralized Debt Obligations

    18               1       (c)         

Total

  $ 126,232     $ 124,386     $ 5,054     $ 5,050     $ 305  
(a) Amounts primarily represent LIHTC investments. Aggregate assets and aggregate liabilities represent estimated balances due to limited availability of financial information associated with certain acquired partnerships.
(b) Amounts reflect involvement with securitization SPEs where PNC transferred to and/or services loans for a SPE and we hold securities issued by that SPE. We also invest in other mortgage and asset-backed securities issued by third-party VIEs with which we have no continuing involvement. Further information on these securities is included in Note 7 Investment Securities and values disclosed represent our maximum exposure to loss for those securities’ holdings.
(c) Included in Equity investments on our Consolidated Balance Sheet.
(d) Included in Other liabilities on our Consolidated Balance Sheet.
(e) Included in Trading securities, Investment securities, Other intangible assets, and Other assets on our Consolidated Balance Sheet.

 

MARKET STREET

Market Street is a multi-seller asset-backed commercial paper conduit that is owned by an independent third party. Market Street’s activities primarily involve purchasing assets or making loans secured by interests in pools of receivables from US corporations that desire access to the commercial paper market. Market Street funds the purchases of assets or loans by issuing commercial paper and is supported by pool-specific credit enhancements, liquidity facilities and program-level credit enhancement. Generally, Market Street mitigates its potential interest rate risk by entering into agreements with its borrowers that reflect interest rates based upon its weighted average commercial paper cost of funds. During 2010 and the first three months of 2011, Market Street met all of its funding needs through the issuance of commercial paper.

PNC Bank, N.A. provides certain administrative services, the program-level credit enhancement and all of the liquidity facilities to Market Street in exchange for fees negotiated based on market rates. Through these arrangements, PNC has the power to direct the activities of the SPE that most significantly affect its economic performance and these arrangements expose PNC to expected losses or residual returns that are significant to Market Street.

The commercial paper obligations at March 31, 2011 and December 31, 2010 were supported by Market Street’s assets. While PNC may be obligated to fund under the $6.7 billion of liquidity facilities for events such as commercial paper market disruptions, borrower bankruptcies, collateral deficiencies or covenant violations, our credit risk under the liquidity facilities is secondary to the risk of first loss provided by the

 

 

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borrower such as by the over-collateralization of the assets or by another third party in the form of deal-specific credit enhancement. Deal-specific credit enhancement that supports the commercial paper issued by Market Street is generally structured to cover a multiple of expected losses for the pool of assets and is sized to generally meet rating agency standards for comparably structured transactions. In addition, PNC would be required to fund $1.4 billion of the liquidity facilities if the underlying assets are in default. Market Street creditors have no direct recourse to PNC.

PNC provides program-level credit enhancement to cover net losses in the amount of 10% of commitments, excluding explicitly rated AAA/Aaa facilities. PNC provides 100% of the enhancement in the form of a cash collateral account funded by a loan facility. This facility expires in June 2015. At March 31, 2011, $689 million was outstanding on this facility. This amount is eliminated in PNC’s Consolidated Balance Sheet as we consolidate Market Street. We are not required to nor have we provided additional financial support to the SPE.

CREDIT CARD SECURITIZATION TRUST

We are the sponsor of several credit card securitizations facilitated through a trust. This bankruptcy-remote SPE or VIE was established to purchase credit card receivables from the sponsor and to issue and sell asset-backed securities created by it to independent third-parties. The SPE was financed primarily through the sale of these asset-backed securities. These transactions were originally structured as a form of liquidity and to afford favorable capital treatment. At March 31, 2011, Series 2007-1 and 2008-3 issued by the SPE were outstanding. Series 2006-1 was paid off during the first quarter of 2011.

Our continuing involvement in these securitization transactions consists primarily of holding certain retained interests and acting as the primary servicer. For each securitization series, our retained interests held are in the form of a pro-rata undivided interest, or sellers’ interest, in the transferred receivables, subordinated tranches of asset-backed securities, interest-only strips, discount receivables, and subordinated interests in accrued interest and fees in securitized receivables. We have consolidated the SPE as we are deemed the primary beneficiary of the entity based upon our level of continuing involvement. Our role as primary servicer gives us the power to direct the activities of the SPE that most significantly affect its economic performance and our holding of retained interests gives us the obligation to absorb or receive expected losses or residual returns that are significant to the SPE. Accordingly, all retained interests held in the credit card SPE are eliminated in consolidation. The underlying assets of the consolidated SPE are restricted only for payment of the beneficial interest issued by the SPE. We are not required to nor have we provided additional financial support to the SPE. Additionally, creditors of the SPE have no direct recourse to PNC.

TAX CREDIT INVESTMENTS

We make certain equity investments in various limited partnerships or limited liability companies (LLCs) that sponsor affordable housing projects utilizing the LIHTC pursuant to Sections 42 and 47 of the Internal Revenue Code. The purpose of these investments is to achieve a satisfactory return on capital, to facilitate the sale of additional affordable housing product offerings and to assist us in achieving goals associated with the Community Reinvestment Act. The primary activities of the investments include the identification, development and operation of multi-family housing that is leased to qualifying residential tenants. Generally, these types of investments are funded through a combination of debt and equity. We typically invest in these partnerships as a limited partner or non-managing member. We make similar investments in other types of tax credit investments.

Also, we are a national syndicator of affordable housing equity (together with the investments described above, the LIHTC investments). In these syndication transactions, we create funds in which our subsidiaries are the general partner or managing member and sell limited partnership or non-managing member interests to third parties, and in some cases may also purchase a limited partnership or non-managing member interest in the fund and/or provide mezzanine financing to the fund. The purpose of this business is to generate income from the syndication of these funds, generate servicing fees by managing the funds, and earn tax credits to reduce our tax liability. General partner or managing member activities include selecting, evaluating, structuring, negotiating, and closing the fund investments in operating limited partnerships or LLCs, as well as oversight of the ongoing operations of the fund portfolio.

Typically, the general partner or managing member will be the party that has the right to make decisions that will most significantly impact the economic performance of the entity. However, certain partnership or LLC agreements provide the limited partner or non-managing member the ability to remove the general partner or managing member without cause. This results in the limited partner or non-managing member being the party that has the right to make decisions that will most significantly impact the economic performance of the entity. The primary sources of losses and benefits in LIHTC investments are the tax credits, tax benefits due to passive losses on the investments, and development and operating cash flows. We have consolidated LIHTC investments in which we are the general partner or managing member and have a limited partnership interest or non-managing member interest that could potentially absorb losses or receive benefits that are significant. The assets are primarily included in Equity investments and Other assets on our Consolidated Balance Sheet with the liabilities classified in Other liabilities and third party investors’ interests included in the Equity section as Noncontrolling interests. Neither creditors nor equity investors in the LIHTC investments have any recourse

 

 

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to our general credit. There are no terms or conditions that have required or could require us, as the primary beneficiary, to provide financial support. Also, we have not provided nor do we intend to provide financial or other support to the limited partnership or LLC that we are not contractually obligated to provide. The consolidated aggregate assets and liabilities of these LIHTC investments are provided in the Consolidated VIEs table and reflected in the “Other” business segment.

For tax credit investments in which we do not have the right to make decisions that will most significantly impact the economic performance of the entity, we are not the primary beneficiary and thus they are not consolidated. These investments are disclosed in the Non-Consolidated VIEs table. The table also reflects our maximum exposure to loss. Our maximum exposure to loss is equal to our legally binding equity commitments adjusted for recorded impairment and partnership results. We use the equity method to account for our investment in these entities with the investments reflected in Equity investments on our Consolidated Balance Sheet. In addition, we increase our recognized investments and recognize a liability for all legally binding unfunded equity commitments. These liabilities are reflected in Other liabilities on our Consolidated Balance Sheet.

RESIDENTIAL AND COMMERCIAL MORTGAGE-BACKED SECURITIZATIONS

In connection with each Agency and Non-Agency securitization discussed above, we evaluate each SPE utilized in these transactions for consolidation. In performing these assessments, we evaluate our level of continuing involvement in these transactions as the magnitude of our involvement ultimately determines whether or not we hold a variable interest and/or are the primary beneficiary of the SPE. Factors we consider in our consolidation assessment include the significance of (1) our role as servicer, (2) our holdings of mortgage-backed securities issued by the securitization SPE, and (3) the rights of third-party variable interest holders.

Our first step in our assessment is to determine whether we hold a variable interest in the securitization SPE. We hold a variable interest in an Agency and Non-Agency securitization SPE through our holding of mortgage-backed securities issued by the SPE and/or our repurchase and recourse obligations. Each SPE in which we hold a variable interest is evaluated to determine whether we are the primary beneficiary of the entity. For Agency securitization transactions, our contractual role as servicer does not give us the power to direct the activities that most significantly affect the economic performance of the SPEs. Thus, we are not the primary beneficiary of these entities. For Non-Agency securitization transactions, we would be the primary beneficiary to the extent our servicing activities give us the power to direct the activities that most significantly affect the economic performance of the SPE and we hold a more than insignificant

variable interest in the entity. At March 31, 2011, our level of continuing involvement in Non-Agency securitization SPEs did not result in PNC being deemed the primary beneficiary of any of these entities. Details about the Agency and Non-Agency securitization SPEs where we hold a variable interest and are not the primary beneficiary are included in the table above. Our maximum exposure to loss as a result of our involvement with these SPEs is the carrying value of the mortgage-backed securities, servicing assets, servicing advances, and our liabilities associated with our repurchase and recourse obligations. Creditors of the securitization SPEs have no recourse to PNC’s assets or general credit.

NOTE 4 LOANS AND COMMITMENTS TO EXTEND CREDIT

Loans outstanding were as follows:

Loans Outstanding

 

In millions    March 31
2011
    December
31 2010
 

Commercial lending

      

Commercial

   $ 56,602     $ 55,177  

Commercial real estate

     17,133       17,934  

Equipment lease financing

     6,215       6,393  

TOTAL COMMERCIAL LENDING

     79,950       79,504  

Consumer lending

      

Home equity

     33,656       34,226  

Residential real estate

     15,333       15,999  

Credit card

     3,707       3,920  

Other

     16,741       16,946  

TOTAL CONSUMER LENDING

     69,437       71,091  

Total loans (a) (b)

   $ 149,387     $ 150,595  
(a) Net of unearned income, net deferred loan fees, unamortized discounts and premiums, and purchase discounts and premiums totaling $2.6 billion and $2.7 billion at March 31, 2011 and December 31, 2010, respectively.
(b) Future accretable yield related to purchased impaired loans is not included in loans outstanding.

At March 31, 2011, we pledged $15.1 billion of loans to the Federal Reserve Bank and $32.9 billion of loans to the Federal Home Loan Bank as collateral for the contingent ability to borrow, if necessary. The comparable amounts at December 31, 2010 were $12.6 billion and $32.4 billion, respectively.

Net Unfunded Credit Commitments

 

In millions    March 31
2011
    December 31
2010
 

Commercial and commercial real estate

   $ 60,150     $ 59,256  

Home equity lines of credit

     19,161       19,172  

Credit card

     14,832       14,725  

Other

     2,638       2,652  

Total

   $ 96,781     $ 95,805  
 

 

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Commitments to extend credit represent arrangements to lend funds or provide liquidity subject to specified contractual conditions. At March 31, 2011, commercial commitments reported above exclude $16.3 billion of syndications, assignments and participations, primarily to financial institutions. The comparable amount at December 31, 2010 was $16.7 billion.

Commitments generally have fixed expiration dates, may require payment of a fee, and contain termination clauses in the event the customer’s credit quality deteriorates. Based on our historical experience, most commitments expire unfunded, and therefore cash requirements are substantially less than the total commitment.

NOTE 5 ASSET QUALITY AND ALLOWANCES FOR LOAN AND LEASE LOSSES AND UNFUNDED LOAN COMMITMENTS AND LETTERS OF CREDIT

Asset Quality

We closely monitor economic conditions and loan performance trends to manage and evaluate our exposure to credit risk. Trends in delinquency rates are a key indicator, among other considerations, of credit risk within the loan portfolios. The measurement of delinquency status is based on the contractual terms of each loan. Loans that are 30 days or more past due in terms of payment are considered delinquent.

The level of nonperforming assets represents another key indicator of the potential for future credit losses. Nonperforming assets include nonperforming loans, TDRs, and other real estate owned (OREO) and foreclosed assets, but exclude purchased impaired loans. See Note 6 Purchased Impaired Loans for further information.

See Note 1 Accounting Policies for additional delinquency, nonperforming, and charge-off information.

 

 

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The following tables display the delinquency status of our loans and our nonperforming assets at March 31, 2011 and December 31, 2010.

Age Analysis of Past Due Accruing Loans

 

     Accruing                       
In millions    Current or Less
Than 30 Days
Past Due
    30-59 Days
Past Due
    60-89 Days
Past Due
    90 Days
Or More
Past Due
    Total Past
Due (a) (b)
    Nonperforming
Loans
    Purchased
Impaired
   

Total

Loans

 

March 31, 2011

                        

Commercial

   $ 54,892     $ 208     $ 56     $ 49     $ 313     $ 1,203     $ 194     $ 56,602  

Commercial real estate

     13,796       315       65       6       386       1,884       1,067       17,133  

Equipment lease financing

     6,097       72       5           77       41           6,215  

Residential real estate

     10,795       205       91       174       470       772       3,296       15,333  

Home equity

     29,824       146       96       165       407       464       2,961       33,656  

Credit card

     3,576       41       25       65       131               3,707  

Other consumer

     16,596       60       25       27       112       29       4       16,741  

Total

   $ 135,576     $ 1,047     $ 363     $ 486     $ 1,896     $ 4,393     $ 7,522     $ 149,387  

Percentage of total loans

     90.75     .70     .24     .33     1.27     2.94     5.04     100.00

December 31, 2010

                        

Commercial

   $ 53,273     $ 251     $ 92     $ 59     $ 402     $ 1,253     $ 249     $ 55,177  

Commercial real estate

     14,713       128       62       43       233       1,835       1,153       17,934  

Equipment lease financing

     6,276       37       2       1       40       77           6,393  

Residential real estate

     11,334       226       107       160       493       818       3,354       15,999  

Home equity

     30,334       159       91       174       424       448       3,020       34,226  

Credit card

     3,765       46       32       77       155               3,920  

Other consumer

     16,752       95       32       28       155       35       4       16,946  

Total

   $ 136,447     $ 942     $ 418     $ 542     $ 1,902     $ 4,466     $ 7,780     $ 150,595  

Percentage of total loans

     90.61     .62     .28     .36     1.26     2.97     5.16     100.00
(a) Past due loan amounts exclude government insured or guaranteed loans, primarily residential mortgages, totaling $2.7 billion and $2.6 billion at March 31, 2011 and December 31, 2010, respectively. These loans are included in the Current category.
(b) Past due loan amounts exclude purchased impaired loans as they are considered performing loans due to the accretion of interest income.

Nonperforming Assets

 

Dollars in millions    March 31, 2011     December 31, 2010  

Nonperforming loans

      

Commercial

   $ 1,203     $ 1,253  

Commercial real estate

     1,884       1,835  

Equipment lease financing

     41       77  

TOTAL COMMERCIAL LENDING

     3,128       3,165  

Consumer (a)

      

Home equity

     464       448  

Residential real estate

     772       818  

Other

     29       35  

TOTAL CONSUMER LENDING

     1,265       1,301  

Total nonperforming loans

     4,393       4,466  

OREO and foreclosed assets

      

Other real estate owned (OREO)

     802       767  

Foreclosed and other assets

     63       68  

TOTAL FORECLOSED AND OTHER ASSETS

     865       835  

Total nonperforming assets

   $ 5,258     $ 5,301  

Nonperforming loans to total loans

     2.94     2.97

Nonperforming assets to total loans, OREO and foreclosed assets

     3.50       3.50  

Nonperforming assets to total assets

     2.03       2.01  
(a) Excludes most consumer loans and lines of credit, not secured by residential real estate, which are charged off after 120 to 180 days past due and are not placed on nonperforming status.

 

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Loans whose contractual terms have been restructured in a manner which grants a concession to a borrower experiencing financial difficulties are considered TDRs. See Note 1 Accounting Policies for additional information. TDRs typically result from our loss mitigation activities and could include rate reductions, principal forgiveness, forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of collateral. Total nonperforming loans in the table above include TDRs of $882 million at March 31, 2011 and $784 million at December 31, 2010.

TDRs returned to performing (accrual) status totaled $639 million and $543 million at March 31, 2011 and December 31, 2010, respectively, and are excluded from nonperforming loans. These loans have demonstrated a period of at least six months of consecutive performance under the modified terms.

In addition, credit cards and certain small business and consumer credit agreements whose terms have been modified are TDRs and totalled $314 million and $331 million at March 31, 2011 and December 31, 2010, respectively. However, since our policy is to exempt these loans from being placed on nonperforming status as permitted by regulatory guidance, these loans are excluded from nonperforming loans. As such, generally under the modified terms, these loans are directly charged off in the period that they become 120 to 180 days past due. At March 31, 2011 and December 31, 2010, remaining commitments to lend additional funds to debtors whose terms have been modified in a commercial or consumer TDR were immaterial.

Additional Asset Quality Indicators

We have two overall portfolio segments – Commercial Lending and Consumer Lending. Each of these two segments is comprised of one or more loan classes. Classes are characterized by similarities in initial measurement, risk attributes and the manner in which we monitor and assess credit risk. The commercial segment is comprised of the commercial, commercial real estate, equipment lease financing, and commercial purchased impaired loan classes. The consumer segment is comprised of the residential real estate, home equity, credit card, other consumer, and consumer purchased impaired loan classes. Asset quality indicators for each of these loan classes are discussed in more detail below.

Commercial Loan Class

For commercial loans, we monitor the performance of the borrower in a disciplined and regular manner based upon the level of credit risk inherent in the loan. To evaluate the level of credit risk, we assign an internal risk rating reflecting the borrower’s PD and LGD. This two-dimensional credit risk- rating methodology provides risk granularity in the monitoring

process on an ongoing basis. We adjust our risk-rating process through updates based on actual experience. The combination of the PD and LGD ratings assigned to a commercial loan, capturing both the combination of expectations of default and loss severity, reflects the relative estimated likelihood of loss for that loan at the reporting date. Loans with low PD and LGD have the lowest likelihood of loss. Conversely, loans with high PD and LGD have the highest likelihood of loss.

Based upon the amount of the lending arrangement and of the credit risk described above, we follow a formal schedule of periodic review. Generally, for higher risk loans this occurs on a quarterly basis, although we have established practices to review such credit risk more frequently, if circumstances warrant.

Commercial Real Estate Loan Class

We manage credit risk associated with our commercial real estate projects and commercial mortgage activities similar to commercial loans by analyzing PD and LGD. However, due to the nature of the collateral, for commercial real estate projects and commercial mortgages, the LGDs tend to be significantly lower than those seen in the commercial class. Additionally, risks connected with commercial real estate projects and commercial mortgage activities tend to be correlated to the loan structure and collateral location, project progress and business environment. As a result, these attributes are also monitored and utilized in assessing credit risk.

As with the commercial class, a quarterly overview is performed to assess geographic, product and loan type concentrations, in addition to industry risk and market and economic concerns. Often as a result of these overviews, more in-depth reviews and increased scrutiny is placed on areas of higher risk, adverse changes in risk ratings, deteriorating operating trends, and/or areas that concern management. The goal of these reviews is to assess risk and take actions to mitigate our exposure to such risks.

Equipment Lease Financing Loan Class

Similar to the other classes of loans within Commercial Lending, loans within the equipment lease financing class undergo a rigorous underwriting process. During this process, a PD and LGD are assigned based on the credit risk.

Based upon the dollar amount of the lease and of the level of credit risk, we follow a formal schedule of periodic review. Generally, this occurs on a quarterly basis, although we have established practices to review such credit risk more frequently, if circumstances warrant. Our review process entails analysis of the following factors: equipment value/residual value, exposure levels, jurisdiction risk, industry risk, guarantor requirements, and regulatory compliance.

 

 

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Commercial Purchased Impaired Loans Class

The credit impacts of purchased impaired loans are primarily determined through the estimation of expected cash flows. Commercial cash flow estimates are influenced by a number of credit related items which include but are not limited to: changes in estimated collateral value, receipt of additional collateral, secondary trading prices, circumstances of possible and/or ongoing liquidation, capital availability, business operations and payment patterns.

We attempt to proactively manage these factors by using various procedures that are customized to the risk of a given loan. These procedures include a review by our Special Asset Committee (SAC), ongoing outreach, contact, and assessment of obligor financial conditions, collateral inspection and appraisal.

See Note 6 Purchased Impaired Loans for additional information.

 

 

Commercial Lending Asset Quality Indicators

 

             Criticized Commercial Loans          
In millions   

Pass

Rated (a)

     Special
Mention (b)
     Substandard (c)      Doubtful (d)      Total
Loans
 

March 31, 2011

                

Commercial

   $ 50,550      $ 1,850      $ 3,603      $ 405      $ 56,408  

Commercial real estate

     10,594        1,193        3,785        494        16,066  

Equipment lease financing

     5,954        81        168        12        6,215  

Purchased impaired loans

     122        33        864        242        1,261  

Total commercial lending (e)

   $ 67,220      $ 3,157      $ 8,420      $ 1,153      $ 79,950  

December 31, 2010

                

Commercial

   $ 48,556      $ 1,926      $ 3,883      $ 563      $ 54,928  

Commercial real estate

     11,014        1,289        3,914        564        16,781  

Equipment lease financing

     6,121        64        162        46        6,393  

Purchased impaired loans

     106        35        883        378        1,402  

Total commercial lending (e)

   $ 65,797      $ 3,314      $ 8,842      $ 1,551      $ 79,504  
(a) Pass Rated assets include loans not classified as “Special Mention,” “Substandard,” or “Doubtful.”
(b) Special Mention rated assets have a potential weakness that deserves management’s close attention. If left uncorrected these potential weaknesses may result in deterioration of repayment prospects at some future date. These assets do not expose us to sufficient risk to warrant adverse classification at this time.
(c) Substandard rated assets have a well-defined weakness or weaknesses that jeopardize the collection or liquidation of debt. They are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected.
(d) Doubtful rated assets possess all the inherent weaknesses of a Substandard asset with the additional characteristics that the weakness makes collection or liquidation in full improbable due to existing facts, conditions, and values.
(e) Nonperforming loans are included above based on their applicable category as “Pass,” “Special Mention,” “Substandard” or “Doubtful.”

 

Residential Real Estate and Home Equity Loan Classes

We use several credit quality indicators, including credit scores, LTV ratios, delinquency rates, loan types and geography to monitor and manage credit risk within the residential real estate and home equity classes. We evaluate mortgage loan performance by source originators and loan servicers. A summary of asset quality indicators follows:

Credit Scores: We use a national third-party provider to update FICO credit scores for residential real estate and home equity loans on at least an annual basis. The updated scores are incorporated into a series of credit monitoring reports and the statistical models that estimate the individual loan risk values.

