PNC

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 2009, for The PNC Financial Services Group, Inc. The reporting period reflects the full impact of the acquisition of National City Corporation, which closed on December 31, 2008. PNC is one of the largest diversified financial services companies in the United States, operating through seven reportable segments: Retail Banking, Corporate & Institutional Banking, Asset Management Group, Residential Mortgage Banking, BlackRock, Global Investment Servicing, and a newly formed Distressed Assets Portfolio. The company is currently integrating National City's operations, with total expected merger and integration costs of approximately $1.2 billion pretax.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenue more than doubled to $3.9 billion, driven primarily by the inclusion of National City's operations. Net interest income increased significantly due to higher average interest-earning assets and an improved net interest margin (3.81% vs. 3.09%).
• Provision for Credit Losses: The provision increased sharply to $880 million from $151 million, reflecting continued credit deterioration in the economy and the need to build reserves for the acquired National City portfolio. Net charge-offs were $431 million.
• Asset Quality: Nonperforming assets rose to $3.5 billion (2.02% of total loans and foreclosed assets) from $2.2 billion (1.23%) at year-end 2008. The allowance for loan and lease losses increased to 2.51% of total loans.
• Capital Position: Tier 1 risk-based capital ratio improved to 10.0% from 9.7% at year-end 2008. However, the Tier 1 common capital ratio was 4.9%.
• Dividend Reduction: In April 2009, the Board reduced the quarterly common stock dividend from $0.66 to $0.10 per share to preserve capital and strengthen the balance sheet.

Guidance, Outlook, and Risks

• Stress Test Requirement: Following the Supervisory Capital Assessment Program (stress tests), the Federal Reserve concluded PNC is well-capitalized but required the company to increase its Tier 1 common capital by $600 million by November 9, 2009. PNC intends to meet this through retained earnings and other capital raising alternatives.
• Outlook: Management expects net interest income and margin to be flat to down for the remainder of 2009 compared to Q1 2009. Credit costs are expected to remain elevated, though the rate of change may slow in Q2 2009.
• Integration Progress: The company realized approximately $400 million in annualized cost savings in Q1 2009, progressing toward a two-year goal of $1.2 billion in savings from the National City acquisition.
• Risks: Key risks include the severity and duration of the recession, further deterioration in asset quality (particularly in commercial real estate and residential mortgages), and the impact of government programs (TARP, FDIC guarantees) on operations and capital flexibility.

Investor Verification Checklist

• Capital Adequacy: Verify the specific plan and timeline for raising the required $600 million in Tier 1 common capital to satisfy the Federal Reserve's stress test requirement.
• Credit Loss Trajectory: Monitor the trend in nonperforming assets and net charge-offs, specifically within the Distressed Assets Portfolio and Commercial Real Estate segments, to assess if the $880 million provision is sustainable or if further increases are needed.
• Integration Costs vs. Savings: Track the realization of the targeted $1.2 billion in annualized cost savings against the $1.2 billion in total merger and integration costs to evaluate the accretive nature of the National City acquisition.
• Dividend Policy: Confirm the long-term impact of the dividend reduction on shareholder returns and the timeline for potential restoration, given the restrictions imposed by the TARP Capital Purchase Program.
• Securities Portfolio: Review the composition of the investment securities portfolio, particularly non-agency mortgage-backed securities, for potential future other-than-temporary impairment (OTTI) charges given the $4.4 billion in net unrealized losses.