Form 10-K
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year ended December 31, 2008

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)

Registrant’s telephone number, including area code - (412) 762-2000

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class      

  Name of Each Exchange

    on Which Registered

Common Stock, par value $5.00

    New York Stock Exchange

$1.60 Cumulative Convertible Preferred Stock-Series C, par value $1.00

    New York Stock Exchange

$1.80 Cumulative Convertible Preferred Stock-Series D, par value $1.00

Depositary Shares Each Representing 1/4000 Interest in a Share of 9.875% Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series L, par value $1.00

    New York Stock Exchange

12.000% Fixed-to-Floating Rate Normal Automatic Preferred Enhanced Capital Securities (issued by National City Capital Trust I)

    New York Stock Exchange

6.625% Trust Preferred Securities (issued by National City Capital Trust II)

    New York Stock Exchange

6.625% Trust Preferred Securities (issued by National City Capital Trust III)

    New York Stock Exchange

8.000% Trust Preferred Securities (issued by National City Capital Trust IV)

    New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

$1.80 Cumulative Convertible Preferred Stock - Series A, par value $1.00

$1.80 Cumulative Convertible Preferred Stock - Series B, par value $1.00

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes X No     

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes      No X

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 if the disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this

Form 10-K or any amendment to this Form 10-K. X

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 Act). Yes      No X

The aggregate market value of the registrant’s outstanding voting common stock held by nonaffiliates on June 30, 2008, determined using the per share closing price on that date on the New York Stock Exchange of $57.10, was approximately $19.7 billion. There is no non-voting common equity of the registrant outstanding.

Number of shares of registrant’s common stock outstanding at February 17, 2009: 444,312,329

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement of The PNC Financial Services Group, Inc. to be filed pursuant to Regulation 14A for the 2009 annual meeting of shareholders (“Proxy Statement”) are incorporated by reference into Part III of this Form 10-K.


Table of Contents

TABLE OF CONTENTS

 

PART I         Page  

Item 1

 

Business.

  2

Item 1A

 

Risk Factors.

  10

Item 1B

 

Unresolved Staff Comments.

  17

Item 2

 

Properties.

  17

Item 3

 

Legal Proceedings.

  17

Item 4

 

Submission of Matters to a Vote of Security Holders.

Executive Officers of the Registrant

Directors of the Registrant

  17
18
18

PART II

   

Item 5

 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

  19
 

Common Stock Performance Graph

  20

Item 6

 

Selected Financial Data.

  21

Item 7

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  23

Item 7A

 

Quantitative and Qualitative Disclosures About Market Risk.

  79

Item 8

 

Financial Statements and Supplementary Data.

  79

Item 9

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

  162

Item 9A

 

Controls and Procedures.

  162

Item 9B

 

Other Information.

  162

PART III

   

Item 10

 

Directors, Executive Officers and Corporate Governance.

  162

Item 11

 

Executive Compensation.

  163

Item 12

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

  163

Item 13

 

Certain Relationships and Related Transactions, and Director Independence.

  165

Item 14

 

Principal Accounting Fees and Services.

  165

PART IV

   

Item 15

 

Exhibits, Financial Statement Schedules.

  165

SIGNATURES

  167

EXHIBIT INDEX

  E-1

PART I

Forward-Looking Statements: From time to time, The PNC Financial Services Group, Inc. (“PNC” or the “Corporation”) has made and may continue to make written or oral forward-looking statements regarding our outlook or expectations for earnings, revenues, expenses, capital levels, liquidity levels, asset quality or other future financial or business performance, strategies or expectations, or the impact of legal, regulatory or supervisory matters on our business operations or performance. This Annual Report on Form 10-K (the “Report” or “Form 10-K”) also includes forward-looking statements. With respect to all such forward- looking statements, you should review our Risk Factors discussion in Item 1A and our Risk Management, Critical Accounting Policies and Judgments, and Cautionary Statement Regarding Forward-Looking Information sections included in Item 7 of this Report.