LTV: We regularly update the property values of real estate collateral and calculate a LTV ratio. This ratio updates our statistical models that estimate individual and class/segment level risk. The LTV ratio tends to indicate potential loss on a given loan and the borrower’s likelihood to make payment according to the contractual obligations.

Delinquency Rates: We monitor levels of delinquency rates for residential real estate and home equity loans.

Geography: Geographic concentrations are monitored to evaluate and manage exposures. Loan purchase programs are sensitive to, and focused within, certain regions to manage geographic exposures and associated risks.

The combination of FICO scores, LTV ratios and geographic location assigned to residential real estate and home equity loans are used to estimate the likelihood of loss for that loan at the reporting date. Loans with high FICO scores and low LTVs tend to have the lower likelihood of loss. Conversely, loans with low FICO scores, high LTVs, and in certain geographic locations tend to have a higher likelihood of loss.

At least annually, we obtain an updated property valuations on the real estate secured loans. For open credit lines secured by real estate or facilities in regions experiencing significant declines in property values, more frequent valuations may occur. The property values are monitored to determine LTV migration and those LTV migrations are stratified within various markets. Trends are analyzed to establish appropriate lending criteria to fit within our desired moderate risk profile.

 

 

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Consumer Real Estate Secured Asset Quality Indicators

 

     Higher Risk Loans (a)     All Other Loans     Total Loans      Loans with LTV > 100%  
In millions    Amount      % of
Total
Loans
    Amount      % of
Total
Loans
    Amount      Amount      % of
Total
Loans
 

March 31, 2011

                          

Home equity (b)

   $ 1,070        3   $ 32,586        97   $ 33,656      $ 265        1

Residential real estate (c)

     644        4     14,689        96     15,333        1,250        8

Total (d)

   $ 1,714        3   $ 47,275        97   $ 48,989      $ 1,515        3

December 31, 2010

                          

Home equity (b)

   $ 1,203        4   $ 33,023        96   $ 34,226      $ 285        1

Residential real estate (c)

     671        4     15,328        96     15,999        1,331        8

Total (d)

   $ 1,874        4   $ 48,351        96   $ 50,225      $ 1,616        3
(a) Higher Risk Loans are defined as loans with a recent FICO credit score of less than or equal to 660 and a LTV ratio greater than or equal to 90%.
(b) Within the higher risk home equity class at March 31, 2011, approximately 12% were in some stage of delinquency and 7% were in late stage (90+ days) delinquency status. These higher risk loans were concentrated with 31% in Pennsylvania, 13% in Ohio, 12% in New Jersey, 7% in Illinois, 5% in Michigan, and 5% in Kentucky, with the remaining loans dispersed across several other states. At December 31, 2010, approximately 10% were in some stage of delinquency and 6% were in late stage (90+ days) delinquency status. These higher risk loans were concentrated with 28% in Pennsylvania, 13% in Ohio, 11% in New Jersey, 7% in Illinois, 6% in Michigan, and 5% in Kentucky, with the remaining loans dispersed across several other states.
(c) Within the higher risk residential real estate class at March 31, 2011, approximately 47% were in some stage of delinquency and 38% were in late stage (90+ days) delinquency status. These higher risk loans were concentrated with 23% in California, 11% in Illinois, 11% in Florida, 8% in Maryland, 5% in New Jersey, and 4% each in Ohio, Pennsylvania, and Virginia, with the remaining loans dispersed across several other states. At December 31, 2010, approximately 49% were in some stage of delinquency and 38% were in late stage (90+ days) delinquency status. These higher risk loans were concentrated with 23% in California, 11% in Florida, 11% in Illinois, 8% in Maryland, and 4% each in Ohio, Pennsylvania, and New Jersey, with the remaining loans dispersed across several other states.
(d) Total loans include purchased impaired loans of $6.3 billion at March 31, 2011 and $6.4 billion at December 31, 2010.

 

Credit Card and Other Consumer Loan Classes

We monitor a variety of asset quality information in the management of the credit card and other consumer loan classes. Other consumer loan classes include education, automobile, and other secured and unsecured lines and loans. Along with the trending of delinquencies and losses for each class, FICO credit score updates are obtained at least annually, as well as a variety of credit bureau attributes.

The combination of FICO scores and delinquency status are used to estimate the likelihood of loss for consumer exposure at the reporting date. Loans with high FICO scores tend to have a lower likelihood of loss. Conversely, loans with low FICO scores tend to have a higher likelihood of loss.

Consumer Purchased Impaired Loans Class

Estimates of the expected cash flows primarily determine the credit impacts of consumer purchased impaired loans. Consumer cash flow estimates are influenced by a number of credit related items which include, but are not limited to, estimated real estate values, payment patterns, FICO scores, economic environment, LTV ratios and the date of origination. These key drivers are monitored regularly to help ensure that concentrations of risk are mitigated and cash flows are maximized.

See Note 6 Purchased Impaired Loans for additional information.

 

 

Credit Card and Other Consumer Loan Classes Asset Quality Indicators

 

     Credit Card (a)     Other Consumer (b)  
Dollars in millions    Amount      % of
Total Loans
    Amount      % of
Total Loans
 

March 31, 2011

            

FICO greater than 719

   $ 1,834        50   $ 4,208        58

650 to 719

     1,076        29       1,999        27  

620 to 649

     191        5       308        4  

Less than 620

     347        9       623        9  

Unscored (c)

     259        7       136        2  

Total loan balance

   $ 3,707        100   $ 7,274        100

Weighted average current FICO score (d)

              717                715  

December 31, 2010

            

FICO greater than 719

   $ 1,895        48   $ 4,135        58

650 to 719

     1,149        29       1,984        28  

620 to 649

     183        5       295        4  

Less than 620

     424        11       652        9  

Unscored (c)

     269        7       81        1  

Total loan balance

   $ 3,920        100   $ 7,147        100

Weighted average current FICO score (d)

              709                713  

 

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(a) At March 31, 2011, we had $58 million of credit card loans that are higher risk (i.e., loans with FICO scores less than 660 and in late stage (90+ days) delinquency status). Within this portfolio, 19% are located in Ohio, 14% in Michigan, 14% in Pennsylvania, 8% in Illinois, and 7% in Indiana, with the remaining loans dispersed across several other states. At December 31, 2010, we had $70 million of credit card loans that are higher risk. Within this portfolio, 20% were located in Ohio, 14% in Michigan, 14% in Pennsylvania, 8% in Illinois, and 7% in Indiana, with the remaining loans dispersed across several other states.
(b) Other consumer loans include non-government guaranteed or insured education loans, automobile loans and other secured and unsecured lines and loans. Other consumer loans for which FICO scores are not used as an asset quality indicator include primarily government guaranteed or insured education loans, as well as consumer loans to high net worth individuals. These loans totaled $9.5 billion and $9.8 billion at March 31, 2011 and December 31, 2010, respectively.
(c) Credit card unscored refers to new accounts issued to borrowers with limited credit history, accounts for which we cannot get an updated FICO (e.g., recent profile changes), cards issued with a business name, and/or collateral secured cards for which FICO scores were not available or required. Management proactively assesses the risk and size of the unscored loan portfolio and, when necessary, takes actions to mitigate the credit risk.
(d) Weighted average current FICO score excludes accounts with no score.

 

Allowances for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit

We maintain the ALLL and the Allowance for Unfunded Loan Commitments and Letters of Credit at levels that we believe to be adequate to absorb estimated probable credit losses incurred in the portfolios as of the balance sheet date. We use the two main portfolio segments – Commercial Lending and Consumer Lending – and we develop and document the ALLL under separate methodologies for each of these segments as further discussed and presented below.

Allowance for Loan and Lease Losses Components

For purchased non-impaired loans, the ALLL is the sum of three components: asset specific/individual impaired reserves, quantitative (formulaic or pooled) reserves, and qualitative (judgmental) reserves. See Note 6 Purchased Impaired Loans for additional ALLL information. While we make allocations to specific loans and pools of loans, the total reserve is available for all loan and lease losses. Although quantitative modeling factors as discussed below are constantly changing as the financial strength of the borrower and overall economic conditions change, there were no significant changes to our ALLL methodology during the first three months of 2011.

Asset Specific/Individual Component

Nonperforming loans and TDRs are considered impaired and are allocated a specific reserve. See Note 1 Accounting Policies for additional information.

Commercial Lending Quantitative Component

The estimates of the quantitative component of ALLL for exposure within the commercial lending portfolio segment are determined through a statistical loss model utilizing PD, LGD, and EAD. Based upon loan risk ratings we assign PDs and LGDs. Each of these statistical parameters is determined based on historical data and observable factors including those pertaining to specific borrowers that have proven to be

statistically significant in the estimation of incurred losses. PD is influenced by such factors as liquidity, industry, obligor financial structure, access to capital, and cash flow. LGD is influenced by collateral type, LTV, and guarantees by related parties.

Consumer Lending Quantitative Component

Quantitative estimates within the consumer lending portfolio segment are calculated using a roll-rate model based on statistical relationships, calculated from historical data that estimate the movement of loan outstandings through the various stages of delinquency and ultimately charge-off. In general, the estimated rates at which loan outstandings roll from one stage of delinquency to another are dependent on various factors such as FICO, LTV ratios, the current economic environment, and geography. Within the consumer lending portfolio segment, our Asset & Liability Management Group manages $3.6 billion of purchased mortgage loans that are serviced by third parties. Asset & Liability Management uses a loan loss reserve methodology that uses delinquent balances and a loss severity assumption to calculate the level of pooled loan loss reserves to be held against the portfolio.

Qualitative Component

While our quantitative reserve methodologies strive to reflect all risk factors, there continues to be a certain element of uncertainty associated with, but not limited to, potential imprecision in the estimation process due to the inherent time lag of obtaining information and normal variations between estimates and actual outcomes. We adjust the ALLL in consideration of these factors. The ALLL also includes factors which may not be directly measured in the determination of asset specific or quantitative reserves. Such qualitative factors include:

   

Credit quality trends;

   

Loss experience in particular portfolios;

   

Macro economic factors; and

   

Changes in risk selection and underwriting standards.

 

 

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Rollforward of Allowance for Loan and Lease Losses and Associated Loan Data

 

In millions    Commercial
Lending
    Consumer
Lending
    Total  

March 31, 2011

        

ALLOWANCE FOR LOAN AND LEASE LOSSES

        

January 1

   $ 2,567     $ 2,320     $ 4,887  

Charge-offs

     (351     (323     (674

Recoveries

     103       38       141  

Net charge-offs

     (248     (285     (533

Provision for credit losses

     127       294       421  

Net change in allowance for unfunded loan commitments and letters of credit

     9       (25     (16

March 31

   $ 2,455     $ 2,304     $ 4,759  

TDRs individually evaluated for impairment

   $ 27     $ 502     $ 529  

Other loans individually evaluated for impairment

     776         776  

Loans collectively evaluated for impairment

     1,355       1,223       2,578  

Purchased impaired loans

     297       579       876  

March 31

   $ 2,455     $ 2,304     $ 4,759  

LOAN PORTFOLIO

        

TDRs individually evaluated for impairment

   $ 260     $ 1,575     $ 1,835  

Other loans individually evaluated for impairment

     2,848         2,848  

Loans collectively evaluated for impairment

     75,581       61,601       137,182  

Purchased impaired loans

     1,261       6,261       7,522  

March 31

   $ 79,950     $ 69,437     $ 149,387  

Ratio of the allowance for loan and lease losses to total loans

     3.07     3.32     3.19

March 31, 2010

        

ALLOWANCE FOR LOAN AND LEASE LOSSES

        

January 1

   $ 3,345     $ 1,727     $ 5,072  

Charge-offs

     (547     (280     (827

Recoveries

     110       26       136  

Net charge-offs

     (437     (254     (691

Provision for credit losses

     393       358       751  

Adoption of ASU 2009-17, Consolidations

       141       141  

Acquired allowance adjustments

     2         2  

Net change in allowance for unfunded loan commitments and letters of credit

     44               44  

March 31

   $ 3,347     $ 1,972     $ 5,319  

TDRs individually evaluated for impairment

   $ 2     $ 108     $ 110  

Other loans individually evaluated for impairment

     1,140         1,140  

Loans collectively evaluated for impairment

     1,918       1,547       3,465  

Purchased impaired loans

     287       317       604  

March 31

   $ 3,347     $ 1,972     $ 5,319  

LOAN PORTFOLIO

        

TDRs individually evaluated for impairment

   $ 33     $ 352     $ 385  

Other loans individually evaluated for impairment

     4,016         4,016  

Loans collectively evaluated for impairment

     76,889       66,303       143,192  

Purchased impaired loans

     1,826       7,847       9,673  

March 31

   $ 82,764     $ 74,502     $ 157,266  

Ratio of the allowance for loan and lease losses to total loans

     4.04     2.65     3.38

Originated Impaired Loans

Originated impaired loans exclude leases and smaller balance homogeneous type loans as well as purchased impaired loans, but include acquired loans that are impaired subsequent to acquisition. See Note 6 Purchased Impaired Loans for additional information. We did not recognize any interest income on originated impaired loans, including TDRs that have not returned to performing status,

while they were impaired during the three months ended March 31, 2011 and March 31, 2010. The following table provides further detail on originated impaired loans individually evaluated for reserves and the associated ALLL.

 

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Originated Impaired Loans

 

In millions    Unpaid
Principal
Balance
     Recorded
Investment
     Associated
Allowance (a)
     Average
Recorded
Investment (b)
 

March 31, 2011

             

Impaired loans with an associated allowance

             

Commercial

   $ 1,648      $ 1,132      $ 374      $ 1,155  

Commercial real estate

     2,013        1,492        429        1,469  

Residential real estate

     625        586        158        525  

Home equity

     765        671        254        647  

Credit card

     286        286        84        294  

Other consumer

     32        32        6        33  

Total impaired loans with an associated allowance

   $ 5,369      $ 4,199      $ 1,305      $ 4,123  

Impaired loans without an associated allowance

             

Commercial

   $ 105      $ 71         $ 73  

Commercial real estate

     576        413                 401  

Total impaired loans without an associated allowance

   $ 681      $ 484               $ 474  

Total impaired loans

   $ 6,050      $ 4,683      $ 1,305      $ 4,597  

December 31, 2010

             

Impaired loans with an associated allowance

             

Commercial

   $ 1,769      $ 1,178      $ 410      $ 1,533  

Commercial real estate

     1,927        1,446        449        1,732  

Residential real estate

     521        465        122        309  

Home equity

     622        622        207        448  

Credit card

     301        301        149        275  

Other consumer

     34        34        7        30  

Total impaired loans with an associated allowance

   $ 5,174      $ 4,046      $ 1,344      $ 4,327  

Impaired loans without an associated allowance

             

Commercial

   $ 87      $ 75         $ 90  

Commercial real estate

     525        389                 320  

Total impaired loans without an associated allowance

   $ 612      $ 464               $ 410  

Total impaired loans

   $ 5,786      $ 4,510      $ 1,344      $ 4,737  
(a) Associated allowance amounts include $529 million and $509 million for TDRs at March 31, 2011 and December 31, 2010, respectively.
(b) Average recorded investment is for the quarter ended March 31, 2011 and year ended December 31, 2010 and does not include the associated allowance.

 

Allowance for Unfunded Loan Commitments and Letters of Credit

We maintain the allowance for unfunded loan commitments and letters of credit at a level we believe is adequate to absorb estimated probable losses related to these unfunded credit facilities. See Note 1 Accounting Policies for additional information.

Rollforward of Allowance for Unfunded Loan Commitments and Letters of Credit

 

In millions    2011      2010  

January 1

   $ 188      $ 296  

Net change in allowance for unfunded loan commitments and letters of credit

     16        (44

March 31

   $ 204      $ 252  
 

 

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NOTE 6 PURCHASED IMPAIRED LOANS

As further described in Note 6 of the 2010 Form 10-K, at December 31, 2008, we identified certain loans related to the National City acquisition, for which there was evidence of credit quality deterioration since origination and it was probable that we would be unable to collect all contractually required principal and interest payments. GAAP requires these loans to be recorded at fair value at acquisition date and prohibits the “carrying over” or the creation of valuation allowances in the initial accounting for such loans acquired in a transfer.

Purchased Impaired Loans

 

     March 31, 2011      December 31, 2010  
In millions    Recorded
Investment
     Outstanding
Balance
     Recorded
Investment
     Outstanding
Balance
 

Commercial

   $ 194      $ 348      $ 249      $ 408  

Commercial real estate

     1,067        1,285        1,153        1,391  

Consumer

     2,965        3,926        3,024        4,121  

Residential real estate

     3,296        3,688        3,354        3,803  

Total

   $ 7,522      $ 9,247      $ 7,780      $ 9,723  

The excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized in interest income over the remaining life of the loan using the constant effective yield method. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference. Changes in the expected cash flows of individual commercial or pooled consumer purchased impaired loans from the date of acquisition will either impact the accretable yield or result in an impairment charge to the provision for credit losses in the period in which the changes become probable. Subsequent decreases to the net present value of expected cash flows will generally result in an impairment charge to the provision for

credit losses, resulting in an increase to the allowance for loan and lease losses, and a reclassification from accretable yield to nonaccretable difference. Prepayments and interest rate decreases for variable rate notes are treated as a reduction of cash flows expected to be collected and a reduction of projections of contractual cash flows such that the nonaccretable difference is not affected. Thus, for decreases in cash flows expected to be collected resulting from prepayments and interest rate decreases for variable rate notes, the effect will be to reduce the yield prospectively.

During the first three months of 2011, $1 million of provision and $22 million of charge-offs were recorded on purchased impaired loans. As of March 31, 2011, decreases in the net present value of expected cash flows of purchased impaired loans resulted in an allowance for loan and lease losses of $876 million on $5.8 billion of the impaired loans while the remaining $1.7 billion of impaired loans required no allowance as net present value of expected cash flows improved or remained the same. Subsequent increases in the net present value of cash flows will result in a recovery of any previously recorded allowance for loan and lease losses, to the extent applicable, and a reclassification from nonaccretable difference to accretable yield, which is recognized prospectively. Disposals of loans, which may include sales of loans or foreclosures, result in removal of the loan from the purchased impaired loan portfolio at its carrying amount.

Activity for the accretable yield for the first three months of 2011 follows.

Accretable Yield

 

In millions    2011  

January 1

   $ 2,185  

Accretion (including cash recoveries)

     (241

Net reclassifications to accretable from non-accretable

     288  

Disposals

     (35

March 31

   $ 2,197  
 

 

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NOTE 7 INVESTMENT SECURITIES

Investment Securities Summary

 

     Amortized      Unrealized     Fair  
In millions    Cost      Gains      Losses     Value  

March 31, 2011

            

Securities Available for Sale

            

Debt securities

            

US Treasury and government agencies

   $ 5,119      $ 133      $ (23   $ 5,229  

Residential mortgage-backed

            

Agency

     29,519        362        (412     29,469  

Non-agency

     7,876        257        (962     7,171  

Commercial mortgage-backed

            

Agency

     1,305        22        (2     1,325  

Non-agency

     1,998        86        (5     2,079  

Asset-backed

     3,005        39        (180     2,864  

State and municipal

     2,254        43        (63     2,234  

Other debt

     3,748        85        (17     3,816  

Total debt securities

     54,824        1,027        (1,664     54,187  

Corporate stocks and other

     340                         340  

Total securities available for sale

   $ 55,164      $ 1,027      $ (1,664   $ 54,527  

Securities Held to Maturity

            

Debt securities

            

Commercial mortgage-backed (non-agency)

   $ 4,169      $ 144      $ (3   $ 4,310  

Asset-backed

     2,287        34        (1     2,320  

Other debt

     9        1                10  

Total securities held to maturity

   $ 6,465      $ 179      $ (4   $ 6,640  
 

December 31, 2010

            
 

Securities Available for Sale

            

Debt securities

            

US Treasury and government agencies

   $ 5,575      $ 157      $ (22   $ 5,710  

Residential mortgage-backed

            

Agency

     31,697        443        (420     31,720  

Non-agency

     8,193        230        (1,190     7,233  

Commercial mortgage-backed

            

Agency

     1,763        40        (6     1,797  

Non-agency

     1,794        73        (11     1,856  

Asset-backed

     2,780        40        (238     2,582  

State and municipal

     1,999        30        (72     1,957  

Other debt

     3,992        102        (17     4,077  

Total debt securities

     57,793        1,115        (1,976     56,932  

Corporate stocks and other

     378                         378  

Total securities available for sale

   $ 58,171      $ 1,115      $ (1,976   $ 57,310  

Securities Held to Maturity

            

Debt securities

            

Commercial mortgage-backed (non-agency)

   $ 4,316      $ 178      $ (4   $ 4,490  

Asset-backed

     2,626        51        (1     2,676  

Other debt

     10        1                11  

Total securities held to maturity

   $ 6,952      $ 230      $ (5   $ 7,177  

 

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The fair value of investment securities is impacted by interest rates, credit spreads, market volatility and liquidity conditions. Net unrealized gains and losses in the securities available for sale portfolio are included in shareholders’ equity as accumulated other comprehensive income or loss, net of tax, unless credit-related.

The following table presents gross unrealized loss and fair value of securities available for sale at March 31, 2011 and December 31, 2010. The securities are segregated between investments that have been in a continuous unrealized loss

position for less than twelve months and twelve months or more based on the point in time the fair value declined below the amortized cost basis. The table includes debt securities where a portion of other-than-temporary impairment (OTTI) has been recognized in accumulated other comprehensive loss.

The gross unrealized loss on debt securities held to maturity was $4 million at March 31, 2011 and $5 million at December 31, 2010 with $608 million and $675 million of positions in a continuous loss position for less than 12 months at March 31, 2011 and December 31, 2010, respectively.

 

 

Gross Unrealized Loss and Fair Value of Securities Available for Sale

 

In millions    Unrealized loss position less
than 12 months
     Unrealized loss position 12
months or more
     Total  
      Unrealized
Loss
   

Fair

Value

     Unrealized
Loss
    Fair
Value
     Unrealized
Loss
   

Fair

Value

 

March 31, 2011

                

Debt securities

                

US Treasury and government agencies

   $ (23   $ 1,115           $ (23   $ 1,115  

Residential mortgage-backed

                

Agency

     (379     15,342      $ (33   $ 736        (412     16,078  

Non-agency

     (8     367        (954     5,485        (962     5,852  

Commercial mortgage-backed

                

Agency

     (2     320             (2     320  

Non-agency

     (4     341        (1     43        (5     384  

Asset-backed

     (2     439        (178     789        (180     1,228  

State and municipal

     (14     550        (49     243        (63     793  

Other debt

     (15     883        (2     13        (17     896  

Total

   $ (447   $ 19,357      $ (1,217   $ 7,309      $ (1,664   $ 26,666  

December 31, 2010

                

Debt securities

                

US Treasury and government agencies

   $ (22   $ 398           $ (22   $ 398  

Residential mortgage-backed

                

Agency

     (406     17,040      $ (14   $ 186        (420     17,226  

Non-agency

     (17     345        (1,173     5,707        (1,190     6,052  

Commercial mortgage-backed

                

Agency

     (6     344             (6     344  

Non-agency

     (8     184        (3     84        (11     268  

Asset-backed

     (5     441        (233     776        (238     1,217  

State and municipal

     (22     931        (50     247        (72     1,178  

Other debt

     (14     701        (3     13        (17     714  

Total

   $ (500   $ 20,384      $ (1,476   $ 7,013      $ (1,976   $ 27,397  

 

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Evaluating Investments for Other-than-Temporary Impairments

For the securities in the above table, as of March 31, 2011 we do not intend to sell and believe we will not be required to sell the securities prior to recovery of the amortized cost basis.