 

ITEM 1 – BUSINESS

BUSINESS OVERVIEW We are one of the largest diversified financial services companies in the United States and are headquartered in Pittsburgh, Pennsylvania. As described further below and elsewhere in this Report, on December 31, 2008, PNC acquired National City Corporation (“National City”), nearly doubling our assets to a total of $291 billion and expanding our total consolidated deposits to $193 billion.

We were incorporated under the laws of the Commonwealth of Pennsylvania in 1983 with the consolidation of Pittsburgh National Corporation and Provident National Corporation. Since 1983, we have diversified our geographical presence, business mix and product capabilities through internal growth, strategic bank and non-bank acquisitions and equity investments, and the formation of various non-banking subsidiaries.

Prior to the National City acquisition, PNC had businesses engaged in retail banking, corporate and institutional banking, asset management, and global investment servicing, providing many of its products and services nationally and others in PNC’s primary geographic markets located in Pennsylvania, New Jersey, Washington, DC, Maryland, Virginia, Ohio, Kentucky and Delaware. PNC also provided certain investment servicing internationally.

National City’s primary businesses prior to its acquisition by PNC included commercial and retail banking, mortgage financing and servicing, consumer finance and asset management, operating through an extensive network in Ohio, Florida, Illinois, Indiana, Kentucky, Michigan, Missouri, Pennsylvania and Wisconsin. National City also conducted selected consumer lending businesses and other financial services on a nationwide basis.

ACQUISITION OF NATIONAL CITY CORPORATION

On December 31, 2008, we acquired National City for approximately $6.1 billion. The total consideration included approximately $5.6 billion of PNC common stock, $150 million of preferred stock, and cash paid to warrant holders by National City.

We completed the acquisition primarily by issuing approximately 95 million shares of PNC common stock. In accordance with purchase accounting methodologies, National City Bank’s balance sheet was adjusted to fair value at which time the bank was under-capitalized from a regulatory perspective. However, PNC’s Consolidated Balance Sheet remained well-capitalized and liquid.

Following the closing, PNC received $7.6 billion from the US Department of the Treasury under the Emergency Economic Stabilization Act of 2008 in exchange for the issuance of preferred stock and a warrant. These proceeds were used to enhance National City Bank’s regulatory capital position to


 

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well-capitalized in order to continue serving the credit and deposit needs of existing and new customers. On a consolidated basis, these proceeds resulted in further improvement to our capital and liquidity positions.

National City, based in Cleveland, Ohio, was one of the nation’s largest financial services companies. In connection with obtaining regulatory approvals for the acquisition, PNC has agreed to divest 61 of National City Bank’s branches in Western Pennsylvania with deposits of approximately $3.9 billion as of December 31, 2008. We expect to merge National City Bank into PNC Bank, National Association (“PNC Bank, N.A.”) in the fourth quarter of 2009.

Additional information regarding our acquisition of National City can be found in the following disclosures:

   

The Executive Summary portion of Item 7 of this Report,

   

Note 2 Acquisitions and Divestitures included in our Notes To Consolidated Financial Statements within Item 8 of this Report, and

   

Our Current Reports on Form 8-K filed October 24, 2008, October 30, 2008, December 23, 2008, and January 2, 2009.

OTHER ACQUISITION AND DIVESTITURE ACTIVITY

On April 4, 2008, we acquired Lancaster, Pennsylvania-based Sterling Financial Corporation for approximately 4.6 million shares of PNC common stock and $224 million in cash. Sterling was a banking and financial services company with approximately $3.2 billion in assets, $2.7 billion in deposits, and 65 branches in south-central Pennsylvania, northern Maryland and northern Delaware.

On March 31, 2008, we sold J.J.B. Hilliard, W.L. Lyons, LLC, a Louisville, Kentucky-based wholly-owned subsidiary of PNC and a full-service brokerage and financial services provider, to Houchens Industries, Inc. We recognized an after-tax gain of $23 million in the first quarter of 2008 in connection with this divestiture.

We include information on significant acquisitions and divestitures in Note 2 Acquisitions and Divestitures in the Notes To Consolidated Financial Statements in Item 8 of this Report and here by reference.

REVIEW OF LINES OF BUSINESS In addition to the following information relating to our lines of business, we incorporate information under the captions Line of Business Highlights, Product Revenue, and Business Segments Review in Item 7 of this Report here by reference. Also, we include financial and other information by business in Note 27 Segment Reporting in the Notes To Consolidated Financial Statements in Item 8 of this Report here by reference.

We have four major businesses engaged in providing banking, asset management and global fund processing products and services: Retail Banking; Corporate & Institutional Banking; BlackRock; and Global Investment Servicing. Assets, revenue

and earnings attributable to foreign activities were not material in the periods presented. The business segment results for 2008 and prior periods do not include the impact of National City, which we acquired on December 31, 2008.

RETAIL BANKING

Retail Banking provides deposit, lending, brokerage, trust, investment management, and cash management services to over 6 million consumer and small business customers within our primary geographic markets. Our customers are serviced through 2,589 offices in our branch network as of December 31, 2008 (including National City branches), the call center and the internet. The branch network is located primarily in Pennsylvania, New Jersey, Washington, DC, Maryland, Virginia, Delaware, Ohio, Kentucky, Indiana, Illinois, Michigan, Missouri, Florida and Wisconsin.

Retail Banking also serves as investment manager and trustee for employee benefit plans and charitable and endowment assets and provides nondiscretionary defined contribution plan services. These services are provided to individuals and corporations primarily within our primary geographic markets.

Our core strategy is to acquire and retain customers who maintain their primary checking and transaction relationships with PNC. We also seek revenue growth by deepening our share of our customers’ financial assets and needs, including savings and liquidity deposits, loans and investable assets. A key element of our strategy is to continue to optimize our physical distribution network by opening and upgrading stand-alone and in-store branches in attractive sites while consolidating or selling branches with less opportunity for growth.

CORPORATE & INSTITUTIONAL BANKING

Corporate & Institutional Banking provides lending, treasury management, and capital markets-related products and services to mid-sized corporations, government 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 companies, 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.

Corporate & Institutional Banking is focused on becoming a premier provider of financial services in each of the markets it


 

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serves. The value proposition to its customers is driven by providing a broad range of competitive and high quality products and services by a team fully committed to delivering the comprehensive resources of PNC to help each client succeed. Corporate & Institutional Banking’s primary goals are to achieve market share growth and enhanced returns by means of expansion and retention of customer relationships and prudent risk and expense management.

BLACKROCK

BlackRock is one of the largest publicly-traded investment management firms in the United States with $1.3 trillion of assets under management at December 31, 2008. BlackRock manages assets on behalf of institutional and individual investors worldwide through a variety of fixed income, cash management, equity and balanced and alternative investment separate accounts and funds. In addition, BlackRock provides risk management, investment system outsourcing and financial advisory services globally to institutional investors.

At December 31, 2008, our equity ownership interest in BlackRock was approximately 33%. Our investment in BlackRock is a strategic asset of PNC and a key component of our diversified earnings stream. The ability of BlackRock to grow assets under management is the key driver of increases in its revenue, earnings and, ultimately, shareholder value. BlackRock’s strategies for growth in assets under management include a focus on achieving client investment performance objectives in a manner consistent with their risk preferences and delivering excellent client service. The business dedicates significant resources to attracting and retaining talented professionals and to the ongoing enhancement of its investment technology and operating capabilities to deliver on this strategy.

GLOBAL INVESTMENT SERVICING

Global Investment Servicing (formerly PFPC) is a leading provider of processing, technology and business intelligence services to asset managers, broker-dealers, and financial advisors worldwide. Securities services include custody, securities lending, and accounting and administration for funds registered under the Investment Company Act of 1940 and alternative investments. Investor services include transfer agency, subaccounting, banking transaction services, and distribution. Financial advisor services include managed accounts and information management. This business segment serviced $2.0 trillion in total assets and 72 million shareholder accounts as of December 31, 2008, both domestically and internationally. International locations include Ireland, Poland and Luxembourg.