On at least a quarterly basis, we conduct a comprehensive security-level assessment on all securities in an unrealized loss position to determine if OTTI exists. An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. An OTTI loss must be recognized for a debt security in an unrealized loss position if we intend to sell the security or it is more likely than not we will be required to sell the security prior to recovery of its amortized cost basis. In this situation, the amount of loss recognized in income is equal to the difference between the fair value and the amortized cost basis of the security. Even if we do not expect to sell the security, we must evaluate the expected cash flows to be received to determine if we believe a credit loss has occurred. In the event of a credit loss, only the amount of impairment associated with the credit loss is recognized in income. The portion of the unrealized loss relating to other factors, such as liquidity conditions in the market or changes in market interest rates, is recorded in accumulated other comprehensive loss.

Equity securities are also evaluated to determine whether the unrealized loss is expected to be recoverable based on whether evidence exists to support a realizable value equal to or greater than the cost basis. If it is probable that we will not recover the amortized cost basis, taking into consideration the estimated recovery period and our ability to hold the equity security until recovery, OTTI is recognized in earnings equal to the difference between the fair value and the amortized cost basis of the security.

The security-level assessment is performed on each security, regardless of the classification of the security as available for sale or held to maturity. Our assessment considers the security structure, recent security collateral performance metrics if applicable, external credit ratings, failure of the issuer to make scheduled interest or principal payments, our judgment and expectations of future performance, and relevant independent industry research, analysis and forecasts. We also consider the severity of the impairment and the length of time the security has been impaired in our assessment. Results of the periodic assessment are reviewed by a cross-functional senior management team representing Asset & Liability Management, Finance, and Market Risk Management.

The senior management team considers the results of the assessments, as well as other factors, in determining whether the impairment is other-than-temporary.

For debt securities, a critical component of the evaluation for OTTI is the identification of credit-impaired securities, where management does not expect to receive cash flows sufficient to recover the entire amortized cost basis of the security. The paragraphs below describe our process for identifying credit impairment for our most significant categories of securities not backed by the US government or its agencies.

Non-Agency Residential Mortgage-Backed Securities and Asset-Backed Securities Collateralized by First-Lien and Second-Lien Residential Mortgage Loans

Potential credit losses on these securities are evaluated on a security by security basis. Collateral performance assumptions are developed for each security after reviewing collateral composition and collateral performance statistics. This includes analyzing recent delinquency roll rates, loss severities, voluntary prepayments, and various other collateral and performance metrics. This information is then combined with general expectations on the housing market and other economic factors to develop estimates of future performance.

Security level assumptions for prepayments, loan defaults, and loss given default are applied to every security using a third-party cash flow model. The third-party cash flow model then generates projected cash flows according to the structure of each security. Based on the results of the cash flow analysis, we determine whether we will recover the amortized cost basis of our security.

Credit Impairment Assessment Assumptions – Non-Agency Residential Mortgage-Backed and Asset-Backed Securities (a)

 

March 31, 2011    Range     Weighted-
average (b)
 

Long-term prepayment rate (annual CPR)

      

Prime

     7-20     14

Alt-A

     3-12        5  

Remaining collateral expected to default

      

Prime

     1-54     20 

Alt-A

     3-89        44  

Loss severity

      

Prime

     14-72     46 

Alt-A

     29-85        58  
(a) Collateralized by first and second-lien non-agency residential mortgage loans.
(b) Calculated by weighting the relevant assumption for each individual security by the current outstanding cost basis of the security.
 

 

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Non-Agency Commercial Mortgage-Backed Securities

Credit losses on these securities are measured using property-level cash flow projections and forward-looking property valuations. Cash flows are projected using a detailed analysis of net operating income (NOI) by property type which, in turn, is based on the analysis of NOI performance over the past several business cycles combined with PNC’s economic outlook for the current cycle. Loss severities are based on property price projections, which are calculated using capitalization rate projections. The capitalization rate projections are based on a combination of historical capitalization rates and expected capitalization rates implied by current market activity, our outlook and relevant independent industry research, analysis and forecast. Securities exhibiting weaker performance within the model are subject to further analysis. This analysis is performed at the loan level, and includes assessing local market conditions, reserves, occupancy, rent rolls and master/special servicer details.

During the first quarter of 2011 and 2010, the OTTI credit losses recognized in noninterest income related to estimated credit losses on securities that we do not expect to sell were as follows:

Summary of OTTI Credit Losses Recognized in Earnings

 

     Three months ended
March 31
 
In millions      2011         2010    

Available for sale securities:

      

Non-agency residential mortgage-backed

   $ (28   $ (73

Asset-backed

     (5     (43

Other debt

     (1        

Total

   $ (34   $ (116

Summary of OTTI Noncredit (Losses) Recoveries Included in Accumulated Other Comprehensive Loss

 

     Three months ended March 31  
In millions    2011     2010  

Total

   $ 4     $ (124

The following table presents a rollforward of the cumulative OTTI credit losses recognized in earnings for all debt securities for which a portion of an OTTI loss was recognized in accumulated other comprehensive loss:

Rollforward of Cumulative OTTI Credit Losses Recognized in Earnings

 

In millions    Non-agency
residential
mortgage-backed
    Non-agency
commercial
mortgage-backed
    Asset-backed     Other debt     Total  

For the three months ended March 31, 2011

            

December 31, 2010

   $ (709   $ (11   $ (223   $ (12   $ (955

Loss where impairment was not previously recognized

     (3         (1     (4

Additional loss where credit impairment was previously recognized

     (25       (5       (30

Reduction due to credit impaired securities sold

             5                       5  

March 31, 2011

   $ (737   $ (6   $ (228   $ (13   $ (984

 

In millions    Non-agency
residential
mortgage-backed
    Non-agency
commercial
mortgage-backed
    Asset-
backed
    Other
debt
    Total  

For the three months ended March 31, 2010

            

December 31, 2009

   $ (479   $ (6   $ (145   $ (12   $ (642

Loss where impairment was not previously recognized

     (12       (5       (17

Additional loss where credit impairment was previously recognized

     (61       (38       (99

Reduction due to credit impaired securities sold

     12                               12  

March 31, 2010

   $ (540   $ (6   $ (188   $ (12   $ (746

Information relating to gross realized securities gains and losses from the sales of securities is set forth in the following table.

Gains (Losses) on Sales of Securities Available for Sale

 

In millions    Proceeds      Gross
Gains
     Gross
Losses
    Net
Gains
    Tax
Expense
 

For the three months ended March 31

              

2011

   $ 8,178      $ 109      $ (72   $ 37     $ 13  

2010

     6,040        144        (54     90       31  

 

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The following table presents, by remaining contractual maturity, the amortized cost, fair value and weighted-average yield of debt securities March 31, 2011.

Contractual Maturity of Debt Securities

 

March 31, 2011

Dollars in millions

   1 Year or
Less
    After 1 Year
through 5 Years
    After 5 Years
through 10 Years
    After 10
Years
    Total  

SECURITIES AVAILABLE FOR SALE

            

US Treasury and government agencies

   $ 50     $ 1,921     $ 2,722     $ 426     $ 5,119  

Residential mortgage-backed

            

Agency

       31       1,358       28,130       29,519  

Non-agency

         32       7,844       7,876  

Commercial mortgage-backed

            

Agency

       684       616       5       1,305  

Non-agency

       125         1,873       1,998  

Asset-backed

     1       449       476       2,079       3,005  

State and municipal

     36       137       330       1,751       2,254  

Other debt

     40       2,321       914       473       3,748  

Total debt securities available for sale

   $ 127     $ 5,668     $ 6,448     $ 42,581     $ 54,824  

Fair value

   $ 126     $ 5,785     $ 6,592     $ 41,684     $ 54,187  

Weighted-average yield, GAAP basis

     1.83     2.76     3.41     4.15     3.92

SECURITIES HELD TO MATURITY

            

Commercial mortgage-backed (non-agency)

   $ 144     $ 55     $ 74     $ 3,896     $ 4,169  

Asset-backed

     80       1,659       212       336       2,287  

Other debt

             1       6       2       9  

Total debt securities held to maturity

   $ 224     $ 1,715     $ 292     $ 4,234     $ 6,465  

Fair value

   $ 232     $ 1,745     $ 297     $ 4,366     $ 6,640  

Weighted-average yield, GAAP basis

     4.36     2.56     2.17     4.87     4.12

Based on current interest rates and expected prepayment speeds, the weighted-average expected maturity of mortgage and other asset-backed debt securities were as follows as of March 31, 2011:

Weighted-Average Expected Maturity of Mortgage and Other Asset-Backed Debt Securities

 

      March 31, 2011  

Agency mortgage-backed securities

     5.1 years   

Non-agency mortgage-backed securities

     4.9 years   

Agency commercial mortgage-backed securities

     5.1 years   

Non-agency commercial mortgage-backed securities

     3.0 years   

Asset-backed securities

     3.1 years   

Weighted-average yields are based on historical cost with effective yields weighted for the contractual maturity of each security.

The following table presents the fair value of securities that have been either pledged to or accepted from others to collateralize outstanding borrowings.

Fair Value of Securities Pledged and Accepted as Collateral

 

In millions    March 31,
2011
     December 31,
2010
 

Pledged to others

   $ 24,607      $ 27,985  

Accepted from others:

       

Permitted by contract or custom to sell or repledge

     2,174        3,529  

Permitted amount repledged to others

     939        1,971  

The securities pledged to others include positions held in our portfolio of investment securities, trading securities, and securities accepted as collateral from others that we are permitted by contract or custom to sell or repledge, and were used to secure public and trust deposits, repurchase agreements, and for other purposes. The securities accepted from others that we are permitted by contract or custom to sell or repledge are a component of Federal funds sold and resale agreements on our Consolidated Balance Sheet.

 

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NOTE 8 FAIR VALUE

Fair Value Measurement

Fair value is defined in GAAP as the price that would be received to sell an asset or the price paid to transfer a liability on the measurement date. The standard focuses on the exit price in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants. GAAP establishes a fair value reporting hierarchy to maximize the use of observable inputs when measuring fair value and defines the three levels of inputs as noted below.

Level 1

Quoted prices in active markets for identical assets or liabilities. Level 1 assets and liabilities may include debt securities, equity securities and listed derivative contracts that are traded in an active exchange market and certain US government agency securities that are actively traded in over-the-counter markets.

Level 2

Observable inputs other than Level 1 such as: quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated to observable market data for substantially the full term of the asset or liability. Level 2 assets and liabilities may include debt securities, equity securities and listed derivative contracts with quoted prices that are traded in markets that are not active, and certain debt and equity securities and over-the-counter derivative contracts whose fair value is determined using a pricing model without significant unobservable inputs. This category generally includes agency residential and commercial mortgage-backed debt securities, asset-backed securities, corporate debt securities, residential mortgage loans held for sale, and derivative contracts.

Level 3

Unobservable inputs that are supported by minimal or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities may include financial instruments whose value is determined using pricing models with internally developed assumptions, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation. This category generally includes certain available for sale and trading securities, commercial mortgage loans held for sale, private equity investments, residential mortgage servicing rights, BlackRock Series C Preferred Stock and certain financial derivative contracts. The available for sale and trading securities within Level 3 include non-agency residential mortgage-backed securities, auction rate securities, certain private-issuer asset-backed securities and corporate debt

securities. Nonrecurring items, primarily certain nonaccrual and other loans held for sale, commercial mortgage servicing rights, equity investments and other assets are also included in this category.

We characterize active markets as those where transaction volumes are sufficient to provide objective pricing information, with reasonably narrow bid/ask spreads and where dealer quotes received do not vary widely and are based on current information. Inactive markets are typically characterized by low transaction volumes, price quotations which vary substantially among market participants or are not based on current information, wide bid/ask spreads, a significant increase in implied liquidity risk premiums, yields, or performance indicators for observed transactions or quoted prices compared to historical periods, a significant decline or absence of a market for new issuance, or any combination of the above factors. We also consider nonperformance risks including credit risk as part of our valuation methodology for all assets and liabilities measured at fair value.

Any models used to determine fair values or to validate dealer quotes based on the descriptions below are subject to review and independent testing as part of our model validation and internal control testing processes. Our Model Validation Committee tests significant models on at least an annual basis. In addition, we have teams, independent of the traders, verify marks and assumptions used for valuations at each period end.

Securities Available for Sale and Trading Securities

Securities accounted for at fair value include both the available for sale and trading portfolios. We use prices obtained from pricing services, dealer quotes or recent trades to determine the fair value of securities. For 53% of our positions, we use prices obtained from pricing services provided by third party vendors. For an additional 12% of our positions, we use prices obtained from the pricing services as the primary input into the valuation process. One of the vendors’ prices are set with reference to market activity for highly liquid assets such as agency mortgage-backed securities, and matrix pricing for other assets, such as CMBS and asset-backed securities. Another vendor primarily uses pricing models considering adjustments for ratings, spreads, matrix pricing and prepayments for the instruments we value using this service, such as non-agency residential mortgage-backed securities, agency adjustable rate mortgage securities, agency CMOs and municipal bonds. Management uses various methods and techniques to corroborate prices obtained from pricing services and dealers, including reference to other dealer or market quotes, by reviewing valuations of comparable instruments, or by comparison to internal valuations. Dealer quotes received are typically non-binding. In circumstances where relevant market prices are limited or unavailable, valuations may require significant management judgments or adjustments to determine fair value. In these cases, the securities are classified as Level 3.

 

 

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The valuation techniques used for securities classified as Level 3 include using a discounted cash flow approach or, in certain instances, identifying a proxy security, market transaction or index. For certain security types, primarily non-agency residential securities, the fair value methodology incorporates values obtained from a discounted cash flow model. The modeling process incorporates assumptions management believes market participants would use to value the security under current market conditions. The assumptions used include prepayment projections, credit loss assumptions, and discount rates, which include a risk premium due to liquidity and uncertainty that are based on both observable and unobservable inputs. We use the discounted cash flow analysis, in conjunction with other relevant pricing information obtained from either pricing services or broker quotes to establish the fair value that management believes is representative under current market conditions. For purposes of determining fair value at March 31, 2011 and December 31, 2010, the relevant pricing service information was the predominant input.

In the proxy approach, the proxy selected has similar credit, tenor, duration, pricing and structuring attributes to the PNC position. The price, market spread, or yield on the proxy is then used to calculate an indicative market price for the security. Depending on the nature of the PNC position and its attributes relative to the proxy, management may make additional adjustments to account for market conditions, liquidity, and nonperformance risk, based on various inputs including recent trades of similar securities, single dealer quotes, and/or other observable and unobservable inputs.

Financial Derivatives

Exchange-traded derivatives are valued using quoted market prices and are classified as Level 1. However, the majority of derivatives that we enter into are executed over-the-counter and are valued using internal models. Readily observable market inputs to these models can be validated to external sources, including industry pricing services, or corroborated through recent trades, dealer quotes, yield curves, implied volatility or other market-related data. Certain derivatives, such as total rate of return swaps, are corroborated to the CMBX index. These derivatives are classified as Level 2. Derivatives priced using significant management judgment or assumptions are classified as Level 3.

The fair values of our derivatives are adjusted for nonperformance risk including credit risk as appropriate. Our nonperformance risk adjustment is computed using new loan pricing and considers externally available bond spreads, in conjunction with internal historical recovery observations. The credit risk adjustment is not currently material to the overall derivatives valuation.

Residential Mortgage Loans Held for Sale

We have elected to account for certain residential mortgage loans originated for sale on a recurring basis at fair value. Residential mortgage loans are valued based on quoted market prices, where available, prices for other traded mortgage loans with similar characteristics, and purchase commitments and bid information received from market participants. These loans are regularly traded in active markets and observable pricing information is available from market participants. The prices are adjusted as necessary to include the embedded servicing value in the loans and to take into consideration the specific characteristics of certain loans that are priced based on the pricing of similar loans. These adjustments represent unobservable inputs to the valuation but are not considered significant to the fair value of the loans. Accordingly, residential mortgage loans held for sale are classified as Level 2.

Residential Mortgage Servicing Rights

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

Commercial Mortgage Loans Held for Sale

We account for certain commercial mortgage loans classified as held for sale at fair value. The election of the fair value option aligns the accounting for the commercial mortgages with the related hedges. At origination, these loans were intended for securitization.

We determine the fair value of commercial mortgage loans held for sale by using a whole loan methodology. Fair value is determined using sale valuation assumptions that management believes a market participant would use in pricing the loans. When available, valuation assumptions included observable inputs based on whole loan sales. Adjustments are made to these assumptions to account for situations when uncertainties exist, including market conditions and liquidity. Credit risk is included as part of our valuation process for these loans by considering expected rates of return for market participants for similar loans in the marketplace. Based on the significance of unobservable inputs, we classified this portfolio as Level 3.

 

 

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Equity Investments

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

Customer Resale Agreements

We have elected to account for structured resale agreements, which are economically hedged using free-standing financial

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

BlackRock Series C Preferred Stock

We have elected to account for the 2.9 million shares of the BlackRock Series C Preferred Stock received in a stock exchange with BlackRock at fair value. The Series C Preferred Stock economically hedges the BlackRock LTIP liability that is accounted for as a derivative. The fair value of the Series C Preferred Stock is determined using a third-party modeling approach, which includes both observable and unobservable inputs. This approach considers expectations of a default/liquidation event and the use of liquidity discounts based on our inability to sell the security at a fair, open market price in a timely manner. Although dividends are equal to common shares and other preferred series, significant transfer restrictions exist on our Series C shares for any purpose other than to satisfy the LTIP obligation. Due to the significance of unobservable inputs, this security is classified as Level 3.

 

 

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Assets and liabilities measured at fair value on a recurring basis, including instruments for which PNC has elected the fair value option, follow.

Fair Value Measurements – Summary

 

     March 31, 2011      December 31, 2010  
In millions    Level 1      Level 2      Level 3      Total Fair
Value
     Level 1      Level 2      Level 3      Total Fair
Value
 

Assets

                           

Securities available for sale

                           

US Treasury and government agencies

   $ 4,808      $ 421         $ 5,229      $ 5,289      $ 421         $ 5,710  

Residential mortgage-backed

                           

Agency

        29,469           29,469           31,720           31,720  

Non-agency

         $ 7,171        7,171            $ 7,233        7,233  

Commercial mortgage-backed

                           

Agency

        1,325           1,325           1,797           1,797  

Non-agency

        2,079           2,079           1,856           1,856  

Asset-backed

        1,840        1,024        2,864           1,537        1,045        2,582  

State and municipal

        1,893        341        2,234           1,729        228        1,957  

Other debt

              3,743        73        3,816                 4,004        73        4,077  

Total debt securities

     4,808        40,770        8,609        54,187        5,289        43,064        8,579        56,932  

Corporate stocks and other

     249        90        1        340        307        67        4        378  

Total securities available for sale

     5,057        40,860        8,610        54,527        5,596        43,131        8,583        57,310  

Financial derivatives (a) (b)

                           

Interest rate contracts

        4,846        41        4,887           5,502        68        5,570  

Other contracts

              180        9        189                 178        9        187  

Total financial derivatives

              5,026        50        5,076                 5,680        77        5,757  

Residential mortgage loans held for sale (c)

        1,826           1,826           1,878           1,878  

Trading securities (d)

                           

Debt (e)

     1,550        600        60        2,210        1,348        367        69        1,784  

Equity

     44                          44        42                          42  

Total trading securities

     1,594        600        60        2,254        1,390        367        69        1,826  

Residential mortgage servicing rights (f)

           1,109        1,109              1,033        1,033  

Commercial mortgage loans held for sale (c)

           858        858              877        877  

Equity investments

                           

Direct investments

           794        794              749        749  

Indirect investments (g)

                       663        663                          635        635  

Total equity investments

                       1,457        1,457                          1,384        1,384  

Customer resale agreements (h)

        823           823           866           866  

Loans (i)

        227        2        229           114        2        116  

Other assets

                           

BlackRock Series C Preferred Stock (j)

           447        447              396        396  

Other

              460        8        468                 450        7        457  

Total other assets

              460        455        915                 450        403        853  

Total assets

   $ 6,651      $ 49,822      $ 12,601      $ 69,074      $ 6,986      $ 52,486      $ 12,428      $ 71,900  

Liabilities

                           

Financial derivatives (b) (k)

                           

Interest rate contracts

      $ 3,666      $ 18      $ 3,684         $ 4,302      $ 56      $ 4,358  

BlackRock LTIP

           447        447              396        396  

Other contracts

              180        11        191                 173        8        181  

Total financial derivatives

              3,846        476        4,322                 4,475        460        4,935  

Trading securities sold short (l)

                           

Debt (e)

   $ 1,211        33           1,244      $ 2,514        16           2,530  

Equity

                                                                       

Total trading securities sold short

     1,211        33                 1,244        2,514        16                 2,530  

Other liabilities

              3                 3                 6                 6  

Total liabilities

   $ 1,211      $ 3,882      $ 476      $ 5,569      $ 2,514      $ 4,497      $ 460      $ 7,471  
(a) Included in Other assets on our Consolidated Balance Sheet.
(b) Amounts at March 31, 2011 and December 31, 2010 are presented gross and are not reduced by the impact of legally enforceable master netting agreements that allow PNC to net positive and negative positions and cash collateral held or placed with the same counterparty. At March 31, 2011 and December 31, 2010, respectively, the net asset amounts were $1.6 billion and $1.9 billion and the net liability amounts were $.9 billion and $1.1 billion.
(c) Included in Loans held for sale on our Consolidated Balance Sheet. PNC has elected the fair value option for certain commercial and residential mortgage loans held for sale.