Global Investment Servicing focuses technological resources on driving efficiency through streamlining operations and developing flexible systems architecture and client-focused servicing solutions. Global Investment Servicing’s mission is to help enable its clients to expand their capabilities, maintain a technical edge, and maximize returns on their internal resources by growing revenue and staying ahead of

competitors. During the past year, Global Investment Servicing expanded its capabilities to serve its clients in the full service subaccounting arena, integrated its recent acquisitions of Albridge Solutions and Coates Analytics, and opened a new servicing unit in Wroclaw, Poland.

BUSINESS SEGMENT CHANGES IN 2009

In addition to our existing business segments, PNC will have three additional business segments beginning in the first quarter of 2009: Residential Mortgage Banking; PNC Asset Management Group; and Distressed Assets Portfolio. These new business segments reflect the impact of our December 31, 2008 acquisition of National City and are more fully described in Note 28 Subsequent Event included in the Notes To Consolidated Financial Statements included under Item 8 of this Report.

SUBSIDIARIES Our corporate legal structure at December 31, 2008 consisted of three domestic subsidiary banks, including their subsidiaries, and approximately 79 active non-bank subsidiaries. PNC Bank, N.A., headquartered in Pittsburgh, Pennsylvania, and National City Bank, headquartered in Cleveland, Ohio, are our principal bank subsidiaries. Our other bank subsidiary is PNC Bank, Delaware. Our non-bank subsidiary, Global Investment Servicing, has obtained a banking license in Ireland and a branch in Luxembourg, which allow Global Investment Servicing to provide depositary services as part of its business. For additional information on our subsidiaries, see Exhibit 21 to this Report.

STATISTICAL DISCLOSURE BY BANK HOLDING COMPANIES The following statistical information is included on the indicated pages of this Report and is incorporated herein by reference:

 

      Form 10-K page

Average Consolidated Balance Sheet And Net Interest Analysis

   157

Analysis Of Year-To-Year Changes In Net Interest Income

   156

Book Values Of Securities

   33 and 108-110

Maturities And Weighted-Average Yield Of Securities

   110

Loan Types

   31, 104 and 158

Selected Loan Maturities And Interest Sensitivity

   161

Nonaccrual, Past Due And Restructured Loans And Other Nonperforming Assets

   60-62, 105 and 158

Potential Problem Loans And Loans Held For Sale

   35 and 60-62

Summary Of Loan Loss Experience

   61-62 and 159

Assignment Of Allowance For Loan And Lease Losses

   61-62 and 159

Average Amount And Average Rate Paid On Deposits

   157

Time Deposits Of $100,000 Or More

   121 and 161

Selected Consolidated Financial Data

   21-22

 

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SUPERVISION AND REGULATION

OVERVIEW

PNC is a bank holding company registered under the Bank Holding Company Act of 1956 as amended (“BHC Act”) and a financial holding company under the Gramm-Leach-Bliley Act (“GLB Act”).

We are subject to numerous governmental regulations, some of which are highlighted below. You should also read Note 23 Regulatory Matters in the Notes To Consolidated Financial Statements in Item 8 of this Report, included here by reference, for additional information regarding our regulatory matters. Applicable laws and regulations restrict permissible activities and investments and require compliance with protections for loan, deposit, brokerage, fiduciary, mutual fund and other customers, among other things. They also restrict our ability to repurchase stock or to receive dividends from bank subsidiaries and impose capital adequacy requirements. The consequences of noncompliance can include substantial monetary and nonmonetary sanctions.

In addition, we are subject to comprehensive examination and supervision by, among other regulatory bodies, the Board of Governors of the Federal Reserve System (“Federal Reserve”) and the Office of the Comptroller of the Currency (“OCC”), which results in examination reports and ratings (which are not publicly available) that can impact the conduct and growth of our businesses. These examinations consider not only compliance with applicable laws and regulations, but also capital levels, asset quality and risk, management ability and performance, earnings, liquidity, and various other factors. An examination downgrade by any of our federal bank regulators potentially can result in the imposition of significant limitations on our activities and growth. These regulatory agencies generally have broad discretion to impose restrictions and limitations on the operations of a regulated entity where the agencies determine, among other things, that such operations are unsafe or unsound, fail to comply with applicable law or are otherwise inconsistent with laws and regulations or with the supervisory policies of these agencies. This supervisory framework could materially impact the conduct, growth and profitability of our operations.