 

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(d) Fair value includes net unrealized gains of $11 million at March 31, 2011 compared with net unrealized losses of $17 million at December 31, 2010.
(e) Approximately 70% of these securities are US Treasury and government agencies securities at March 31, 2011.
(f) Included in Other intangible assets on our Consolidated Balance Sheet.
(g) The indirect equity funds are not redeemable, but PNC receives distributions over the life of the partnership from liquidation of the underlying investments by the investee.
(h) Included in Federal funds sold and resale agreements on our Consolidated Balance Sheet. PNC has elected the fair value option for these items.
(i) Included in Loans on our Consolidated Balance Sheet.
(j) PNC has elected the fair value option for these shares.
(k) Included in Other liabilities on our Consolidated Balance Sheet.
(l) Included in Other borrowed funds on our Consolidated Balance Sheet.

Reconciliations of assets and liabilities measured at fair value on a recurring basis using Level 3 inputs for the three months ended March 31, 2011 and 2010 follow.

Three Months Ended March 31, 2011

 

             Total realized / unrealized
gains or losses (a)
                                         

(*) Attributable
to unrealized
gains or
losses related
to assets and
liabilities
held at

March 31,
2011

 

Level 3 Instruments Only

In millions

   Fair
Value
Dec. 31,
2010
     Included in
Earnings (*)
    Included in
other
comprehensive
income
     Purchases      Sales     Issuances      Settlements     Fair
Value
March 31,
2011
   

Assets

                          

Securities available for sale

                          

Residential mortgage-backed non-agency

   $ 7,233      $ (6   $ 255      $ 42           $ (353   $ 7,171     $ (28

Asset-backed

     1,045        (3     54                (72     1,024       (5

State and municipal

     228          2        116             (5     341      

Other debt

     73        (1     2         $ (1          73       (1

Corporate stocks and other

     4                                                   (3     1          

Total securities available for sale

     8,583        (10     313        158        (1              (433     8,610       (34

Financial derivatives

     77        43                  (70     50       38  

Trading securities – Debt

     69        (4                (5     60       (5

Residential mortgage servicing rights

     1,033        36          48        $ 39        (47     1,109       35  

Commercial mortgage loans held for sale

     877        (7           (7        (5     858       (6

Equity investments

                          

Direct investments

     749        13          47        (15          794       11  

Indirect investments

     635        44                11        (27                      663       42  

Total equity investments

     1,384        57                58        (42                      1,457       53  

Loans

     2                       2      

Other assets

                          

BlackRock Series C Preferred Stock

     396        51                    447       51  

Other

     7                         1                                 8          

Total other assets

     403        51                1                                 455       51  

Total assets

   $ 12,428      $ 166     $ 313      $ 265      $ (50   $ 39      $ (560   $ 12,601     $ 132  

Total liabilities (c)

   $ 460      $ 64                       $ 3              $ (51   $ 476     $ 64  

 

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Three Months Ended March 31, 2010

 

             Total realized / unrealized
gains or losses (a)
                                  (*) Attributable
to unrealized
gains or losses
related to
assets and
liabilities held
at March 31,
2010
 

Level 3 Instruments Only

In millions

   Fair Value
December 31,
2009
     Included
in
Earnings
(*)
    Included in
other
comprehensive
income
    Purchases,
issuances,
and
settlements,
net
    Transfers
into
Level 3
(b)
     Transfers
out of
Level 3
(b)
    Fair
Value
March 31,
2010
    

Assets

                       

Securities available for sale

                       

Residential mortgage-backed agency

   $ 5          $ (5              

Residential mortgage-backed non-agency

     8,302      $ (69   $ 285       (808        $ 7,710      $ (73

Commercial mortgage-backed non-agency

     6            $ 2       $ (5     3       

Asset-backed

     1,254        (43     57       (81          1,187        (43

State and municipal

     266          (6     11       1          272       

Other debt

     53          3       (2     29          83       

Corporate stocks and other

     47                (1     1                        47           

Total securities available for sale

     9,933        (112     338       (884     32        (5     9,302        (116

Financial derivatives

     50        36                86        51  

Trading securities – Debt

     89        (4       (8          77        (4

Residential mortgage servicing rights

     1,332        (35       (26          1,271        (34

Commercial mortgage loans held for sale

     1,050        9         (18          1,041        9  

Equity investments

                       

Direct investments

     595        25         (18          602        15  

Indirect investments

     593        17               (4                      606        11  

Total equity investments

     1,188        42               (22                      1,208        26  

Other assets

                       

BlackRock Series C Preferred Stock

     486        (30       (4          452       

Other

     23                (3     (11                      9           

Total other assets

     509        (30     (3     (15                      461           

Total assets

   $ 14,151       $ (94   $ 335     $ (973   $ 32      $ (5   $ 13,446      $ (68

Total liabilities (c)

   $ 506      $ (14           $ 2                      $ 494      $ 27  
(a) Losses for assets are bracketed while losses for liabilities are not.
(b) PNC’s policy is to recognize transfers in and transfers out as of the end of the reporting period.
(c) Financial derivatives.

 

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Net gains (realized and unrealized) included in earnings relating to Level 3 assets and liabilities were $102 million for the first three months of 2011 compared with net losses of $80 million for the first three months of 2010. These amounts included net unrealized gains of $68 million and amortization and accretion of $24 million for the first three months of 2011 compared with net unrealized losses of $95 million and amortization and accretion of $32 million for the first three months of 2010. The amortization and accretion amounts were included in interest income, and all other amounts were included in noninterest income on the Consolidated Income Statement.

During the first three months of 2011 and 2010, no material transfers of assets or liabilities between the hierarchy levels occurred.

Nonrecurring Fair Value Changes

We may be required to measure certain other financial assets at fair value on a nonrecurring basis. These adjustments to fair value usually result from the application of lower-of-cost-or-fair value accounting or write-downs of individual assets due to impairment.

The amounts below for nonaccrual loans represent the carrying value of loans for which adjustments are primarily based on the appraised value of collateral or the net book

value of the collateral from the borrower’s most recent financial statements if no appraisal is available. If an appraisal is outdated due to changed project or market conditions, or if the net book value is utilized, management applies internal assumptions in determining fair value. The amounts below for loans held for sale represent the carrying value of loans for which adjustments are primarily based on observable market data, management’s internal assumptions or the appraised value of collateral. The fair value determination of the equity investment resulting in an impairment loss included below was based on observable market data for other comparable entities as adjusted for internal assumptions and unobservable inputs. The amounts below for commercial mortgage servicing rights reflect an impairment of three strata at March 31, 2011 and at December 31, 2010, respectively. The fair value of commercial mortgage servicing rights is estimated by using an internal valuation model. The model calculates the present value of estimated future net servicing cash flows considering estimates of servicing revenue and costs, discount rates and prepayment speeds. The amounts below for long-lived assets held for sale represent the carrying value of the asset for which adjustments are primarily based upon the most recent appraised value or, if the net book value is utilized, management applies internal assumptions in determining fair value.

 

 

Fair Value Measurements – Nonrecurring (a)

 

     Fair Value     

Gains (Losses)

Three months ended

 
In millions    March 31
2011
     December 31
2010
     March 31
2011
    March 31
2010
 

Assets

            

Nonaccrual loans

   $ 458      $ 429      $ (71   $ (34

Loans held for sale

     60        350        (1     (2

Equity investments (b)

        3         

Commercial mortgage servicing rights

     627        644        (35     (4

Other intangible assets

        1         

Foreclosed and other assets

     149        245        (29     (30

Long-lived assets held for sale

     33        25        (1     (9

Total assets

   $ 1,327      $ 1,697      $ (137   $ (79

 

(a) All Level 3.
(b) Includes LIHTC and other equity investments.

 

Fair Value Option

Refer to the Fair Value Measurement section of this Note 8 regarding the fair value of commercial mortgage loans held for sale, residential mortgage loans held for sale, customer resale agreements, and BlackRock Series C Preferred Stock.

Commercial Mortgage Loans Held for Sale

Interest income on these loans is recorded as earned and reported on the Consolidated Income Statement in other interest income. The impact on earnings of offsetting economic hedges is not reflected in these amounts. Changes in fair value due to instrument-specific credit risk for both the first three months of 2011 and 2010 were not material.

Residential Mortgage Loans Held for Sale

Interest income on these loans is recorded as earned and reported on the Consolidated Income Statement in other interest income. Throughout 2010 and the first three months of 2011, certain residential mortgage loans for which we elected the fair value option were subsequently reclassified to portfolio loans. Changes in fair value due to instrument-specific credit risk for the first three months of 2011 and 2010 were not material.

 

 

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Customer Resale Agreements

Interest income on structured resale agreements is reported on the Consolidated Income Statement in other interest income. Changes in fair value due to instrument-specific credit risk for both the first three months of 2011 and 2010 were not material.

The changes in fair value included in noninterest income for items for which we elected the fair value option follow.

Fair Value Option – Changes in Fair Value (a)

 

     Gains (Losses)
Three months ended
 
In millions    March 31
2011
    March 31
2010
 

Assets

      

Customer resale agreements

   $ (8   $ 1  

Commercial mortgage loans held for sale

     (7     9  

Residential mortgage loans held for sale

     48       46  

Residential mortgage loans – portfolio

     10       2  

BlackRock Series C Preferred Stock

     51       (30

 

(a) The impact on earnings of offsetting hedged items or hedging instruments is not reflected in these amounts.

Fair values and aggregate unpaid principal balances of items for which we elected the fair value option follow.

Fair Value Option – Fair Value and Principal Balances

 

In millions    Fair Value      Aggregate Unpaid
Principal Balance
    Difference  

March 31, 2011

         

Customer resale agreements

   $ 823      $ 771     $ 52  

Residential mortgage loans held for sale

         

Performing loans

     1,798        1,768       30  

Loans 90 days or more past due

     25        31       (6

Nonaccrual loans

     3        6       (3

Total

     1,826        1,805       21  

Commercial mortgage loans held for sale (a)

         

Performing loans

     836        986       (150

Nonaccrual loans

     22        32       (10

Total

     858        1,018       (160

Residential mortgage loans – portfolio

         

Performing loans

     55        71       (16

Loans 90 days or more past due

     78        85       (7

Nonaccrual loans

     96        190       (94

Total

   $ 229      $ 346     $ (117

December 31, 2010

         

Customer resale agreements

   $ 866      $ 806     $ 60  

Residential mortgage loans held for sale

         

Performing loans

     1,844        1,839       5  

Loans 90 days or more past due

     33        41       (8

Nonaccrual loans

     1        2       (1

Total

     1,878        1,882       (4

Commercial mortgage loans held for sale (a)

         

Performing loans

     847        990       (143

Nonaccrual loans

     30        49       (19

Total

     877        1,039       (162

Residential mortgage loans – portfolio

         

Performing loans

     36        44       (8

Loans 90 days or more past due

     64        67       (3

Nonaccrual loans

     16        31       (15

Total

   $ 116      $ 142     $ (26

 

(a) There were no loans 90 days or more past due within this category at March 31, 2011 or December 31, 2010.

 

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ADDITIONAL FAIR VALUE INFORMATION RELATED TO FINANCIAL INSTRUMENTS

 

     March 31, 2011      December 31, 2010  
In millions    Carrying
Amount
    

Fair

Value

     Carrying
Amount
    

Fair

Value

 

Assets

               

Cash and short-term assets

   $ 8,081      $ 8,081      $ 9,711      $ 9,711  

Trading securities

     2,254        2,254        1,826        1,826  

Investment securities

     60,992        61,167        64,262        64,487  

Loans held for sale

     2,980        2,982        3,492        3,492  

Net loans (excludes leases)

     138,414        140,365        139,316        141,431  

Other assets

     4,537        4,537        4,664        4,664  

Mortgage servicing rights

     1,754        1,763        1,698        1,707  

Financial derivatives

               

Designated as hedging instruments under GAAP

     1,104        1,104        1,255        1,255  

Not designated as hedging instruments under GAAP

     3,972        3,972        4,502        4,502  
   

Liabilities

               

Demand, savings and money market deposits

     142,610        142,610        141,990        141,990  

Time deposits

     39,380        39,705        41,400        41,825  

Borrowed funds

     35,326        37,401        39,821        41,273  

Financial derivatives

               

Designated as hedging instruments under GAAP

     75        75        85        85  

Not designated as hedging instruments under GAAP

     4,247        4,247        4,850        4,850  

Unfunded loan commitments and letters of credit

     188        188        173        173  

 

The aggregate fair values in the table above do not represent the total market value of PNC’s assets and liabilities as the table excludes the following:

   

real and personal property,

   

lease financing,

   

loan customer relationships,

   

deposit customer intangibles,

   

retail branch networks,

   

fee-based businesses, such as asset management and brokerage, and

   

trademarks and brand names.

We used the following methods and assumptions to estimate fair value amounts for financial instruments.

General

For short-term financial instruments realizable in three months or less, the carrying amount reported on our Consolidated Balance Sheet approximates fair value. Unless otherwise stated, the rates used in discounted cash flow analyses are based on market yield curves.

Cash and Short-Term Assets

The carrying amounts reported on our Consolidated Balance Sheet for cash and short-term investments approximate fair values primarily due to their short-term nature. For purposes of this disclosure only, short-term assets include the following:

   

due from banks,

   

interest-earning deposits with banks,

   

federal funds sold and resale agreements,

   

cash collateral,

   

customers’ acceptances, and

   

accrued interest receivable.

Securities

Securities include both the investment securities (comprised of available for sale and held to maturity securities) and trading portfolios. We use prices obtained from pricing services, dealer quotes or recent trades to determine the fair value of securities. For 55% of our positions, we use prices obtained from pricing services provided by third party vendors. For an additional 11% of our positions, we use prices obtained from the pricing services as the primary input into the valuation process. One of the vendors’ prices are set with reference to market activity for highly liquid assets such as agency mortgage-backed securities, and matrix pricing for other assets, such as CMBS and asset-backed securities. Another vendor primarily uses pricing models considering adjustments for ratings, spreads, matrix pricing and prepayments for the instruments we value using this service, such as non-agency residential mortgage-backed securities, agency adjustable rate mortgage securities, agency CMOs and municipal bonds. Management uses various methods and techniques to corroborate prices obtained from pricing services and dealers, including reference to other dealers’ quotes, by reviewing valuations of comparable instruments, or by comparison to internal valuations. Dealer quotes received are typically non-binding.

 

 

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NET LOANS AND LOANS HELD FOR SALE

Fair values are estimated based on the discounted value of expected net cash flows incorporating assumptions about prepayment rates, net credit losses and servicing fees. For purchased impaired loans, fair value is assumed to equal PNC’s recorded investment, which represents the present value of expected future principal and interest cash flows, as adjusted for any ALLL recorded for these loans. See Note 6 Purchased Impaired Loans for additional information. For revolving home equity loans and commercial credit lines, this fair value does not include any amount for new loans or the related fees that will be generated from the existing customer relationships. Non-accrual loans are valued at their estimated recovery value. Also refer to the Fair Value Measurement and Fair Value Option sections of this Note 8 regarding the fair value of commercial and residential mortgage loans held for sale. Loans are presented net of the ALLL and do not include future accretable discounts related to purchased impaired loans.

OTHER ASSETS

Other assets as shown in the accompanying table include the following:

   

FHLB and FRB stock,

   

equity investments carried at cost and fair value, and

   

BlackRock Series C Preferred Stock.

Investments accounted for under the equity method, including our investment in BlackRock, are not included in the accompanying table.

The carrying amounts of private equity investments are recorded at fair value. The valuation procedures applied to direct investments and affiliated partnership interests include techniques such as multiples of adjusted earnings of the entity, independent appraisals, anticipated financing and sales transactions with third parties, or the pricing used to value the entity in a recent financing transaction. We value indirect investments in private equity funds based on net asset value as provided in the financial statements that we receive from their managers. Due to the time lag in our receipt of the financial information and based on a review of investments and valuation techniques applied, adjustments to the manager-provided value are made when available recent investment portfolio company or market information indicates a significant change in value from that provided by the general partner.

Fair value of the noncertificated interest-only strips is estimated based on the discounted value of expected net cash flows. The aggregate carrying value of our investments that

are carried at cost and FHLB and FRB stock was $2.2 billion at March 31, 2011 and $2.4 billion as of December 31, 2010, both of which approximate fair value at each date.

MORTGAGE SERVICING ASSETS

Fair value is based on the present value of the estimated future cash flows, incorporating assumptions as to prepayment speeds, discount rates, escrow balances, interest rates, cost to service and other factors.

The key valuation assumptions for commercial and residential mortgage loan servicing assets at March 31, 2011 and December 31, 2010 are included in Note 9 Goodwill and Other Intangible Assets.

CUSTOMER RESALE AGREEMENTS

Refer to the Fair Value Measurement section of this Note 8 regarding the fair value of customer resale agreements.

DEPOSITS

The carrying amounts of noninterest-bearing demand and interest-bearing money market and savings deposits approximate fair values. For time deposits, which include foreign deposits, fair values are estimated based on the discounted value of expected net cash flows assuming current interest rates.

BORROWED FUNDS

The carrying amounts of Federal funds purchased, commercial paper, repurchase agreements, proprietary trading short positions, cash collateral, other short-term borrowings, acceptances outstanding and accrued interest payable are considered to be their fair value because of their short-term nature. For all other borrowed funds, fair values are estimated primarily based on dealer quotes or discounted cash flow analysis.

UNFUNDED LOAN COMMITMENTS AND LETTERS OF CREDIT

The fair value of unfunded loan commitments and letters of credit is determined from a market participant’s view including the impact of changes in interest rates, credit and other factors. Because the interest rate on substantially all unfunded loan commitments and letters of credit varies with changes in market rates, these instruments are subject to little fluctuation in fair value due to changes in interest rates. We establish a liability on these facilities related to their creditworthiness.

FINANCIAL DERIVATIVES

Refer to the Fair Value Measurement section of this Note 8 regarding the fair value of financial derivatives.

 

 

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NOTE 9 GOODWILL AND OTHER INTANGIBLE ASSETS

Changes in goodwill and other intangible assets during the first three months of 2011 follow:

 

Summary of Changes in Goodwill and Other Intangible Assets

 

In millions    Goodwill     Customer-
Related
    Servicing
Rights
 

December 31, 2010

   $ 8,149     $ 903     $ 1,701  

Additions/adjustments:

        

Other

     (3      

Mortgage and other loan servicing rights

         119  

Impairment charge

         (35

Amortization

             (41     (29

March 31, 2011

   $ 8,146     $ 862     $ 1,756  

Assets and liabilities of acquired entities are recorded at estimated fair value as of the acquisition date and are subject to refinement as information relative to the fair values at the date of acquisition becomes available.

Our investment in BlackRock changes when BlackRock repurchases its shares in the open market or issues shares for an acquisition or pursuant to its employee compensation plans. We adjust goodwill when BlackRock repurchases its shares at an amount greater (or less) than book value per share which results in an increase (or decrease) in our percentage ownership interest.

The gross carrying amount, accumulated amortization and net carrying amount of other intangible assets by major category consisted of the following:

Other Intangible Assets

 

In millions    March 31
2011
    December 31
2010
 

Customer-related and other intangibles

      

Gross carrying amount

   $ 1,524     $ 1,524  

Accumulated amortization

     (662     (621

Net carrying amount

   $ 862     $ 903  

Mortgage and other loan servicing rights

      

Gross carrying amount

   $ 2,393     $ 2,293  

Valuation allowance

     (75     (40

Accumulated amortization

     (562     (552

Net carrying amount

   $ 1,756     $ 1,701  

Total

   $ 2,618     $ 2,604  

While certain of our other intangible assets have finite lives and are amortized primarily on a straight-line basis, certain core deposit intangibles are amortized on an accelerated basis.

For customer-related and other intangibles, the estimated remaining useful lives range from less than one year to 10 years, with a weighted-average remaining useful life of 9 years.

Amortization expense on existing intangible assets, net of impairment reversal (charge) follows:

Amortization Expense on Existing Intangible Assets, Net (a)

 

In millions        

Three months ended March 31, 2011

   $ 105  

Three months ended March 31, 2010

     78  

Remainder of 2011

     188  

2012

     225  

2013

     215  

2014

     212  

2015

     194  

2016

     162  
(a) Includes the impact of impairment charges (reversals).

Changes in commercial mortgage servicing rights follow:

Commercial Mortgage Servicing Rights

 

In millions    2011     2010  

January 1

   $ 665     $ 921  

Additions (a)

     43       25  

Impairment (charge) reversal

     (35     (4

Amortization expense

     (28     (21

March 31

   $ 645     $ 921  
(a) Additions for the first three months of 2011 included $15 million from loans sold with servicing retained and $28 million from purchases of servicing rights from third parties. Comparable amounts for the first three months of 2010 were $14 million and $11 million.
 

 

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We recognize as an other intangible asset the right to service mortgage loans for others. Commercial mortgage servicing rights are purchased in the open market and originated when loans are sold with servicing retained. Commercial mortgage servicing rights are initially recorded at fair value. These rights are subsequently measured using the amortization method. Accordingly, the commercial mortgage servicing rights are substantially amortized in proportion to and over the period of estimated net servicing income over a period of 5 to 10 years.

Commercial mortgage servicing rights are periodically evaluated for impairment. For purposes of impairment, the commercial mortgage servicing rights are stratified based on asset type, which characterizes the predominant risk of the underlying financial asset. If the carrying amount of any individual stratum exceeds its fair value, a valuation reserve is established with a corresponding charge to Corporate Services on our Consolidated Income Statement.

The fair value of commercial mortgage servicing rights is estimated by using an internal valuation model. The model calculates the present value of estimated future net servicing cash flows considering estimates on servicing revenue and costs, discount rates and prepayment speeds.

Changes in the residential mortgage servicing rights follow:

Residential Mortgage Servicing Rights

 

In millions    2011     2010  

January 1

   $ 1,033     $ 1,332  

Additions:

      

From loans sold with servicing retained

     39       20  

Purchases

     48      

Changes in fair value due to:

      

Time and payoffs (a)

     (47     (45

Other (b)

     36       (36

March 31

   $ 1,109     $ 1,271  

Unpaid principal balance of loans serviced for others at March 31

   $ 127,246     $ 141,395  
(a) Represents decrease in mortgage servicing rights value due to passage of time, including the impact from both regularly scheduled loan principal payments and loans that paid down or paid off during the period.
(b) Represents mortgage servicing rights value changes resulting primarily from market-driven changes in interest rates.

We recognize mortgage servicing right assets on residential real estate loans when we retain the obligation to service these loans upon sale and the servicing fee is more than adequate compensation. Mortgage servicing rights are subject to declines in value principally from actual or expected prepayment of the underlying loans and defaults. We manage this risk by economically hedging the fair value of mortgage servicing rights with securities and derivative instruments which are expected to increase in value when the value of mortgage servicing rights declines.

The fair value of residential mortgage servicing rights is estimated by using third party software with internal valuation assumptions. The software calculates the present value of estimated future net servicing cash flows considering estimates on servicing revenue and costs, discount rates, prepayment speeds and future mortgage rates.