We are also subject to regulation by the Securities and Exchange Commission (“SEC”) by virtue of our status as a public company and due to the nature of some of our businesses.

As a regulated financial services firm, our relationships and good standing with regulators are of fundamental importance to the continuation and growth of our businesses. The Federal Reserve, OCC, SEC, and other domestic and foreign regulators have broad enforcement powers, and powers to approve, deny, or refuse to act upon our applications or notices to conduct new activities, acquire or divest businesses or assets and deposits, or reconfigure existing operations.

 

Due to the current economic environment and issues facing the financial services industry, as well as the effect of the change from the Bush to the Obama administration, we anticipate new legislative and regulatory initiatives over the next several years, including many focused specifically on banking and other financial services in which we are engaged. These initiatives will be in addition to the actions already taken by Congress and the regulators, including the Emergency Economic Stabilization Act of 2008 (“EESA”) and the American Recovery and Reinvestment Act of 2009 (the “Recovery Act”). Developments to date, as well as those that come in the future, have had and are likely to continue to have an impact on the conduct of our business. The more detailed description of the significant regulations to which we are subject that follows is based on the current regulatory environment and is subject to potentially material change.

On February 10, 2009, the US Department of the Treasury announced a capital assistance program to ensure that banking institutions are appropriately capitalized, with high quality capital. A key component of the program is a one-time forward-looking supervisory assessment of the capital needs of the 19 largest bank holding companies (those such as PNC with risk-weighted assets of $100 billion or more) under a more challenging economic environment than currently projected.

To conduct the exercise, these bank holding companies will be asked to analyze their loans and securities portfolios, as well as off-balance sheet commitments and contingencies, to determine expected future losses under “base case” and “more adverse” economic scenarios. They will also be asked to forecast internal resources available to absorb losses, including pre-provision revenue and reserves.

Should the supervisory agencies determine based on the assessment that an additional capital buffer is warranted, bank holding companies will be given a six month period to raise the additional capital from private sources. Otherwise, bank holding companies that have undergone this forward-looking capital test will have access to the US Department of the Treasury capital in the form of mandatorily convertible preferred shares.

In light of the economic downturn and the actions taken by Congress, the US Department of the Treasury and other regulatory agencies to address the credit crisis, there is an increased focus by regulators on lending activities by banks and the relationship between those activities and governmental efforts to improve this situation. Also at least in part driven by the current economic and financial situation, there is an increased focus on fair lending and other issues related to the mortgage industry. Ongoing mortgage-related regulatory reforms include measures aimed at limiting mortgage foreclosures.

There has been a heightened focus recently on consumer protection issues generally, including those related to the protection of confidential customer information.


 

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Over the last several years, there has been an increasing regulatory focus on compliance with anti-money laundering laws and regulations, resulting in, among other things, several significant publicly announced enforcement actions.

There are numerous rules governing the regulation of financial services institutions and their holding companies. Accordingly, the following discussion is general in nature and does not purport to be complete or to describe all of the laws and regulations that apply to us.

BANK REGULATION

As a bank holding company and a financial holding company, we are subject to supervision and regular inspection by the Federal Reserve. Our subsidiary banks and their subsidiaries are subject to supervision and examination by applicable federal and state banking agencies, principally the OCC with respect to PNC Bank, N.A. and National City Bank, and the Federal Reserve Bank of Cleveland and the Office of the State Bank Commissioner of Delaware with respect to PNC Bank, Delaware.

Because of PNC’s equity ownership interest in BlackRock, BlackRock is subject to the supervision and regulation of the Federal Reserve.