The fair value of residential and commercial MSRs and significant inputs to the valuation model as of March 31, 2011 are shown in the tables below. The expected and actual rates of mortgage loan prepayments are significant factors driving the fair value. Management uses a third party model to estimate future residential mortgage loan prepayments and internal proprietary models to estimate future commercial mortgage loan prepayments. These models have been refined based on historical performance of PNC’s managed portfolio, as adjusted for current market conditions. Future interest rates are another important factor in the valuation of MSRs. Management utilizes market implied forward interest rates to estimate the future direction of mortgage and discount rates. Changes in the shape and slope of the forward curve in future periods may result in volatility in the fair value estimate.

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

The following tables set forth the fair value of commercial and residential MSRs and the sensitivity analysis of the hypothetical effect on the fair value of MSRs to immediate adverse changes of 10% and 20% in those assumptions:

Commercial Mortgage Loan Servicing Assets – Key Valuation Assumptions

 

Dollars in millions   March 31,
2011
    December 31,
2010
 

Fair value

  $ 654     $ 674  

Weighted-average life (years)

    6.2       6.3  

Weighted-average constant prepayment rate

    13%-25%        10%-24%   

Decline in fair value from 10% adverse change

  $ 8     $ 8  

Decline in fair value from 20% adverse change

  $ 15     $ 16  

Spread over forward interest rate swap rates

    7%-9 %        7%-9 %   

Decline in fair value from 10% adverse change

  $ 13     $ 13  

Decline in fair value from 20% adverse change

  $ 25     $ 26  
 

 

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Residential Mortgage Loan Servicing Assets – Key Valuation Assumptions

 

Dollars in millions   March 31,
2011
    December 31,
2010
 

Fair value

  $ 1,109     $ 1,033  

Weighted-average life (years)

    6.2       5.8  

Weighted-average constant prepayment rate

    11.75 %        12.61 %   

Decline in fair value from 10% adverse change

  $ 48     $ 41  

Decline in fair value from 20% adverse change

  $ 93     $ 86  

Spread over forward interest rate swap rates

    12.11 %        12.18 %   

Decline in fair value from 10% adverse change

  $ 47     $ 43  

Decline in fair value from 20% adverse change

  $ 90     $ 83  

Revenue from mortgage and other loan servicing comprised of contractually specified servicing fees, late fees, and ancillary fees follows:

Revenue from Mortgage and Other Loan Servicing

 

In millions    2011      2010  

Three months ended March 31

   $ 159      $ 182  

We also generate servicing revenue from fee-based activities provided to others.

Revenue from commercial mortgage servicing rights, residential mortgage servicing rights and other loan servicing are reported on our Consolidated Income Statement in the line items Corporate services, Residential mortgage, and Consumer services, respectively.

NOTE 10 CAPITAL SECURITIES OF SUBSIDIARY TRUSTS AND PERPETUAL TRUST SECURITIES

CAPITAL SECURITIES OF SUBSIDIARY TRUSTS

Our capital securities of subsidiary trusts are described in Note 13 Capital Securities of Subsidiary Trusts and Perpetual Trust Securities in our 2010 Form 10-K. All of these Trusts are wholly owned finance subsidiaries of PNC. In the event of certain changes or amendments to regulatory requirements or federal tax rules, the capital securities are redeemable. The financial statements of the Trusts are not included in PNC’s consolidated financial statements in accordance with GAAP.

The obligations of the respective parent of each Trust, when taken collectively, are the equivalent of a full and unconditional guarantee of the obligations of such Trust under the terms of the capital securities. Such guarantee is subordinate in right of payment in the same manner as other

junior subordinated debt. There are certain restrictions on PNC’s overall ability to obtain funds from its subsidiaries. For additional disclosure on these funding restrictions, including an explanation of dividend and intercompany loan limitations, see Note 21 Regulatory Matters in our 2010 Form 10-K.

PNC is also subject to restrictions on dividends and other provisions potentially imposed under the Exchange Agreements with Trust II and Trust III, as described in Note 13 in our 2010 Form 10-K in the Perpetual Trust Securities section, and to other provisions similar to or in some ways more restrictive than those potentially imposed under those agreements.

PERPETUAL TRUST SECURITIES

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

In February 2008, PNC Preferred Funding LLC (the LLC), one of our indirect subsidiaries, sold $375 million of 8.700% Fixed-to-Floating Rate Non-Cumulative Exchangeable Perpetual Trust Securities of PNC Preferred Funding Trust III (Trust III) to third parties in a private placement. In connection with the private placement, Trust III acquired $375 million of Fixed-to-Floating Rate Non-Cumulative Perpetual Preferred Securities of the LLC (the LLC Preferred Securities). The sale was similar to the March 2007 private placement by the LLC of $500 million of 6.113% Fixed-to-Floating Rate Non-Cumulative Exchangeable Trust Securities (the Trust II Securities) of PNC Preferred Funding Trust II (Trust II) in which Trust II acquired $500 million of LLC Preferred Securities and to the December 2006 private placement by PNC REIT Corp. of $500 million of 6.517% Fixed-to-Floating Rate Non-Cumulative Exchangeable Perpetual Trust Securities (the Trust I Securities) of PNC Preferred Funding Trust I (Trust I) in which Trust I acquired $500 million of LLC Preferred Securities. PNC REIT Corp. owns 100% of LLC’s common voting securities. As a result, LLC is an indirect subsidiary of PNC and is consolidated on our Consolidated Balance Sheet. Trust I, II and III’s investment in LLC Preferred Securities is characterized as a noncontrolling interest on our Consolidated Balance Sheet since we are not the primary beneficiary of Trust I, Trust II and Trust III. This noncontrolling interest totaled $1.3 billion at March 31, 2011.

Our 2010 Form 10-K includes additional information regarding the Trust I and Trust II Securities, including descriptions of replacement capital and dividend restriction covenants. The Trust III Securities include dividend restriction covenants similar to those described for Trust II Securities.

 

 

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NOTE 11 CERTAIN EMPLOYEE BENEFIT AND STOCK-BASED COMPENSATION PLANS

PENSION AND POSTRETIREMENT PLANS

As described in Note 14 Employee Benefit Plans in our 2010 Form 10-K, we have a noncontributory, qualified defined benefit pension plan covering eligible employees. Benefits are determined using a cash balance formula where earnings credits are a percentage of eligible compensation. Pension contributions are based on an actuarially determined amount necessary to fund total benefits payable to plan participants.

We also maintain nonqualified supplemental retirement plans for certain employees and provide certain health care and life insurance benefits for qualifying retired employees (postretirement benefits) through various plans. The nonqualified pension and postretirement benefit plans are unfunded. The Company reserves the right to terminate or make plan changes at any time.

The components of our net periodic pension and post-retirement benefit cost for the first three months of 2011 and 2010 were as follows:

Net Periodic Pension and Postretirement Benefits Costs

 

     Qualified
Pension Plan
    Nonqualified
Retirement
Plans
     Postretirement
Benefits
 

Three months ended

March 31

In millions

   2011      2010     2011      2010      2011      2010  

Net periodic cost consists of:

                      

Service cost

   $ 27      $ 24     $ 1      $ 1      $ 1      $ 1  

Interest cost

     49        51       3        3        5        5  

Expected return on plan assets

     (75      (72               

Amortization of prior service cost

     (2      (2             (1      (1

Amortization of actuarial losses

     4        9       1        1        1           

Net periodic cost (benefit)

   $ 3      $ 10     $ 5      $ 5      $ 6      $ 5  

STOCK-BASED COMPENSATION PLANS

As more fully described in Note 15 Stock-Based Compensation Plans in our 2010 Form 10-K, we have long-term incentive award plans (Incentive Plans) that provide for the granting of incentive stock options, nonqualified stock options, stock appreciation rights, incentive shares/performance units, restricted stock, restricted share units, other share-based awards and dollar-denominated awards to executives and, other than incentive stock options, to non-employee directors. Certain Incentive Plan awards may be paid in stock, cash or a combination of stock and cash. We typically grant a substantial portion of our stock-based compensation awards during the first quarter of the year. As of March 31, 2011, no stock appreciation rights were outstanding.

Total compensation expense recognized related to all share-based payment arrangements during the first three months of 2011 and 2010 was $30 million and $27 million, respectively.

NONQUALIFIED STOCK OPTIONS

Options are granted at exercise prices not less than the market value of common stock on the grant date. Generally, options become exercisable in installments after the grant date. No option may be exercisable after 10 years from its grant date. Payment of the option exercise price may be in cash or shares of common stock at market value on the exercise date. The exercise price may be paid in previously owned shares.

For purposes of computing stock option expense, we estimated the fair value of stock options primarily by using the Black-Scholes option-pricing model. Option pricing models require the use of numerous assumptions, many of which are very subjective.

Option Pricing Assumptions

 

Weighted-average for the three months ended

March 31

   2011     2010  

Risk-free interest rate

     2.8     2.9

Dividend yield

     0.6        0.7   

Volatility

     34.7        32.7   

Expected life

     5.9 yrs.        6.0 yrs.   

Grant-date fair value

   $ 22.82      $ 18.44   
 

 

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Stock Option Rollforward

 

     PNC     

PNC Options
Converted From
National City

Options

     Total  
In thousands, except weighted-average data    Shares     Weighted-
Average
Exercise
Price
     Shares     Weighted-
Average
Exercise
Price
     Shares     Weighted-
Average
Exercise
Price
 

Outstanding at December 31, 2010

     19,825     $ 56.36        1,214     $ 678.09        21,039     $ 92.25  

Granted

     833       64.04               833       64.04  

Exercised

     (108     44.61               (108     44.61  

Cancelled

     (2,250     74.37        (44     395.51        (2,294     80.59  

Outstanding at March 31, 2011

     18,300     $ 54.57        1,170     $ 688.84        19,470     $ 92.68  

Exercisable at March 31, 2011

     11,817     $ 57.64        1,170     $ 688.84        12,987     $ 114.50  

 

During the first three months of 2011 we issued 108,150 shares from treasury stock in connection with stock option exercise activity. As with past exercise activity, we currently intend to utilize treasury stock primarily for any future stock option exercises.

INCENTIVE/PERFORMANCE UNIT SHARE AWARDS AND RESTRICTED STOCK/UNIT AWARDS

The fair value of nonvested incentive/performance unit share awards and restricted stock/unit awards is initially determined based on prices not less than the market value of our common stock price on the date of grant. The value of certain incentive/performance unit share awards are subsequently remeasured based on the achievement of one or more financial and other performance goals over a three-year period. The Personnel and Compensation Committee of the Board of Directors approves the final award payout with respect to incentive/performance unit share awards. Restricted stock/unit awards have various vesting periods generally ranging from 36 months to 60 months.

Beginning in 2011, we incorporated two changes to certain awards under our existing long-term incentive compensation programs. For certain grants of incentive performance units, the future payout amount will be subject to a negative annual adjustment if PNC fails to meet certain risk-related performance metrics. This adjustment is in addition to the existing financial performance metrics relative to our peers. These grants have a three-year performance period and are payable in either stock or a combination of stock and cash.

Additionally, performance-based restricted share units (performance RSUs) were granted in 2011 to certain of our executives in lieu of stock options. These performance RSUs have a service condition, an internal risk-related performance condition, and an external market condition. Satisfaction of the performance condition is based on four independent one-year performance periods and are payable solely in stock.

 

 

Nonvested Incentive/Performance Unit Share Awards and Restricted Stock/Unit Awards — Rollforward

 

Shares in thousands    Nonvested
Incentive/
Performance
Unit Shares
    Weighted-
Average
Grant Date
Fair Value
     Nonvested
Restricted
Stock/
Unit
Shares
    Weighted-
Average
Grant Date
Fair Value
 

December 31, 2010

     363     $ 56.40        2,250     $ 49.95  

Granted

     623       64.21        874       64.09  

Vested/Released

     (156     59.54        (398     58.14  

Forfeited

                      (16     56.28  

March 31, 2011

     830     $ 61.68        2,710     $ 53.27  

 

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In the chart above, the unit shares and related weighted-average grant-date fair value of the incentive/performance awards exclude the effect of dividends on the underlying shares, as those dividends will be paid in cash.

At March 31, 2011, there was $88 million of unrecognized deferred compensation expense related to nonvested share-based compensation arrangements granted under the Incentive Plans. This cost is expected to be recognized as expense over a period of no longer than five years.

LIABILITY AWARDS

Beginning in 2008, we granted cash-payable restricted share units to certain executives. The grants were made primarily as part of an annual bonus incentive deferral plan. While there are time-based and service-related vesting criteria, there are no market or performance criteria associated with these awards. Compensation expense recognized related to these awards was recorded in prior periods as part of annual cash bonus criteria. As of March 31, 2011, there were 764,979 of these cash-payable restricted share units outstanding.

During the third quarter of 2009, we entered into an agreement with certain of our executives regarding a portion of their salary to be payable in stock units. These units, which are cash-payable, have no future service, market or performance criteria and as such are fully expensed at grant date. These units totaled 280,174 at December 31, 2010 and were settled in cash on March 31, 2011 for approximately $18 million.

Nonvested Cash-Payable Restricted Share Unit—Rollforward

 

In thousands    Nonvested
Cash-Payable
Restricted
Unit Shares
    Aggregate
Intrinsic
Value
 

Outstanding at December 31, 2010

     1,112      

Granted

     525      

Vested and Released

     (547    

Forfeited

     (5    

Outstanding at March 31, 2011

     1,085     $ 68,367  

NOTE 12 FINANCIAL DERIVATIVES

We use derivative financial instruments (derivatives) primarily to help manage exposure to interest rate, market and credit risk and reduce the effects that changes in interest rates may have on net income, fair value of assets and liabilities, and cash flows. We also enter into derivatives with customers to facilitate their risk management activities.

Derivatives represent contracts between parties that usually require little or no initial net investment and result in one party delivering cash or another type of asset to the other party based on a notional amount and an underlying as specified in

the contract. Derivative transactions are often measured in terms of notional amount, but this amount is generally not exchanged and it is not recorded on the balance sheet. The notional amount is the basis to which the underlying is applied to determine required payments under the derivative contract. The underlying is a referenced interest rate, commonly LIBOR, security price, credit spread or other index. Certain contracts and commitments, such as residential and commercial real estate loan commitments associated with loans to be sold, also qualify as derivative instruments.

All derivatives are carried on our Consolidated Balance Sheet at fair value. Derivative balances are presented on a net basis taking into consideration the effects of legally enforceable master netting agreements. Cash collateral exchanged with counterparties is also netted against the applicable derivative fair values.

Further discussion on how derivatives are accounted for is included in Note 1 Accounting Policies in our 2010 Form 10-K.

Derivatives Designated in Hedge Relationships

Certain derivatives used to manage interest rate risk as part of our asset and liability risk management activities are designated as accounting hedges under GAAP. Derivatives hedging the risks associated with changes in the fair value of assets or liabilities are considered fair value hedges, while derivatives hedging the variability of expected future cash flows are considered cash flow hedges. Designating derivatives as accounting hedges allows for gains and losses

on those derivatives, to the extent effective, to be recognized in the income statement in the same period the hedged items affect earnings.

Cash Flow Hedges

We enter into receive-fixed, pay-variable interest rate swaps to modify the interest rate characteristics of designated commercial loans from variable to fixed in order to reduce the impact of changes in future cash flows due to market interest rate changes. For these cash flow hedges, any changes in the fair value of the derivatives that are effective in offsetting changes in the forecasted interest cash flows are recorded in accumulated other comprehensive income and are reclassified to interest income in conjunction with the recognition of interest receipts on the loans. In the 12 months that follow March 31, 2011, we expect to reclassify from the amount currently reported in accumulated other comprehensive income net derivative gains of $382 million pretax, or $248 million after-tax, in association with interest receipts on the hedged loans. This amount could differ from amounts actually recognized due to changes in interest rates, hedge dedesignations, and the addition of other hedges subsequent to March 31, 2011. The maximum length of time over which

 

 

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forecasted loan cash flows are hedged is 10 years. We use statistical regression analysis to assess the effectiveness of these hedge relationships at both the inception of the hedge relationship and on an ongoing basis.

We also periodically enter into forward purchase and sale contracts to hedge the variability of the consideration that will be paid or received related to the purchase or sale of debt securities classified as available for sale. The forecasted purchase or sale is consummated upon gross settlement of the forward contract itself. As a result, hedge ineffectiveness, if any, is typically minimal. Gains and losses on these forward contracts are recorded in accumulated other comprehensive income and are recognized in earnings when the hedged cash flows affect earnings. In the 12 months that follow March 31, 2011, we expect to reclassify from the amount currently reported in accumulated other comprehensive loss, net derivative gains of $29 million pretax, or $19 million after-tax, as adjustments of yield on securities available for sale. The maximum length of time we are hedging forecasted purchases is three months. There were no amounts in accumulated other comprehensive income related to the forecasted sale of securities at March 31, 2011.

There were no components of derivative gains or losses excluded from the assessment of hedge effectiveness related to either cash flow hedge strategy.

During the first three months of 2011 and 2010, there were no gains or losses from cash flow hedge derivatives reclassified to earnings because it became probable that the original forecasted transaction would not occur.

Fair Value Hedges

We enter into receive-fixed, pay-variable interest rate swaps to hedge changes in the fair value of outstanding fixed-rate debt and borrowings caused by fluctuations in market interest rates. The specific products hedged include bank notes, Federal Home Loan Bank borrowings, and senior and subordinated debt. We also enter into pay-fixed, receive- variable interest rate swaps to hedge changes in the fair value of fixed rate investment securities caused by fluctuations in market interest rates. The specific products hedged include US Treasury, government agency and other debt securities. For these hedge relationships, we use statistical regression analysis to assess hedge effectiveness at both the inception of the hedge relationship and on an ongoing basis. There were no components of derivative gains or losses excluded from the assessment of hedge effectiveness.

Further detail regarding the notional amounts, fair values and gains and losses recognized related to derivatives used in fair value and cash flow hedge strategies is presented in the tables that follow.

The ineffective portion of the change in value of our fair value and cash flow hedge derivatives resulted in net losses of $6

million for the first three months of 2011 compared with net losses of less than $1 million for the first three months of 2010.

Derivatives Not Designated in Hedge Relationships

We also enter into derivatives which are not designated as accounting hedges under GAAP.

The majority of these derivatives are used to manage risk related to residential and commercial mortgage banking activities and are considered economic hedges. Although these derivatives are used to hedge risk, they are not designated as accounting hedges because the contracts they are hedging are typically also carried at fair value on the balance sheet, resulting in symmetrical accounting treatment for both the hedging instrument and the hedged item.

Our residential mortgage banking activities consist of originating, selling and servicing mortgage loans. Residential mortgage loans that will be sold in the secondary market, and the related loan commitments, which are considered derivatives, are accounted for at fair value. Changes in the fair value of the loans and commitments due to interest rate risk are hedged with forward loan sale contracts and Treasury and Eurodollar futures and options. Gains and losses on the loans and commitments held for sale and the derivatives used to economically hedge them are included in residential mortgage noninterest income on the Consolidated Income Statement.

We typically retain the servicing rights related to residential mortgage loans that we sell. Residential mortgage servicing rights are accounted for at fair value with changes in fair value influenced primarily by changes in interest rates. Derivatives used to hedge the fair value of residential mortgage servicing rights include interest rate futures, swaps and options, including caps, floors, and swaptions, and forward contracts to purchase mortgage-backed securities. Gains and losses on residential mortgage servicing rights and the related derivatives used for hedging are included in residential mortgage noninterest income.

Certain commercial mortgage loans are also sold into the secondary market as part of our commercial mortgage banking activities and are accounted for at fair value. Derivatives used to economically hedge these loans and commitments from changes in fair value due to interest rate risk and credit risk include forward loan sale contracts, interest rate swaps, and credit default swaps. Gains and losses on the commitments, loans and derivatives are included in other noninterest income.

The residential and commercial loan commitments associated with loans to be sold which are accounted for as derivatives are valued based on the estimated fair value of the underlying loan and the probability that the loan will fund within the terms of the commitment. The fair value also takes into account the fair value of the embedded servicing right.

 

 

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We offer derivatives to our customers in connection with their risk management needs. These derivatives primarily consist of interest rate swaps, interest rate caps, floors, swaptions, and foreign exchange and equity contracts. We primarily manage our market risk exposure from customer transactions by entering into offsetting derivative transactions with third-party dealers. Gains and losses on customer-related derivatives are included in other noninterest income.

The derivatives portfolio also includes derivatives used for other risk management activities. These derivatives are entered into based on stated risk management objectives.

This segment of the portfolio includes credit default swaps (CDS) used to mitigate the risk of economic loss on a portion of our loan exposure. We also sell loss protection to mitigate the net premium cost and the impact of mark-to-market accounting on CDS purchases to hedge the loan portfolio. The fair values of these derivatives typically are based on related credit spreads. Gains and losses on the derivatives entered into for other risk management are included in other noninterest income.

Included in the customer, mortgage banking risk management, and other risk management portfolios are written interest-rate caps and floors entered into with customers and for risk management purposes. We receive an upfront premium from the counterparty and are obligated to make payments to the counterparty if the underlying market interest rate rises above or falls below a certain level designated in the contract. At March 31, 2011, the fair value of the written caps and floors liability on our Consolidated Balance Sheet was $16 million compared with $15 million at December 31, 2010. Our ultimate obligation under written options is based on future market conditions and is only quantifiable at settlement.

Further detail regarding the derivatives not designated in hedging relationships is presented in the tables that follow.

Derivative Counterparty Credit Risk

By entering into derivative contracts we are exposed to credit risk. We seek to minimize credit risk through internal credit approvals, limits, monitoring procedures, executing master netting agreements and collateral requirements. We generally enter into transactions with counterparties that carry high quality credit ratings. Nonperformance risk including credit risk is included in the determination of the estimated net fair value.

We generally have established agreements with our major derivative dealer counterparties that provide for exchanges of marketable securities or cash to collateralize either party’s positions. At March 31, 2011, we held cash, US government securities and mortgage-backed securities totaling $980 million under these agreements. We pledged cash of $642 million under these agreements. To the extent not netted against derivative fair values under a master netting agreement, cash pledged is included in Other assets and cash held is included in Other borrowed funds on our Consolidated Balance Sheet.

The credit risk associated with derivatives executed with customers is essentially the same as that involved in extending loans and is subject to normal credit policies. We may obtain collateral based on our assessment of the customer’s credit quality.

We periodically enter into risk participation agreements to share some of the credit exposure with other counterparties related to interest rate derivative contracts or to take on credit exposure to generate revenue. We will make/receive payments under these agreements if a customer defaults on its obligation to perform under certain derivative swap contracts. Risk participation agreements are included in the derivatives table that follows. Our exposure related to risk participations where we sold protection is discussed in the Credit Derivatives section below.

Contingent Features

Some of PNC’s derivative instruments contain provisions that require PNC’s debt to maintain an investment grade credit rating from each of the major credit rating agencies. If PNC’s debt ratings were to fall below investment grade, it would be in violation of these provisions, and the counterparties to the derivative instruments could request immediate payment or demand immediate and ongoing full overnight collateralization on derivative instruments in net liability positions.

The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a net liability position on March 31, 2011 was $825 million for which PNC had posted collateral of $627 million in the normal course of business. The maximum amount of collateral PNC would have been required to post if the credit-risk-related contingent features underlying these agreements had been triggered on March 31, 2011, would be an additional $198 million.

 

 

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Derivatives Total Notional or Contractual Amounts and Estimated Net Fair Values

 

     Asset Derivatives      Liability Derivatives  
     March 31, 2011      December 31, 2010      March 31, 2011      December 31, 2010  
In millions    Notional/
Contract
Amount
     Fair
Value (a)
     Notional/
Contract
Amount
     Fair
Value (a)
     Notional/
Contract
Amount
     Fair
Value (b)
     Notional/
Contract
Amount
    Fair
Value (b)
 

Derivatives designated as hedging instruments under GAAP

                        

Interest rate contracts:

                        

Cash flow hedges

   $ 12,985      $ 327      $ 13,635      $ 377      $ 3,261      $ 39      $ 3,167     $ 53  

Fair value hedges

     10,501        777        9,878        878        1,462        36        1,594       32  

Total derivatives designated as hedging instruments

   $ 23,486      $ 1,104      $ 23,513      $ 1,255      $ 4,723      $ 75      $ 4,761     $ 85  

Derivatives not designated as hedging instruments under GAAP

                        

Derivatives used for residential mortgage banking activities:

                        

Residential mortgage servicing

                        

Interest rate contracts

   $ 116,160      $ 1,400      $ 112,236      $ 1,490      $ 60,030      $ 1,130      $ 66,476     $ 1,419  

Loan sales

                        

Interest rate contracts

     6,095        36        11,765        119        3,286        19        3,585       31  

Subtotal

   $ 122,255      $ 1,436      $ 124,001      $ 1,609      $ 63,316      $ 1,149      $ 70,061     $ 1,450  

Derivatives used for commercial mortgage banking activities:

                        

Interest rate contracts

   $ 857      $ 41      $ 1,159      $ 75      $ 1,498      $ 77      $ 1,813     $ 111  

Credit contracts:

                        

Credit default swaps

     215        8        210        8                                     

Subtotal

   $ 1,072      $ 49      $ 1,369      $ 83      $ 1,498      $ 77      $ 1,813     $ 111  

Derivatives used for customer-related activities:

                        

Interest rate contracts

   $ 56,666      $ 2,299      $ 54,060      $ 2,611      $ 48,668      $ 2,381      $ 49,619     $ 2,703  

Foreign exchange contracts

     4,762        155        3,659        149        5,168        165        4,254       155  

Equity contracts

     198        13        195        16        141        17        139       19  

Credit contracts:

                        

Risk participation agreements

     1,375        4        1,371        5        1,628        3        1,367       2  

Other contracts

     255        1                          85        1                   

Subtotal

   $ 63,256      $ 2,472      $ 59,285      $ 2,781      $ 55,690      $ 2,567      $ 55,379     $ 2,879  

Derivatives used for other risk management activities:

                        

Interest rate contracts

   $ 1,047      $ 7      $ 3,420      $ 20      $ 405      $ 2      $ 1,099     $ 9  

Foreign exchange contracts

                 31        4        32       4  

Credit contracts:

                        

Credit default swaps

     378        8        376        9        165        1        175       1  

Other contracts (c)

                                         209        447        209       396  

Subtotal

   $ 1,425      $ 15      $ 3,796      $ 29      $ 810      $ 454      $ 1,515     $ 410  

Total derivatives not designated as hedging instruments

   $ 188,008      $ 3,972      $ 188,451      $ 4,502      $ 121,314      $ 4,247      $ 128,768     $ 4,850  

Total Gross Derivatives

   $ 211,494      $ 5,076      $ 211,964      $ 5,757      $ 126,037      $ 4,322      $ 133,529     $ 4,935  

Less: Legally enforceable master netting agreements

        2,769           3,203           2,769          3,203  

Less: Cash collateral

              688                 659                 624                674  

Total Net Derivatives

            $ 1,619               $ 1,895               $ 929              $ 1,058  
(a) Included in Other Assets on our Consolidated Balance Sheet.
(b) Included in Other Liabilities on our Consolidated Balance Sheet.
(c) Includes PNC’s obligation to fund a portion of certain BlackRock LTIP programs.

 

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Gains (losses) on derivative instruments and related hedged items follow:

Derivatives Designated in GAAP Hedge Relationships – Fair Value Hedges

 

                 March 31, 2011     March 31, 2010  
Three months ended              Gain
(Loss) on
Derivatives
Recognized
in Income
    Gain (Loss)
on Related
Hedged
Items
Recognized
in Income
    Gain
(Loss) on
Derivatives
Recognized
in Income
    Gain
(Loss) on
Related
Hedged
Items
Recognized
in Income
 
In millions    Hedged Items    Location    Amount     Amount     Amount     Amount  

Interest rate contracts

   US Treasury and Government Agencies Securities    Investment securities (interest income)    $ 15     $ (14      

Interest rate contracts

   Other Debt Securities    Investment securities (interest income)      4       (4      

Interest rate contracts

   Federal Home Loan Bank borrowings    Borrowed funds (interest expense)        $ (25   $ 24  

Interest rate contracts

   Subordinated debt    Borrowed funds (interest expense)      (59     51       60       (65

Interest rate contracts

   Bank notes and senior debt    Borrowed funds (interest expense)      (50     50       42       (39

Total

             $ (90   $ 83     $ 77     $ (80

Derivatives Designated in GAAP Hedge Relationships – Cash Flow Hedges

 

Three months ended

In millions

   Gain (Loss) on Derivatives
Recognized in OCI
(Effective Portion)
     Gain Reclassified from Accumulated
OCI into Income
(Effective Portion)
     Gain Recognized in Income
on Derivatives
(Ineffective Portion)
 
                    Location    Amount      Location     Amount  

March 31, 2011

   Interest rate contracts    $ 14      Interest income    $ 88        Interest income      $ 1  
         Noninterest income      34         

March 31, 2010

   Interest rate contracts    $ 240      Interest income    $ 94        Interest income      $ 3  
                   Noninterest income      22                   

 

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Derivatives Not Designated as Hedging Instruments under GAAP

 

     Three months ended
March 31
 
In millions        2011             2010      

Derivatives used for residential mortgage banking activities:

      

Residential mortgage servicing

      

Interest rate contracts

   $ 11     $ 70  

Loan sales

      

Interest rate contracts

     15       (21

Gains (losses) included in residential mortgage banking activities (a)

   $ 26     $ 49  

Derivatives used for commercial mortgage banking activities:

      

Interest rate contracts

   $ 3     $ (21

Credit contracts

     2       (7

Gains (losses) from commercial mortgage banking activities (b)

   $ 5     $ (28

Derivatives used for customer-related activities:

      

Interest rate contracts

   $ 28     $ (6

Foreign exchange contracts

     14       13  

Equity contracts

     (2     (1

Credit contracts

             (1

Gains (losses) from customer-related activities (b)

   $ 40     $ 5  

Derivatives used for other risk management activities:

      

Interest rate contracts

   $ 1     $ 1  

Foreign exchange contracts

     (1     (1

Credit contracts

     (1     4  

Other contracts (c)

     (51     30  

Gains (losses) from other risk management activities (b)

   $ (52   $ 34  

Total gains (losses) from derivatives not designated as hedging instruments

   $ 19     $ 60  
(a) Included in residential mortgage noninterest income
(b) Included in other noninterest income.
(c) Relates to BlackRock LTIP.

CREDIT DERIVATIVES

The credit derivative underlying is based on the credit risk of a specific entity, entities, or an index. As discussed above, we enter into credit derivatives, specifically credit default swaps and risk participation agreements, as part of our commercial mortgage banking hedging activities and for customer and other risk management purposes. Detail regarding credit default swaps and risk participations sold follows:

Credit Default Swaps

 

      March 31, 2011              December 31, 2010  
Dollars in millions    Notional
Amount
     Estimated
Net Fair
Value
     Weighted-
Average
Remaining
Maturity
In Years
            Notional
Amount
     Estimated
Net Fair
Value
     Weighted-
Average
Remaining
Maturity
In Years
 

Credit Default Swaps – Sold

                      

Single name

   $ 75      $ 4        5.5         $ 45      $ 4        2.8  

Index traded

     188        2        1.8           189        2        2.0  

Total

   $ 263      $ 6        2.8         $ 234      $ 6        2.2  

Credit Default Swaps – Purchased

                      

Single name

   $ 310      $ 1        2.4         $ 317      $ 2        2.6  

Index traded

     185        8        38.5           210        8        38.8  

Total

   $ 495      $ 9        15.9         $ 527      $ 10        17.0  

Total

   $ 758      $ 15        11.4         $ 761      $ 16        12.5  

 

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The notional amount of these credit default swaps by credit rating follows:

Credit Ratings of Credit Default Swaps

 

Dollars in millions    March 31,
2011
     December 31,
2010
 

Credit Default Swaps – Sold

       

Investment grade (a)

   $ 250      $ 220  

Subinvestment grade (b)

     13        14  

Total

   $ 263      $ 234  

Credit Default Swaps – Purchased

       

Investment grade (a)

   $ 360      $ 385  

Subinvestment grade (b)

     135        142  

Total

   $ 495      $ 527  

Total

   $ 758      $ 761  
(a) Investment grade with a rating of BBB-/Baa3 or above based on published rating agency information.
(b) Subinvestment grade with a rating below BBB-/Baa3 based on published rating agency information.

The referenced/underlying assets for these credit default swaps follow:

Referenced/Underlying Assets of Credit Default Swaps

 

      Corporate
Debt
    Commercial
mortgage-
backed
securities
    Loans  

March 31, 2011

     66     25     9

December 31, 2010

     62     28     10

We enter into credit default swaps under which we buy loss protection from or sell loss protection to a counterparty for the occurrence of a credit event related to a referenced entity or index. The maximum amount we would be required to pay under the credit default swaps in which we sold protection, assuming all referenced underlyings experience a credit event at a total loss, without recoveries, was $263 million at March 31, 2011 and $234 million at December 31, 2010.

Risk Participation Agreements

We have sold risk participation agreements with terms ranging from less than one year to 26 years. We will be required to make payments under these agreements if a customer defaults on its obligation to perform under certain derivative swap contracts with third parties.

Risk Participation Agreements Sold

 

Dollars in millions    Notional
Amount
     Estimated
Net Fair
Value
    Weighted-
Average
Remaining
Maturity
In Years
 

March 31, 2011

   $ 1,628      $ (3     6.4  

December 31, 2010

   $ 1,367      $ (2     2.0  

Based on our internal risk rating process of the underlying third parties to the swap contracts, the percentages of the exposure amount of risk participation agreements sold by internal credit rating follow:

Internal Credit Ratings of Risk Participation Agreements Sold

 

      March 31,
2011
    December 31,
2010
 

Pass (a)

     92     95

Below pass (b)

     8     5
(a) Indicates the expected risk of default is currently low.
(b) Indicates a higher degree of risk of default.

Assuming all underlying swap counterparties defaulted at March 31, 2011, the exposure from these agreements would be $76 million based on the fair value of the underlying swaps, compared with $49 million at December 31, 2010.

 

 

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NOTE 13 EARNINGS PER SHARE

Basic and Diluted Earnings per Common Share

 

     Three months ended
March 31
 
In millions, except per share data    2011     2010  

Basic

    

Net income from continuing operations

   $ 832     $ 648  

Less:

    

Net income (loss) attributable to noncontrolling interests

     (5     (5

Dividends distributed to common shareholders

     52       45  

Dividends distributed to preferred shareholders

     4       93  

Preferred stock discount accretion

             250  

Undistributed net income from continuing operations

   $ 781     $ 265  

Undistributed net income from discontinued operations

             23  

Undistributed net income

   $ 781     $ 288  

Percentage of undistributed income allocated to common shares

     99.68      99.70 

Undistributed income from continuing operations allocated to common shares

   $ 779     $ 264  

Plus: common dividends

     52       45  

Net income from continuing operations attributable to basic common shares

   $ 831     $ 309  

Net income from discontinued operations attributable to common shares

             23  

Net income attributable to basic common shares

   $ 831     $ 332  

Basic weighted-average common shares outstanding

     524       498  

Basic earnings per common share from continuing operations

   $ 1.59     $ .62  

Basic earnings per common share from discontinued operations

             .05  

Basic earnings per common share

   $ 1.59     $ .67  

Diluted

    

Net income from continuing operations attributable to basic common shares

   $ 831     $ 309  

Less: BlackRock common stock equivalents

     5       2  

Net income from continuing operations attributable to diluted common shares

   $ 826     $ 307  

Net income from discontinued operations attributable to common shares

             23  

Net income attributable to diluted common shares

   $ 826     $ 330  

Basic weighted-average common shares outstanding

     524       498  

Dilutive potential common shares (a) (b)

     2       2  

Diluted weighted-average common shares outstanding

     526       500  

Diluted earnings per common share from continuing operations

   $ 1.57     $ .61  

Diluted earnings per common share from discontinued operations

             .05  

Diluted earnings per common share

   $ 1.57     $ .66  

(a)    Excludes stock options considered to be anti-dilutive

     5       14   

(b)    Excludes warrants considered to be anti-dilutive

     22        22   

 

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NOTE 14 TOTAL EQUITY AND OTHER COMPREHENSIVE INCOME

Activity in total equity for the first three months of 2011 follows. The par value of our preferred stock outstanding at March 31, 2011 totaled $.1 million and is excluded from the table.

Rollforward of Total Equity

 

     Shareholders’ Equity  
In millions   Shares
Outstanding
Common
Stock
    Common
Stock
    Capital
Surplus –
Preferred
Stock
    Capital
Surplus –
Common
Stock
and
Other
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss)
    Treasury
Stock
    Non-controlling
Interests
    Total
Equity
 

Balance at January 1, 2011

    526      $ 2,682     $ 647     $ 12,057     $ 15,859     $ (431   $ (572   $ 2,596     $ 32,838  

Net income

              837             (5     832  

Other comprehensive income (loss), net of tax

                       

Net unrealized gains on other-than-temporary impairment debt securities

                147             147  

Net unrealized securities gains

                17             17  

Net unrealized losses on cash flow hedge derivatives

                (68           (68

Pension, other postretirement and postemployment benefit plan adjustments

                10             10  

Other

                                            16                       16  

Comprehensive income (loss)

                                                            (5     954  

Cash dividends declared

                       

Common ($.10 per share)

              (52             (52

Preferred

              (4             (4

Common stock activity (a)

            1                 1  

Treasury stock activity (a)

            (13         (12       (25

Other

                            11                               (6     5  

Balance at March 31, 2011

    526      $ 2,682     $ 647     $ 12,056     $ 16,640     $ (309   $ (584   $ 2,585     $ 33,717  
(a) Common and net treasury stock activity totaled less than .5 million shares.

Comprehensive income for the first three months of 2010 was $1.4 billion.

Change in Accumulated Other Comprehensive Income (Loss)

 

Three months ended March 31, 2011

In millions

   Pretax     Tax
(Expense)
Benefit
    After-tax  

Change in net unrealized securities losses:

        

Decrease in net unrealized OTTI losses on debt securities

   $ 197     $ (72   $ 125  

Less: OTTI losses realized in net income

     (34     12       (22

Change in net unrealized losses on OTTI securities

     231       (84     147  

Increase in net unrealized gains for non-OTTI securities

     65       (24     41  

Less: Net gains realized in net income

     37       (13     24  

Change in net unrealized gains on non-OTTI securities

     28       (11     17  

Change in net unrealized securities losses

     259       (95     164  

Change in net unrealized gains on cash flow hedge derivatives:

        

Increase in net unrealized gains during the period on cash flow hedge derivatives

     14       (5     9  

Less: Net gains realized in net income

     122       (45     77  

Change in net unrealized gains on cash flow hedge derivatives

     (108     40       (68

Change in pension, other postretirement and postemployment benefit plan adjustments

     16       (6     10  

Change in other, net

     33       (17     16  

Change in other comprehensive income (loss)

   $ 200     $ (78   $ 122  

 

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Accumulated Other Comprehensive Income (Loss) Components

 

    March 31, 2011     December 31, 2010  
In millions   Pretax     After-tax     Pretax     After-tax  

Net unrealized securities gains (losses)

  $ 178     $ 112     $ 150     $ 95  

OTTI losses on debt securities

    (790     (499     (1,021     (646

Net unrealized gains on cash flow hedge derivatives

    716       454       824       522  

Pension, other postretirement and postemployment benefit plan adjustments

    (582     (370     (598     (380

Other, net

    (14     (6     (47     (22

Accumulated other comprehensive income (loss)

  $ (492   $ (309   $ (692   $ (431

NOTE 15 INCOME TAXES

The net operating loss carryforwards at March 31, 2011 and December 31, 2010 follow:

Net Operating Loss Carryforwards

 

In millions    March 31,
2011
     December 31,
2010
 

Federal

   $ 30      $ 54  

State

     1,550        1,600  

Valuation allowance – State

     21        21  

The federal net operating loss carryforwards expire from 2027 to 2028. The state net operating loss carryforwards will expire from 2011 to 2031. We have established a valuation allowance of $21 million relating to the state net operating losses at March 31, 2011 and December 31, 2010.

PNC’s consolidated federal income tax returns through 2006 have been audited by the IRS and we have resolved all matters through the IRS Appeals Division. The IRS began its examination of PNC’s 2007 and 2008 consolidated federal income tax returns during the third quarter of 2010.

The consolidated federal income tax returns of National City through 2007 have been audited by the IRS. Certain adjustments remain under review by the IRS Appeals Division for years 2003-2007. The IRS began its examination of National City’s 2008 consolidated federal income tax return during the third quarter of 2010.

We had unrecognized tax benefits of $294 million at March 31, 2011 and $238 million at December 31, 2010. At March 31, 2011, the amount of unrecognized tax benefits that if recognized would impact the effective tax rate was $125 million.

NOTE 16 LEGAL PROCEEDINGS

We establish accruals for legal proceedings when information related to the loss contingencies represented by those matters indicates both that a loss is probable and that the amount of loss can be reasonably estimated. Any such accruals are adjusted thereafter as appropriate to reflect changed circumstances. We also determine estimates of possible losses or ranges of possible losses, whether in excess of any related accrued liability or where there is no accrued liability, for those matters disclosed in this Note 16 and in Note 22 Legal Proceedings in Part II, Item 8 of our 2010 Form 10-K (“Prior Disclosure”) when we are able to do so. For disclosed matters where we are able to estimate such possible losses or ranges of possible losses, as of March 31, 2011, we estimate that it is reasonably possible that we could incur losses in an aggregate amount up to approximately $375 million, with it also being reasonably possible that we could incur no such losses at all in these matters. The estimates included in this amount are based on our analysis of currently available information and are subject to significant judgment and a variety of assumptions and uncertainties. As new information is obtained we may change our estimates. Due to the inherent subjectivity of the assessments and unpredictability of outcomes of legal proceedings, any amounts accrued or included in this aggregate amount may not represent the ultimate loss to us from the legal proceedings in question. Thus, our exposure and ultimate losses may be higher or lower, and possibly significantly so, than the amounts accrued or this aggregate amount.

The aggregate estimated amount provided above does not include an estimate for every matter disclosed in this Note 16 or in Prior Disclosure, as we are unable, at this time, to estimate the losses that it is reasonably possible that we could incur or ranges of such losses with respect to some of the matters disclosed for one or more of the following reasons. In our experience, legal proceedings are inherently unpredictable. In many legal proceedings, various factors exacerbate this inherent unpredictability, including, among others, one or more of the following: the proceeding is in its early stages; the damages sought are unspecified, unsupported or uncertain; it is unclear whether a case brought as a class action will be allowed to proceed on that basis or, if permitted to proceed as a class action, how the class will be defined; the plaintiff is seeking relief other than compensatory damages; the matter presents meaningful legal uncertainties, including novel issues of law; we have not engaged in meaningful settlement discussions; discovery has not started or is not complete; there are significant facts in dispute; and there are a large number of parties named as defendants (including where it is uncertain how liability, if any, will be shared among multiple defendants). Generally, the less progress that has been made in the proceedings or the broader the range of potential results, the harder it is for us to estimate losses or ranges of losses that it is reasonably possible we could incur. Therefore, as the estimated aggregate amount disclosed above does not include all of the matters disclosed below, the

 

 

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amount disclosed above does not represent our maximum reasonably possible loss exposure for all of the matters disclosed in this Note 16 or in Prior Disclosure. The estimated aggregate amount also does not reflect any of our exposure to matters not so disclosed, as discussed below under “Other.”

We include in some of the descriptions of individual matters in Prior Disclosure certain quantitative information related to the plaintiff’s claim against us alleged in the plaintiff’s pleadings or otherwise publicly available. While information of this type may provide insight into the potential magnitude of a matter, it does not necessarily represent our estimate of reasonably possible loss or our judgment as to any currently appropriate accrual.

Some of our exposure in matters described below may be offset by applicable insurance coverage. We do not consider the possible availability of insurance coverage in determining the amounts of any accruals or any estimates of possible losses or ranges of possible losses.

The disclosure below updates the description of legal proceedings in Prior Disclosure.

Securities and State Law Fiduciary Cases against National City

In The Dispatch Printing Company, et al. v. National City Corporation, et al. (Case No. 08CVH-6506) pending in the Franklin County, Ohio, Court of Common Pleas , trial is currently scheduled to begin in 2012.

Visa

With respect to the series of antitrust lawsuits filed against Visa®, MasterCard®, and several major financial institutions, including cases naming National City (since merged into PNC) and its subsidiary, National City Bank of Kentucky (since merged into National City Bank which has since merged into PNC Bank, N.A.), which have been consolidated for pretrial proceedings in the United States District Court for the Eastern District of New York under the caption In re Payment Card Interchange Fee and Merchant-Discount Antitrust Litigation (Master File No. 1:05-md-1720-JG-JO): In March 2011, we entered into a MasterCard Settlement and Judgment Sharing Agreement with MasterCard and other financial institution defendants and an Omnibus Agreement Regarding Interchange Litigation Sharing and Settlement Sharing with Visa, MasterCard and other financial institution defendants. The Omnibus Agreement, in substance, apportions a resolution of all claims against all defendants in this litigation into a Visa portion and a MasterCard portion, with the Visa portion being two-thirds and the MasterCard portion being one-third. This apportionment only applies in the case of either a global settlement involving all defendants or an adverse judgment against the defendants, to the extent that damages either are related to the merchants’ inter-network conspiracy claims or are otherwise not attributed to specific MasterCard or Visa conduct or damages. The MasterCard portion (or any MasterCard-related liability not subject to the

Omnibus Agreement) will then be apportioned under the MasterCard Settlement and Judgment Sharing Agreement among MasterCard and PNC and the other financial institution defendants parties to this agreement. Under this agreement, PNC’s responsibility for MasterCard-related exposure is, in percentage terms, de minimis. The responsibility for the Visa portion (or any Visa-related liability not subject to the Omnibus Agreement) will be apportioned under the pre-existing indemnification responsibilities and judgment and loss sharing agreements.