Parent Company Liquidity and Dividends.  The principal source of our liquidity at the parent company level is dividends from PNC Bank, N.A. and National City Bank. PNC Bank, N.A. and National City Bank are subject to various federal and state restrictions on their ability to pay dividends to PNC Bancorp, Inc., and PNC, respectively, the direct parents of the subsidiary banks. Our subsidiary banks are also subject to federal laws limiting extensions of credit to their parent holding company and non-bank affiliates as discussed in Note 23 Regulatory Matters included in the Notes To Consolidated Financial Statements in Item 8 of this Report, which is incorporated herein by reference. Further information on bank level liquidity and parent company liquidity and on certain contractual restrictions is also available in the Liquidity Risk Management section and in the “Perpetual Trust Securities”, “PNC Capital Trust E Trust Preferred Securities”, and “Acquired Entity Trust Preferred Securities” sections of the Off-Balance Sheet Arrangements and VIEs section of Item 7 of this Report.

Under Federal Reserve policy, a bank holding company is expected to act as a source of financial strength to each of its subsidiary banks and to commit resources to support each such bank. Consistent with the “source of strength” policy for subsidiary banks, the Federal Reserve has stated that, as a matter of prudent banking, a bank holding company generally should not maintain a rate of cash dividends unless its net income available to common shareholders has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears to be consistent with the corporation’s capital needs, asset quality and overall financial condition. Also, there

are restrictions on dividends associated with our December 31, 2008 issuance of preferred stock to the US Department of the Treasury under the TARP Capital Purchase Program, as discussed in Note 19 Shareholders’ Equity of the Notes To Consolidated Financial Statements under Item 8 of this Report.

Additional Powers Under the GLB Act.  The GLB Act permits a qualifying bank holding company to become a “financial holding company” and thereby to affiliate with financial companies engaging in a broader range of activities than would otherwise be permitted for a bank holding company. Permitted affiliates include securities underwriters and dealers, insurance companies and companies engaged in other activities that are determined by the Federal Reserve, in consultation with the Secretary of the Treasury, to be “financial in nature or incidental thereto” or are determined by the Federal Reserve unilaterally to be “complementary” to financial activities. We became a financial holding company as of March 13, 2000.

The Federal Reserve is the “umbrella” regulator of a financial holding company, with its operating entities, such as its subsidiary broker-dealers, investment managers, investment companies, insurance companies and banks, also subject to the jurisdiction of various federal and state “functional” regulators with normal regulatory responsibility for companies in their lines of business.

As subsidiaries of a financial holding company under the GLB Act, our non-bank subsidiaries are allowed to conduct new financial activities or acquire non-bank financial companies with after-the-fact notice to the Federal Reserve. In addition, our non-bank subsidiaries (and any financial subsidiaries of subsidiary banks) are now permitted to engage in certain activities that were not permitted for banks and bank holding companies prior to enactment of the GLB Act, and to engage on less restrictive terms in certain activities that were previously permitted. Among other activities, we currently rely on our status as a financial holding company to conduct mutual fund distribution activities, merchant banking activities, and securities underwriting and dealing activities.

In addition, the GLB Act permits national banks, such as PNC Bank, N.A. and National City Bank, to engage in expanded activities through the formation of a “financial subsidiary.” In order to qualify to establish or acquire a financial subsidiary, PNC Bank, N.A., National City Bank and PNC Bank, Delaware must be “well capitalized” and “well managed” and may not have a less than “satisfactory” Community Reinvestment Act (“CRA”) rating. A national bank that is one of the largest 50 insured banks in the United States, such as PNC Bank, N.A. and National City Bank, must also have issued debt (which, for this purpose, may include the uninsured portion of a national bank’s long-term certificates of deposit) with certain minimum ratings. PNC Bank, N.A. and National City Bank have filed financial subsidiary certifications with the OCC and currently engage in


 

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insurance agency activities through financial subsidiaries. PNC Bank, N.A. and National City Bank may also generally engage through a financial subsidiary in any activity that is financial in nature or incidental to a financial activity. Certain activities, however, are impermissible for a financial subsidiary of a national bank, including insurance underwriting, insurance investments, real estate investment or development, and merchant banking.