Adelphia

In April 2011, the parties settled the remaining Adelphia-related lawsuit in which a PNC subsidiary was a defendant (W. R. Huff Asset Management Co., L.L.C. v. Deloitte & Touche, L.L.P., et al. (03 MD 1529 (LMM), 03-CV-5752 (LMM)). This lawsuit, brought by holders of debt securities of Adelphia, was pending for pretrial purposes in the United States District Court for the Southern District of New York. The plaintiffs in this lawsuit alleged violations of the federal securities laws and sought, among other things, unspecified damages, interest, and attorneys’ fees. The amount of the settlement was not material to PNC and had been accrued.

CBNV Mortgage Litigation

In February 2011, in In re: Community Bank of Northern Virginia and Guaranty Bank Second Mortgage Litigation (No. 03-0425 (W.D. Pa.), MDL No. 1674), currently pending in the United States District Court for the Western District of Pennsylvania, the counsel with whom the defendants negotiated the original settlement and who were appointed settlement class counsel notified the district court that they have determined that the settlement is no longer in the best interests of the class covered by the settlement (referred to as the Kessler class). Settlement class counsel have also asked to be appointed interim class counsel, along with certain of the lawyers for the objectors to the settlement, for future proceedings.

Overdraft Litigation

With respect to the lawsuits consolidated for pre-trial proceedings in the United States District Court for the Southern District of Florida (the “MDL Court”) under the caption In re Checking Account Overdraft Litigation (MDL No. 2036, Case No. 1:09-MD-02036-JLK ), our motion to dismiss the consolidated amended complaint was denied in March 2011. The MDL Court has scheduled trial for 2013 for the cases that will be tried in that court.

In Henry v. PNC Bank, National Association (No. GD-10-022974), pending in the Court of Common Pleas of Allegheny County, Pennsylvania, we filed our Preliminary Objections in March 2011.

In Trombley, et al. v. National City Bank (Civil Action No. 10-00232 (JDB)), pending against National City Bank in the United States District Court for the District of Columbia, the court has delayed the hearing on final approval of the settlement until July 2011.

 

 

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Other Mortgage-Related Litigation

In Federal Home Loan Bank of Chicago v. Bank of America Funding Corp., et al. (Case No. 10CH45033)), pending in the Circuit Court of Cook County, Illinois, the plaintiff amended its complaint in March 2011 and filed a corrected amended complaint in April 2011. The corrected amended complaint does not identify any additional transaction for which the plaintiff seeks recovery from PNC nor does it add any additional substantive allegations.

Regulatory and Governmental Inquiries

As a result of the regulated nature of our business and that of a number of our subsidiaries, particularly in the banking and securities areas, we and our subsidiaries are the subject of investigations, audits and other forms of regulatory inquiry, in some cases as part of regulatory reviews of specified activities at multiple industry participants, including those described below and in Prior Disclosure.

In April 2011, as a result of a publicly-disclosed interagency horizontal review of residential mortgage servicing operations at fourteen federally regulated mortgage servicers, PNC entered into a consent order with the Board of Governors of the Federal Reserve System and PNC Bank, N.A. (“PNC Bank”) entered into a consent order with the Office of the Comptroller of the Currency. Collectively, these consent orders describe certain foreclosure-related practices and controls that the regulators found to be deficient and require PNC and PNC Bank to, among other things, develop and implement plans and programs to enhance PNC’s residential mortgage servicing and foreclosure processes, retain an independent consultant to review certain residential mortgage foreclosure actions, take certain remedial actions, and oversee compliance with the orders and the new plans and programs. The two orders do not foreclose the potential for civil money penalties from either of these regulators. Other governmental, legislative and regulatory inquiries on this topic, referred to in Prior Disclosure, are on-going, and may result in significant additional actions, penalties or other remedies.

Our practice is to cooperate fully with regulatory and governmental investigations, audits and other inquiries, including those described above and in Prior Disclosure. Such investigations, audits and other inquiries may lead to remedies including fines, penalties, restitution or alterations in our business practices.

Other

In addition to the proceedings or other matters described above, PNC and persons to whom we may have indemnification obligations, in the normal course of business, are subject to various other pending and threatened legal proceedings in which claims for monetary damages and other relief are asserted. We do not anticipate, at the present time, that the ultimate aggregate liability, if any, arising out of such other legal proceedings will have a material adverse effect on our financial position. However, we cannot now determine whether or not any claims asserted against us or others to

whom we may have indemnification obligations, whether in the proceedings or other matters specifically described above, Prior Disclosure or otherwise, will have a material adverse effect on our results of operations in any future reporting period, which will depend on, among other things, the amount of the loss resulting from the claim and the amount of income otherwise reported for the reporting period.

See Note 17 Commitments and Guarantees for additional information regarding the Visa indemnification and our other obligations to provide indemnification, including to current and former officers, directors, employees and agents of PNC and companies we have acquired.

NOTE 17 COMMITMENTS AND GUARANTEES

Equity Funding and Other Commitments

Our unfunded commitments at March 31, 2011 included private equity investments of $300 million and other investments of $9 million.

Standby Letters of Credit

We issue standby letters of credit and have risk participations in standby letters of credit and bankers’ acceptances issued by other financial institutions, in each case to support obligations of our customers to third parties, such as remarketing programs for customers’ variable rate demand notes. Net outstanding standby letters of credit and internal credit ratings were as follows:

Net Outstanding Standby Letters of Credit

 

Dollars in billions    March 31
2011
    December 31
2010
 

Net outstanding standby letters of credit

   $ 10.2     $ 10.1  

Internal credit ratings (as a percentage of portfolio):

      

Pass (a)

     92      90 

Below pass (b)

         10 
(a) Indicates that expected risk of loss is currently low.
(b) Indicates a higher degree of risk of default.

If the customer fails to meet its financial or performance obligation to the third party under the terms of the contract or there is a need to support a remarketing program, then upon the request of the guaranteed party, we would be obligated to make payment to them. The standby letters of credit and risk participations in standby letters of credit and bankers’ acceptances outstanding on March 31, 2011 had terms ranging from less than 1 year to 8 years. The aggregate maximum amount of future payments PNC could be required to make under outstanding standby letters of credit and risk participations in standby letters of credit and bankers’ acceptances was $13.6 billion at March 31, 2011, of which $7.1 billion support remarketing programs.

As of March 31, 2011, assets of $2.5 billion secured certain specifically identified standby letters of credit. Recourse provisions from third parties of $3.4 billion were also available for this purpose as of March 31, 2011. In addition, a

 

 

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portion of the remaining standby letters of credit and letter of credit risk participations issued on behalf of specific customers is also secured by collateral or guarantees that secure the customers’ other obligations to us. The carrying amount of the liability for our obligations related to standby letters of credit and risk participations in standby letters of credit and bankers’ acceptances was $243 million at March 31, 2011.

Standby Bond Purchase Agreements and Other Liquidity Facilities

We enter into standby bond purchase agreements to support municipal bond obligations. At March 31, 2011, the aggregate of our commitments under these facilities was $84 million. We also enter into certain other liquidity facilities to support individual pools of receivables acquired by commercial paper conduits. At March 31, 2011 our total commitments under these facilities were $145 million.

Indemnifications

As further described in our 2010 Form 10-K, we are a party to numerous acquisition or divestiture agreements under which we have purchased or sold, or agreed to purchase or sell, various types of assets. These agreements generally include indemnification provisions under which we indemnify the third parties to these agreements against a variety of risks to the indemnified parties as a result of the transaction in question. When PNC is the seller, the indemnification provisions will generally also provide the buyer with protection relating to the quality of the assets we are selling and the extent of any liabilities being assumed by the buyer. Due to the nature of these indemnification provisions, we cannot quantify the total potential exposure to us resulting from them.

We provide indemnification in connection with securities offering transactions in which we are involved. When we are the issuer of the securities, we provide indemnification to the underwriters or placement agents analogous to the indemnification provided to the purchasers of businesses from us, as described above. When we are an underwriter or placement agent, we provide a limited indemnification to the issuer related to our actions in connection with the offering and, if there are other underwriters, indemnification to the other underwriters intended to result in an appropriate sharing of the risk of participating in the offering. Due to the nature of these indemnification provisions, we cannot quantify the total potential exposure to us resulting from them.

In the ordinary course of business, we enter into certain types of agreements that include provisions for indemnifying third parties. We also enter into certain types of agreements, including leases, assignments of leases, and subleases, in which we agree to indemnify third parties for acts by our agents, assignees and/or sublessees, and employees. We also enter into contracts for the delivery of technology service in which we indemnify the other party against claims of patent

and copyright infringement by third parties. Due to the nature of these indemnification provisions, we cannot calculate our aggregate potential exposure under them.

We engage in certain insurance activities which require our employees to be bonded. We satisfy this bonding requirement by issuing letters of credit which were insignificant in amount at March 31, 2011.

In the ordinary course of business, we enter into contracts with third parties under which the third parties provide services on behalf of PNC. In many of these contracts, we agree to indemnify the third party service provider under certain circumstances. The terms of the indemnity vary from contract to contract and the amount of the indemnification liability, if any, cannot be determined.

We are a general or limited partner in certain asset management and investment limited partnerships, many of which contain indemnification provisions that would require us to make payments in excess of our remaining unfunded commitments. While in certain of these partnerships the maximum liability to us is limited to the sum of our unfunded commitments and partnership distributions received by us, in the others the indemnification liability is unlimited. As a result, we cannot determine our aggregate potential exposure for these indemnifications.

Pursuant to their bylaws, PNC and its subsidiaries provide indemnification to directors, officers and, in some cases, employees and agents against certain liabilities incurred as a result of their service on behalf of or at the request of PNC and its subsidiaries. PNC and its subsidiaries also advance on behalf of covered individuals costs incurred in connection with certain claims or proceedings, subject to written undertakings by each such individual to repay all amounts advanced if it is ultimately determined that the individual is not entitled to indemnification. We generally are responsible for similar indemnifications and advancement obligations that companies we acquire had to their officers, directors and sometimes employees and agents at the time of acquisition. We advanced such costs on behalf of several such individuals with respect to pending litigation or investigations during the first three months of 2011. It is not possible for us to determine the aggregate potential exposure resulting from the obligation to provide this indemnity or to advance such costs.

In connection with the sale of GIS, and in addition to indemnification provisions as part of the divestiture agreement, PNC agreed to continue to act for the benefit of GIS as securities lending agent for certain of GIS’s clients. In such role, we provide indemnification to those clients against the failure of the borrowers to return the securities. The market value of the securities lent is fully secured on a daily basis; therefore, the exposure to us is limited to temporary shortfalls in the collateral as a result of short-term fluctuations in trading prices of the loaned securities. At March 31, 2011,

 

 

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the total maximum potential exposure as a result of these indemnity obligations was $7.5 billion, although the collateral at the time exceeded that amount. In addition, the purchaser of GIS, The Bank of New York Mellon Corporation, has entered into an agreement to indemnify PNC with respect to such exposure on the terms set forth in such indemnification agreement. Also in connection with the GIS divestiture, PNC has agreed to indemnify the buyer generally as described above.

VISA Indemnification

Our payment services business issues and acquires credit and debit card transactions through Visa U.S.A. Inc. card association or its affiliates (Visa). Our 2010 Form 10-K has additional information regarding the October 2007 Visa restructuring, our involvement with judgment and loss sharing agreements with Visa and certain other banks, and other 2010 developments in this area.

In March 2011, Visa funded $400 million to their litigation escrow account and reduced the conversion ratio of Visa B to A shares. We consequently recognized our estimated $38 million share of the $400 million as a reduction of our previously established indemnification liability and a reduction of noninterest expense.

Our Visa indemnification liability included on our Consolidated Balance Sheet at March 31, 2011 totaled $32 million as a result of the indemnification provision in Section 2.05j of the Visa By-Laws and/or the indemnification provided through the judgment and loss sharing agreements. Any ultimate exposure to the specified Visa litigation may be different than this amount.

Recourse and Repurchase Obligations

As discussed in Note 3 Loans Sale and Servicing Activities and Variable Interest Entities, PNC has sold commercial mortgage and residential mortgage loans directly or indirectly in securitizations and whole-loan sale transactions with continuing involvement. One form of continuing involvement includes certain recourse and loan repurchase obligations associated with the transferred assets in these transactions.

Commercial Mortgage Recourse Obligations

We originate, close and service commercial mortgage loans which are sold to FNMA under FNMA’s DUS program. We have similar arrangements with FHLMC.

Under these programs, we generally assume up to a one-third pari passu risk of loss on unpaid principal balances through a loss share arrangement. The unpaid principal balance outstanding of loans sold as a participant in these programs was $13.2 billion at both March 31, 2011 and December 31, 2010, and the potential maximum exposure under the loss share arrangements was $4.0 billion at both March 31, 2011 and December 31, 2010. We maintain a reserve based upon these potential losses. The reserve for losses under these

programs totaled $56 million and $54 million as of March 31, 2011 and December 31, 2010, respectively, and is included in Other liabilities on our Consolidated Balance Sheet. The comparable reserve as of March 31, 2010 was $65 million. If payment is required under these programs, we would not have a contractual interest in the collateral underlying the mortgage loans on which losses occurred, although the value of the collateral is taken into account in determining our share of such losses. Our exposure and activity associated with these recourse obligations are reported in the Corporate & Institutional Banking segment.

Analysis of Commercial Mortgage Recourse Obligations

 

In millions    2011     2010  

January 1

   $ 54     $ 71  

Reserve adjustments, net

     2       (6

March 31

   $ 56     $ 65  

Residential Mortgage Loan Repurchase Obligations

While residential mortgage loans are sold on a non-recourse basis, we assume certain loan repurchase obligations associated with mortgage loans we have sold to investors. These loan repurchase obligations primarily relate to situations where PNC is alleged to have breached certain origination covenants and representations and warranties made to purchasers of the loans in the respective purchase and sale agreements. Residential mortgage loans covered by these loan repurchase obligations include first and second-lien mortgage loans we have sold through Agency securitizations, Non-Agency securitizations, and whole-loan sale transactions. As discussed in Note 3 in our 2010 Form 10-K, Agency securitizations consist of mortgage loans sale transactions with FNMA, FHLMC, and GNMA, while Non-Agency securitizations and whole-loan sale transactions consist of mortgage loans sale transactions with private investors. Our exposure and activity associated with these loan repurchase obligations is reported in the Residential Mortgage Banking segment. In addition, PNC’s residential mortgage loan repurchase obligations include certain brokered home equity loans/lines that were sold to private investors by National City prior to our acquisition. PNC is no longer engaged in the brokered home equity lending business, and our exposure under these loan repurchase obligations is reported in the Distressed Assets Portfolio segment.

Loan covenants and representations and warranties are established through loan sale agreements with various investors to provide assurance that PNC has sold loans to investors of sufficient investment quality. Key aspects of such covenants and representations and warranties include the loan’s compliance with any applicable loan criteria established by the investor, including underwriting standards, delivery of all required loan documents to the investor or its designated party, sufficient collateral valuation, and the validity of the lien securing the loan. As a result of alleged breaches of these contractual obligations, investors may request PNC to indemnify them against losses on certain loans or to repurchase loans.

 

 

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These investor indemnification or repurchase claims are typically settled on an individual loan basis through make-whole payments or loan repurchases; however, on occasion we may negotiate pooled settlements with investors.

Indemnifications for loss or loan repurchases typically occur when, after review of the claim, we agree insufficient evidence exists to dispute the investor’s claim that a breach of a loan covenant and representation and warranty has occurred, such breach has not been cured, and the effect of such breach is deemed to have had a material and adverse effect on the value of the transferred loan. Depending on the sale agreement and upon proper notice from the investor, we typically respond to such indemnification and repurchase requests within 60 days, although final resolution of the claim may take a longer period of time. With the exception of the sales agreements associated with the Agency securitizations, most sale agreements do not provide for penalties or other remedies if we do not respond timely to investor indemnification or repurchase requests.

Origination and sale of residential mortgages is an ongoing business activity and, accordingly, management continually assesses the need for indemnification and repurchase liabilities pursuant to the associated investor sale agreements. We

establish indemnification and repurchase liabilities for estimated losses on sold first and second-lien mortgages and home equity loans/lines for which indemnification is expected to be provided or for loans that are expected to be repurchased. For the first and second-lien mortgage sold portfolio, we have established an indemnification and repurchase liability pursuant to investor sale agreements based on claims made and our estimate of future claims on a loan by loan basis. These relate primarily to loans originated during 2006-2008. For the home equity loans/lines sold portfolio, we have established indemnification and repurchase liabilities based upon this same methodology for loans sold during 2005-2007.

Indemnification and repurchase liabilities are initially recognized when loans are sold to investors and are subsequently evaluated for adequacy by management. Initial recognition and subsequent adjustments to the indemnification and repurchase liability for the first and second-lien mortgage sold portfolio are recognized in Residential mortgage revenue on the Consolidated Income Statement. Since PNC is no longer engaged in the brokered home equity lending business, only subsequent adjustments are recognized to the home equity loans/lines indemnification and repurchase liability. These adjustments are recognized in Other noninterest income on the Consolidated Income Statement.

 

 

Management’s subsequent evaluation of these indemnification and repurchase liabilities is based upon trends in indemnification and repurchase requests, actual loss experience, known and inherent risks in the underlying serviced loan portfolios, and current economic conditions. As part of its evaluation, management considers estimated loss projections over the life of the subject loan portfolio. At March 31, 2011 and December 31, 2010, the total indemnification and repurchase liability for estimated losses on indemnification and repurchase claims totaled $252 million and $294 million, respectively, and was included in Other liabilities on the Consolidated Balance Sheet. The comparable reserve as of March 31, 2010 was $247 million. An analysis of the changes in this liability during the first three months of 2011 and 2010 follows:

Analysis of Indemnification and Repurchase Liability for Asserted Claims and Unasserted Claims

 

     2011     2010  
In millions    Residential
Mortgages
(a)
    Home
Equity
Loans/
Lines
(b)
    Total     Residential
Mortgages
(a)
    Home
Equity
Loans/
Lines (b)
    Total  

January 1

   $ 144     $ 150     $ 294     $ 229     $ 41     $ 270  

Reserve adjustments, net

     14         14       27       19       46  

Losses - loan repurchases and settlements

     (34     (22     (56     (68     (1     (69

March 31

   $ 124     $ 128     $ 252     $ 188     $ 59     $ 247  
(a) Repurchase obligation associated with sold loan portfolios of $134.2 billion and $158.0 billion at March 31, 2011 and March 31, 2010, respectively.
(b) Repurchase obligation associated with sold loan portfolios of $6.3 billion and $7.3 billion at March 31, 2011 and March 31, 2010, respectively. PNC is no longer engaged in the brokered home equity business which was acquired with National City.

 

REINSURANCE AGREEMENTS

We have two wholly-owned captive insurance subsidiaries which provide reinsurance to third-party insurers related to insurance sold to our customers. These subsidiaries enter into various types of reinsurance agreements with third-party insurers where the subsidiary assumes the risk of loss through

either an excess of loss or quota share agreement up to 100% reinsurance. In excess of loss agreements, these subsidiaries assume the risk of loss for an excess layer of coverage up to specified limits, once a defined first loss percentage is met. In quota share agreements, the subsidiaries and third-party insurers share the responsibility for payment of all claims.

 

 

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Reserves recognized for probable losses on these policies and the aggregate maximum exposure up to the specified limits for all reinsurance contracts were as follows:

REINSURANCE AGREEMENTS

 

In millions except as noted   March 31,
2011
 

Reserves for probable losses

  $ 119   

Maximum exposure (billions)

  $ 4.9   

The comparable amount of reserves for probable losses as of December 31, 2010 was $150 million.

Repurchase and Resale Agreements

We enter into repurchase and resale agreements where we transfer investment securities to/from a third party with the agreement to repurchase/resell those investment securities at a future date for a specified price. These transactions are accounted for as collateralized borrowings/financings.

NOTE 18 SEGMENT REPORTING

We have six reportable business segments:

   

Retail Banking

   

Corporate & Institutional Banking

   

Asset Management Group

   

Residential Mortgage Banking

   

BlackRock

   

Distressed Assets Portfolio

Results of individual businesses are presented based on our management accounting practices and management structure. There is no comprehensive, authoritative body of guidance for management accounting equivalent to GAAP; therefore, the financial results of our individual businesses are not necessarily comparable with similar information for any other company. We refine our methodologies from time to time as our management accounting practices are enhanced and our businesses and management structure change.

Financial results are presented, to the extent practicable, as if each business operated on a stand-alone basis. As permitted under GAAP, we have aggregated the business results for certain similar operating segments for financial reporting purposes.

Assets receive a funding charge and liabilities and capital receive a funding credit based on a transfer pricing methodology that incorporates product maturities, duration and other factors.

Capital is intended to cover unexpected losses and is assigned to our business segments using our risk-based economic capital model, including consideration of the goodwill and other intangible assets at those business segments, as well as the diversification of risk among the business segments. We have revised certain capital allocations among our business

segments, including amounts for prior periods. PNC’s total capital did not change as a result of these adjustments for any periods presented.

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

Total business segment financial results differ from consolidated income from continuing operations before noncontrolling interests, which itself excludes the earnings and revenue attributable to GIS through March 31, 2010 that is reflected in discontinued operations. The impact of these differences is reflected in the “Other” category in the business segment tables. “Other” includes residual activities that do not meet the criteria for disclosure as a separate reportable business, such as gains or losses related to BlackRock transactions including LTIP share distributions and obligations, integration costs, asset and liability management activities including net securities gains or losses and certain trading activities, exited businesses, equity management activities, alternative investments, intercompany eliminations, most corporate overhead, and differences between business segment performance reporting and financial statement reporting (GAAP), including the presentation of net income attributable to noncontrolling interests. Assets, revenue and earnings attributable to foreign activities were not material in the periods presented for comparative purposes.

BUSINESS SEGMENT PRODUCTS AND SERVICES

Retail Banking provides deposit, lending, brokerage, trust, investment management, and cash management services to consumer and small business customers within our primary geographic markets. Our customers are serviced through our branch network, call centers and the internet. The branch network is located primarily in Pennsylvania, Ohio, New Jersey, Michigan, Maryland, Illinois, Indiana, Kentucky, Florida, Virginia, Missouri, Delaware, Washington, D.C., and Wisconsin.