Because of issues regarding the operations of National City Bank, PNC has entered into an agreement with the Federal Reserve, and PNC Bank, N.A. and National City Bank have entered into agreements with the OCC, pursuant to which we are providing a plan for National City Bank to address these issues. If PNC fails to satisfy the concerns of the regulators within six-months of the acquisition of National City Bank (that is, by June 30, 2009), and no extension of the time period is granted, the Federal Reserve would have broad authority to limit PNC’s activities, including a requirement that we conform existing non-banking activities to activities that were permissible prior to the enactment of the GLB Act. In addition, pursuant to the agreements with the OCC, the OCC could limit the activities of PNC Bank, N.A. and National City Bank if the concerns are not addressed satisfactorily by June 30, 2009, or within any additional time granted by the OCC. PNC Bank, N.A. and National City Bank could be required to conform the activities of their financial subsidiaries to activities in which a national bank could engage directly. The potential impact of these consequences for PNC and the two banks is primarily on the conduct of existing merchant banking, securities underwriting and dealing, and insurance activities that in part can be addressed through alternative means of conducting these activities and that in any event is not expected to be material to PNC’s consolidated business.

Other Federal Reserve and OCC Regulation.  The federal banking agencies possess broad powers to take corrective action as deemed appropriate for an insured depository institution and its holding company. The extent of these powers depends upon whether the institution in question is considered “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Generally, the smaller an institution’s capital base in relation to its risk-weighted assets, the greater the scope and severity of the agencies’ powers, ultimately permitting the agencies to appoint a receiver for the institution. Business activities may also be influenced by an institution’s capital classification. For instance, only a “well capitalized” depository institution may accept brokered deposits without prior regulatory approval and an “adequately capitalized” depository institution may accept brokered deposits only with prior regulatory approval. At December 31, 2008, each of our domestic subsidiary banks exceeded the required ratios for classification as “well capitalized.” For additional discussion of capital adequacy requirements, we refer you to “Funding and Capital Sources” in the Consolidated Balance Sheet Review section of Item 7 of

this Report and to Note 23 Regulatory Matters included in the Notes To Consolidated Financial Statements in Item 8 of this Report.

Laws and regulations limit the scope of our permitted activities and investments. In addition to the activities that would be permitted to be conducted by a financial subsidiary, national banks (such as PNC Bank, N.A. and National City Bank) and their operating subsidiaries may engage in any activities that are determined by the OCC to be part of or incidental to the business of banking.

Moreover, examination ratings of “3” or lower, lower capital ratios than peer group institutions, regulatory concerns regarding management, controls, assets, operations or other factors, can all potentially result in practical limitations on the ability of a bank or bank holding company to engage in new activities, grow, acquire new businesses, repurchase its stock or pay dividends, or to continue to conduct existing activities.

The Federal Reserve’s prior approval is required whenever we propose to acquire all or substantially all of the assets of any bank or thrift, to acquire direct or indirect ownership or control of more than 5% of the voting shares of any bank or thrift, or to merge or consolidate with any other bank holding company or thrift holding company. When reviewing bank acquisition applications for approval, the Federal Reserve considers, among other things, each subsidiary bank’s record in meeting the credit needs of the communities it serves in accordance with the CRA. Our ability to grow through acquisitions could be limited by these approval requirements.

At December 31, 2008, PNC Bank, N.A., National City Bank, and PNC Bank, Delaware were rated “outstanding” with respect to CRA.

FDIC Insurance. All three of our domestic subsidiary banks are insured by the FDIC and subject to premium assessments. Regulatory matters could increase the cost of FDIC deposit insurance premiums to an insured bank as FDIC deposit insurance premiums are “risk based.” Therefore, higher fee percentages would be charged to banks that have lower capital ratios or higher risk profiles. These risk profiles take into account weaknesses that are found by the primary banking regulator through its examination and supervision of the bank. A negative evaluation by the FDIC or a bank’s primary federal banking regulator could increase the costs to a bank and result in an aggregate cost of deposit funds higher than that of competing banks in a lower risk category.

Our subsidiary banks are subject to “cross-guarantee” provisions under federal law that provide that if one of these banks fails or requires FDIC assistance, the FDIC may assess a “commonly-controlled” bank for the estimated losses suffered by the FDIC. Such liability could have a material adverse effect on our financial condition or that of the assessed bank. While the FDIC’s claim is junior to the claims


 

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of depositors, holders of secured liabilities, general creditors and subordinated creditors, it is superior to the claims of the bank’s shareholders and affiliates, including PNC and intermediate bank holding companies.