Corporate & Institutional Banking provides lending, treasury management, and capital markets-related products and services to mid-sized corporations, government and not-for-profit entities, and selectively to large corporations. Lending products include secured and unsecured loans, letters of credit and equipment leases. Treasury management services include cash and investment management, receivables management, disbursement services, funds transfer services, information reporting, and global trade services. Capital markets-related products and services include foreign exchange, derivatives, loan syndications, mergers and acquisitions advisory and related services to middle-market

 

 

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companies, our multi-seller conduit, securities underwriting, and securities sales and trading. Corporate & Institutional Banking also provides commercial loan servicing, and real estate advisory and technology solutions for the commercial real estate finance industry. Corporate & Institutional Banking provides products and services generally within our primary geographic markets, with certain products and services offered nationally and internationally.

Asset Management Group includes personal wealth management for high net worth and ultra high net worth clients and institutional asset management. Wealth management products and services include financial planning, customized investment management, private banking, tailored credit solutions and trust management and administration for individuals and their families. Institutional asset management provides investment management, custody, and retirement planning services. The institutional clients include corporations, unions, municipalities, non-profits, foundations and endowments located primarily in our geographic footprint.

Residential Mortgage Banking directly originates primarily first lien residential mortgage loans on a nationwide basis with a significant presence within the retail banking footprint, and also originates loans through majority or minority owned affiliates. Mortgage loans represent loans collateralized by one-to-four-family residential real estate. These loans are typically underwritten to government agency and/or third party standards, and sold, servicing retained, to secondary mortgage conduits FNMA, FHLMC, Federal Home Loan

Banks and third-party investors, or are securitized and issued under the GNMA program. The mortgage servicing operation performs all functions related to servicing mortgage loans—primarily those in first lien position—for various investors and for loans owned by PNC. Certain loans originated through majority or minority owned affiliates are sold to others.

BlackRock is the largest publicly traded investment management firm in the world. BlackRock manages assets on behalf of institutional and individual investors worldwide through a variety of equity, fixed income, multi-asset class, alternative and cash management separate accounts and funds, including iShares®, the global product leader in exchange-traded funds. In addition, BlackRock provides market risk management, financial markets advisory and enterprise investment system services globally to a broad base of clients. At March 31, 2011, our economic interest in BlackRock was 20%.

PNC received cash dividends from BlackRock of $53 million during the first three months of 2011 and $46 million during the first three months of 2010.

Distressed Assets Portfolio includes commercial residential development loans, cross-border leases, consumer brokered home equity loans, retail mortgages, non-prime mortgages, and residential construction loans. These loans require special servicing and management oversight given current market conditions. We obtained the majority of these loans through acquisitions of other companies.

 

 

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Results Of Businesses

 

Three months ended March 31

In millions

   Retail
Banking
    Corporate &
Institutional
Banking
    Asset
Management
Group
    Residential
Mortgage
Banking
    BlackRock      Distressed
Assets
Portfolio
    Other     Consolidated  

2011

                   

Income Statement

                   

Net interest income

   $ 818     $ 782     $ 60     $ 56        $ 236     $ 224     $ 2,176  

Noninterest income

     429       299       162       202     $ 108        9       246       1,455  

Total revenue

     1,247       1,081       222       258       108        245       470       3,631  

Provision for (recoveries of) credit losses

     276       (30     (6     8          152       21       421  

Depreciation and amortization

     47       43       10       3            69       172  

Other noninterest expense

     954       402       150       134                53       205       1,898  

Income (loss) from continuing operations before income taxes and noncontrolling interests

     (30     666       68       113       108        40       175       1,140  

Income taxes (benefit)

     (12     234       25       42       22        15       (18     308  

Income (loss) from continuing operations before noncontrolling interests

   $ (18   $ 432     $ 43     $ 71     $ 86      $ 25     $ 193     $ 832  

Inter-segment revenue

           $ 3     $ 3     $ 2     $ 4      $ (3   $ (9        

Average Assets (a)

   $ 66,669     $ 76,980     $ 6,918     $ 11,619     $ 5,530      $ 14,101     $ 80,737     $ 262,554  

2010

                   

Income Statement

                   

Net interest income

   $ 869     $ 882     $ 63     $ 74        $ 342     $ 149     $ 2,379  

Noninterest income

     490       371       164       154     $ 99        (12     118       1,384  

Total revenue

     1,359       1,253       227       228       99        330       267       3,763  

Provision for (recoveries of) credit losses

     339       236       9       (16        165       18       751  

Depreciation and amortization

     63       36       10       1            73       183  

Other noninterest expense

     912       410       146       119                48       295       1,930  

Income (loss) from continuing operations before income taxes and noncontrolling interests

     45       571       62       124       99        117       (119     899  

Income taxes (benefit)

     21       203       23       46       22        44       (108     251  

Income (loss) from continuing operations before noncontrolling interests

   $ 24     $ 368     $ 39     $ 78     $ 77      $ 73     $ (11   $ 648  

Inter-segment revenue

           $ 16     $ 4     $ 2     $ 4      $ (3   $ (23        

Average Assets (a)

   $ 68,354     $ 79,575     $ 7,041     $ 8,855     $ 6,225      $ 19,507     $ 77,591     $ 267,148  
(a) Period-end balances for BlackRock.

 

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Statistical Information (Unaudited)

The PNC Financial Services Group, Inc.

Average Consolidated Balance Sheet And Net Interest Analysis

 

      First Quarter 2011     Fourth Quarter 2010  

Taxable-equivalent basis Dollars in millions

   Average
Balances
    Interest
Income/
Expense
     Average
Yields/
Rates
    Average
Balances
    Interest
Income/
Expense
     Average
Yields/
Rates
 

Assets

              

Interest-earning assets:

              

Investment securities

              

Securities available for sale

              

Residential mortgage-backed

              

Agency

   $ 29,134      $ 263         3.61 %    $ 28,457     $ 258        3.64

Non-agency

     8,057        105         5.23        8,495        134        6.30  

Commercial mortgage-backed

     3,298        39         4.74        3,325        39        4.81  

Asset-backed

     2,757        19         2.70        2,824        19        2.67  

US Treasury and government agencies

     5,682        36         2.51        6,250        38        2.39  

State and municipal

     2,081        26         4.95        1,732        22        4.95  

Other debt

     3,994        26         2.58        3,618        24        2.69  

Corporate stocks and other

     443                 .06        418                 .09  

Total securities available for sale

     55,446        514         3.70        55,119        534        3.88  

Securities held to maturity

              

Commercial mortgage-backed

     4,239        55         5.22        4,311        55        5.17  

Asset-backed

     2,463        16         2.53        2,849        19        2.59  

Other

     9           4.90        10        1        5.84  

Total securities held to maturity

     6,711        71         4.24        7,170        75        4.14  

Total investment securities

     62,157        585         3.76        62,289        609        3.91  

Loans

              

Commercial

     56,300        710         5.04        54,065        750        5.43  

Commercial real estate

     17,545        203         4.63        18,555        244        5.15  

Equipment lease financing

     6,307        79         5.00        6,375        83        5.18  

Consumer

     54,460        670         4.99        54,741        691        5.01  

Residential real estate

     15,518        239         6.15        16,145        211        5.23  

Total loans

     150,130        1,901         5.09        149,881        1,979        5.21  

Loans held for sale

     3,193        69         8.77        3,331        55        6.53  

Federal funds sold and resale agreements

     2,813        8         1.19        2,130        9        1.67  

Other

     5,802        44         3.06        6,164        41        2.71  

Total interest-earning assets/interest income

     224,095        2,607         4.67        223,795        2,693        4.76  

Noninterest-earning assets:

              

Allowance for loan and lease losses

     (4,835 )           (5,039     

Cash and due from banks

     3,393             3,516       

Other

     39,901             41,286       

Total assets

   $ 262,554           $ 263,558       

Liabilities and Equity

              

Interest-bearing liabilities:

              

Interest-bearing deposits

              

Money market

   $ 58,556        51         .35      $ 58,436       55        .37  

Demand

     26,313        7         .10        25,388        6        .10  

Savings

     7,656        3         .19        7,221        3        .18  

Retail certificates of deposit

     36,509        116         1.28        39,201        136        1.37  

Other time

     515        3         2.77        598        3        2.40  

Time deposits in foreign offices

     3,452        2         .21        2,799        2        .19  

Total interest-bearing deposits

     133,001        182         .55        133,643        205        .61  

Borrowed funds

              

Federal funds purchased and repurchase agreements

     6,376        2         .16        4,552        3        .25  

Federal Home Loan Bank borrowings

     5,088        13         1.02        6,168        15        .97  

Bank notes and senior debt

     11,745        68         2.31        13,073        95        2.85  

Subordinated debt

     9,353        128         5.46        9,490        138        5.82  

Other

     5,847        14         .98        4,947        14        1.09  

Total borrowed funds

     38,409        225         2.35        38,230        265        2.74  

Total interest-bearing liabilities/interest expense

     171,410        407         .95        171,873       470        1.08  

Noninterest-bearing liabilities and equity:

              

Noninterest-bearing deposits

     47,755             47,998       

Allowance for unfunded loan commitments and letters of credit

     188             193       

Accrued expenses and other liabilities

     9,771             10,506       

Equity

     33,430             32,988       

Total liabilities and equity

   $ 262,554                       $ 263,558                   

Interest rate spread

          3.72             3.68  

Impact of noninterest-bearing sources

          .22             .25  

Net interest income/margin

           $ 2,200          3.94 %            $ 2,223        3.93

Nonaccrual loans are included in loans, net of unearned income. The impact of financial derivatives used in interest rate risk management is included in the interest income/expense and average yields/rates of the related assets and liabilities. Basis adjustments related to hedged items are included in noninterest-earning assets and noninterest-bearing liabilities. Average balances of securities are based on amortized historical cost (excluding adjustments to fair value, which are included in other assets). Average balances for certain loans and borrowed funds accounted for at fair value, with changes in fair value recorded in trading noninterest income, are included in noninterest-earning assets and noninterest-bearing liabilities. The interest-earning deposits with the Federal Reserve are included in the ‘Other’ interest-earning assets category.

 

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Average Consolidated Balance Sheet And Net Interest Analysis (Continued)

 

Third Quarter 2010     Second Quarter 2010     First Quarter 2010  

Average

Balances

  Interest
Income/
Expense
    Average
Yields/
Rates
    Average
Balances
    Interest
Income/
Expense
    Average
Yields/Rates
    Average
Balances
    Interest
Income/
Expense
    Average
Yields/Rates
 
               
               
               
               
               

$22,916

  $ 229       4.00 %   $ 20,382     $ 196       3.83   $ 21,926     $ 228       4.16

8,917

    134       6.04       9,358        140       5.97       10,213        150       5.87  

3,100

    42       5.34       2,962        39       5.29       5,357        71       5.29  

2,436

    21       3.51       1,695        21       4.96       1,992        22       4.40  

7,758

    52       2.67       8,708        61       2.81       7,493        60       3.19  

1,323

    17       5.19       1,356        19       5.50       1,365        21       6.26  

3,092

    21       2.64       2,526        18       2.94       1,874        16       3.39  

472

            .12       446                .13       457                .10  

50,014

    516       4.13       47,433        494       4.16       50,677        568       4.48  
               

4,130

    60       5.81       4,264        60       5.62       2,110        31       5.82  

3,435

    21       2.45       3,697        24       2.61       3,665        25       2.76  

9

            7.87       21                9.29       160        5       11.97  

7,574

    81       4.29       7,982        84       4.23       5,935        61       4.10  

57,588

    597       4.15       55,415        578       4.17       56,612        629       4.44  
               

53,502

    713       5.21       54,349        729       5.30       55,464        696       5.02  

19,847

    223       4.40       20,963        269       5.08       22,423        309       5.51  

6,514

    86       5.27       6,080        77       5.13       6,131        79       5.12  

55,036

    708       5.11       54,939        736       5.37       55,349        730       5.35  

16,766

    281       6.70       18,576        359       7.73       19,397        358       7.39  

151,665

    2,011       5.24       154,907        2,170       5.58       158,764        2,172       5.50  

3,021

    55       7.22       2,646        87       13.15       2,476        66       10.80  

1,602

    9       2.26       2,193        10       1.73       1,669        9       2.23  

9,801

    51       2.04       9,419        46       1.93       7,471        47       2.55  

223,677

    2,723       4.82       224,580        2,891       5.13       226,992        2,923       5.17  
               

(5,290)

        (5,113 )          (5,136    

3,436

        3,595            3,735      

42,756

        41,304            41,557      

$264,579

      $ 264,366         $ 267,148      
               
               
               

$58,016

    62       .42     $ 58,679       68       .46     $ 57,923       76       .53  

25,078

    7       .11       24,953        9       .14       24,672        11       .18  

7,092

    3       .18       7,075        4       .19       6,623        3       .19  

41,724

    155       1.47       43,745        156       1.44       47,162        181       1.55  

740

    5       2.54       881        6       2.90       1,039        8       3.01  

2,650

    1       .23       2,661        1       .21       3,034        2       .21  

135,300

    233       .68       137,994        244       .71       140,453        281       .81  
               

4,179

    3       .29       4,159        3       .29       4,344        4       .39  

7,680

    20       1.04       8,575        19       .83       9,603        17       .73  

12,799

    92       2.81       12,666        49       1.53       12,616        84       2.65  

9,569

    127       5.27       9,764        110       4.54       9,769        130       5.30  

4,886

    11       .89       6,005        14       .92       5,934        11       .77  

39,113

    253       2.56       41,169        195       1.88       42,266        246       2.33  

174,413

    486       1.10       179,163       439       .98       182,719       527       1.16  
               

45,306

        44,308            42,631      

218

        251            295      

12,687

        10,446            10,401      

31,955

        30,198            31,102      

$264,579

                  $ 264,366                     $ 267,148                  
      3.72           4.15           4.01  
              .24                       .20                       .23  
    $ 2,237       3.96 %           $ 2,452       4.35           $ 2,396       4.24

Loan fees for the three months ended March 31, 2011, December 31, 2010, September 30, 2010, June 30, 2010, and March 31, 2010 were $38 million, $37 million, $29 million, $43 million, and $45 million, respectively.

Interest income includes the effects of taxable-equivalent adjustments using a marginal federal income tax rate of 35% to increase tax-exempt interest income to a taxable-equivalent basis. The taxable-equivalent adjustments to interest income for the three months ended March 31, 2011, December 31, 2010, September 30, 2010, June 30, 2010, and March 31, 2010 were $24 million, $22 million, $22 million, $19 million, and $18 million, respectively.

 

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PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

See the information set forth in Note 16 Legal Proceedings in the Notes To Consolidated Financial Statements under Part I, Item 1 of this Report, which is incorporated by reference in response to this item.

ITEM 1A. RISK FACTORS

There are no material changes from any of the risk factors previously disclosed in PNC’s 2010 Form 10-K in response to Part I, Item 1A.

ITEM 2. UNREGISTERED SALES OF EQUITY

SECURITIES AND USE OF PROCEEDS

(c) Details of our repurchases of PNC common stock during the first quarter of 2011 are included in the following table:

In thousands, except per share data

 

2011 period  

Total shares
purchased

(a)

    Average
price
paid per
share
    Total shares
purchased as
part of
publicly
announced
programs (b)
    Maximum
number of
shares
that may
yet be
purchased
under the
programs
(b)
 

January 1 – 31

    141      $ 61.29         24,710   

February 1 – 28

    274      $ 62.24         24,710   

March 1 – 31

    125      $ 61.74         24,710   

Total

    540      $ 61.88                  
(a) Reflects PNC common stock purchased in connection with our various employee benefit plans. No shares were purchased under the program referred to in note (b) to this table during the first quarter of 2011.

Effective January 2011, employer matching contributions to the PNC Incentive Savings Plan were no longer made in PNC common stock, but rather in cash. Note 14 Employee Benefit Plans in the Notes To Consolidated Financial Statements in Item 8 of our 2010 Form 10-K includes additional information regarding our employee benefit plans that use PNC common stock.

(b) Our current stock repurchase program allows us to purchase up to 25 million shares on the open market or in privately negotiated transactions. This program was authorized on October 4, 2007 and will remain in effect until fully utilized or until modified, superseded or terminated.

ITEM 6. EXHIBITS

The following exhibit index lists Exhibits filed, or in the case of Exhibits 32.1 and 32.2 furnished, with this Quarterly Report on Form 10-Q:

EXHIBIT INDEX

 

  10.70    The Corporation’s 2006 Incentive Award Plan, as amended and restated effective as of March 11, 2011
  10.71    2011 forms of employee stock option, restricted stock, restricted share unit and performance unit agreements
  10.72    Form of change of control employment agreements
  12.1    Computation of Ratio of Earnings to Fixed Charges
  12.2    Computation of Ratio of Earnings to Fixed Charges and Preferred Stock Dividends
  31.1    Certification of Chairman and Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  31.2    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  32.1    Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350
  32.2    Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350
  99.3    Consent order between The PNC Financial Services Group, Inc. and the Board of Governors of the Federal Reserve System.
   Incorporated by reference to Exhibit 99.1 of PNC’s Current Report on Form 8-K filed April 14, 2011.
  99.4    Consent order between PNC Bank, National Association and the Office of the Comptroller of the Currency.
   Incorporated by reference to Exhibit 99.2 of PNC’s Current Report on Form 8-K filed April 14, 2011.
101    Interactive Data File (XBRL)

You can obtain copies of these Exhibits electronically at the SEC’s website at www.sec.gov or by mail from the Public Reference Section of the SEC, at 100 F Street, N.E., Washington, DC 20549 at prescribed rates. The Exhibits are also available as part of this Form 10-Q on or through PNC’s corporate website at www.pnc.com/secfilings. Shareholders and bondholders may also obtain copies of Exhibits, without charge, by contacting Shareholder Relations at 800-843-2206 or via e-mail at investor.relations@pnc.com. The interactive data file (XBRL) exhibit is only available electronically.

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on May 9, 2011 on its behalf by the undersigned thereunto duly authorized.

 

The PNC Financial Services Group, Inc.  

/s/ Richard J. Johnson

 

Richard J. Johnson

 

Executive Vice President and Chief Financial Officer

 

(Principal Financial Officer)

 
 

 

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CORPORATE INFORMATION

THE PNC FINANCIAL SERVICES GROUP, INC.

Corporate Headquarters

The PNC Financial Services Group, Inc.

One PNC Plaza, 249 Fifth Avenue

Pittsburgh, Pennsylvania 15222-2707

412-762-2000

Stock Listing The common stock of the PNC Financial Services Group, Inc. is listed on the New York Stock Exchange under the symbol PNC.

Internet Information The PNC Financial Services Group, Inc.’s financial reports and information about its products and services are available on the internet at www.pnc.com. We provide information for investors on our corporate website under “About PNC – Investor Relations,” such as Investor Events, Quarterly Earnings, SEC Filings, Financial Information, Financial Press Releases and Message from the Chairman. Under “Investor Relations,” we will from time to time post information that we believe may be important or useful to investors. We generally post the following shortly before or promptly following its first use or release: financially-related press releases (including earnings releases), various SEC filings, presentation materials associated with earnings and other investor conference calls or events, and access to live and taped audio from such calls or events. When warranted, we will also use our website to expedite public access to time-critical information regarding PNC in advance of distribution of a press release or a filing with the SEC disclosing the same information. You can also find the SEC reports and corporate governance information described in the sections below in the Investor Relations section of our website.

Where we have included web addresses in this Report, such as our web address and web addresses of the SEC and of BlackRock, we have included those web addresses as inactive textual references only. Except as specifically incorporated by reference into this Report, information on those websites is not part hereof.

Financial Information We are subject to the informational requirements of the Securities Exchange Act of 1934, as amended (Exchange Act), and, in accordance with the Exchange Act, we file annual, quarterly and current reports, proxy statements, and other information with the SEC. You can obtain copies of these and other filings, including exhibits, electronically at the SEC’s internet website at www.sec.gov or on or through PNC’s corporate internet website at www.pnc.com/secfilings. Shareholders and bond holders may also obtain copies of these filings without charge by contacting Shareholder Services at 800-982-7652 or via the online contact form at www.computershare.com/contactus for copies without exhibits, and by contacting Shareholder Relations at 800-843-2206 or via email at

investor.relations@pnc.com for copies of exhibits, including financial statement and schedule exhibits where applicable. The interactive data file (XBRL) exhibit is only available electronically.

Corporate Governance at PNC Information about our Board of Directors and its committees and corporate governance at PNC is available on PNC’s corporate website at www.pnc.com/corporategovernance. Shareholders who would like to request printed copies of PNC’s Code of Business Conduct and Ethics or our Corporate Governance Guidelines or the charters of our Board’s Audit, Nominating and Governance, Personnel and Compensation, or Risk Committees (all of which are posted on the PNC corporate website) may do so by sending their requests to George P. Long, III, Chief Governance Counsel and Corporate Secretary, at corporate headquarters at the above address. Copies will be provided without charge to shareholders.

Inquiries For financial services call 888-PNC-2265.

Individual shareholders should contact Shareholder Services at 800-982-7652.

Analysts and institutional investors should contact William H. Callihan, Senior Vice President, Director of Investor Relations, at 412-762-8257 or via email at investor.relations@pnc.com.

News media representatives and others seeking general information should contact Fred Solomon, Vice President, Corporate Communications, at 412-762-4550 or via email at corporate.communications@pnc.com.

Common Stock Prices/Dividends Declared The table below sets forth by quarter the range of high and low sale and quarter-end closing prices for The PNC Financial Services Group, Inc. common stock and the cash dividends declared per common share.

      High      Low      Close      Cash
Dividends
Declared
(a)
 

2011 Quarter

             

First

   $ 65.19       $ 59.67       $ 62.99       $ .10   

Total

                              $ .10   

2010 Quarter

             

First

   $ 61.80      $ 50.46      $ 59.70      $ .10  

Second

     70.45        56.30        56.50        .10  

Third

     62.99        49.43        51.91        .10  

Fourth

     61.79        50.69        60.72        .10  

Total

                              $ .40  
(a) Our Board approved a second quarter cash dividend of $.35 per common share, which was paid on May 5, 2011.
 

 

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Dividend Policy Holders of PNC common stock are entitled to receive dividends when declared by the Board of Directors out of funds legally available for this purpose. Our Board of Directors may not pay or set apart dividends on the common stock until dividends for all past dividend periods on any series of outstanding preferred stock have been paid or declared and set apart for payment. The Board presently intends to continue the policy of paying quarterly cash dividends. The amount of any future dividends will depend on economic and market conditions, our financial condition and operating results, and other factors, including contractual restrictions and applicable government regulations and policies (such as those relating to the ability of bank and non-bank subsidiaries to pay dividends to the parent company and regulatory capital limitations).

Dividend Reinvestment And Stock Purchase Plan

The PNC Financial Services Group, Inc. Dividend Reinvestment and Stock Purchase Plan enables holders of our common and preferred stock to conveniently purchase additional shares of common stock. You can obtain a prospectus and enrollment form by contacting Shareholder Services at 800-982-7652.

Registrar And Stock Transfer Agent

Computershare Trust Company, N.A.

250 Royall Street

Canton, MA 02021

800-982-7652

 

 

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