SECURITIES AND RELATED REGULATION

The SEC, together with either the OCC or the Federal Reserve, regulates our registered broker-dealer subsidiaries. These subsidiaries are also subject to rules and regulations promulgated by the Financial Industry Regulatory Authority (“FINRA”), among others.

Several of our subsidiaries are registered with the SEC as investment advisers and provide services both directly to clients and to PNC affiliates and related entities, including registered investment companies. Our investment advisor subsidiaries are subject to the requirements of the Investment Advisers Act of 1940, as amended, and the SEC’s regulations thereunder. The principal purpose of the regulations applicable to investment advisers is the protection of clients and the securities markets, rather than the protection of creditors and shareholders of investment advisors. The regulations applicable to investment advisers cover all aspects of the investment advisory business, including limitations on the ability of investment advisers to charge performance-based or non-refundable fees to clients; record-keeping; operational, marketing and reporting requirements; disclosure requirements; limitations on principal transactions between an adviser or its affiliates and advisory clients; as well as general anti-fraud prohibitions. These investment advisory subsidiaries also may be subject to state securities laws and regulations.

In addition, our investment advisory subsidiaries that are investment advisors to registered investment companies and other managed accounts are subject to the requirements of the Investment Company Act of 1940, as amended, and the SEC’s regulations thereunder, including Allegiant Asset Management Company, a wholly-owned subsidiary of National City Bank and registered investment advisor that serves as the investment advisor for the Allegiant mutual funds. Global Investment Servicing is subject to regulation by the SEC as a service provider to registered investment companies.

Additional legislation, changes in rules promulgated by the SEC, other federal and state regulatory authorities and self-regulatory organizations, or changes in the interpretation or enforcement of existing laws and rules may directly affect the method of operation and profitability of investment advisers. The profitability of investment advisers could also be affected by rules and regulations that impact the business and financial communities in general, including changes to the laws governing taxation, antitrust regulation and electronic commerce.

Over the past several years, the SEC and other governmental agencies have been investigating the mutual fund and hedge

fund industries, including Allegiant, Global Investment Servicing and other industry participants. The SEC has proposed various rules, and legislation has been introduced in Congress, intended to reform the regulation of these industries. The effect of regulatory reform has, and is likely to continue to, increase the extent of regulation of the mutual fund and hedge fund industries and impose additional compliance obligations and costs on our subsidiaries involved with those industries.

Under provisions of the federal securities laws applicable to broker-dealers, investment advisers and registered investment companies and their service providers, a determination by a court or regulatory agency that certain violations have occurred at a company or its affiliates can result in fines, restitution, a limitation of permitted activities, disqualification to continue to conduct certain activities and an inability to rely on certain favorable exemptions. Certain types of infractions and violations can also affect a public company in its timing and ability to expeditiously issue new securities into the capital markets. In addition, expansion of activities of a broker-dealer generally requires approval of FINRA and regulators may take into account a variety of considerations in acting upon such applications, including internal controls, capital, management experience and quality, prior enforcement and disciplinary history and supervisory concerns.

Global Investment Servicing and BlackRock are also subject to regulation by appropriate authorities in the foreign jurisdictions in which they do business.

BlackRock has subsidiaries in securities and related businesses subject to SEC and FINRA regulation, as described above. For additional information about the regulation of BlackRock, we refer you to the discussion under the “Regulation” section of Item 1 Business in BlackRock’s most recent Annual Report on Form 10-K, which may be obtained electronically at the SEC’s website at www.sec.gov.

COMPETITION

We are subject to intense competition from various financial institutions and from non-bank entities that engage in similar activities without being subject to bank regulatory supervision and restrictions.

In making loans, our subsidiary banks compete with traditional banking institutions as well as consumer finance companies, leasing companies and other non-bank lenders, and institutional investors including CLO managers, hedge funds, mutual fund complexes and private equity firms. Loan pricing, structure and credit standards are extremely important in the current environment as we seek to achieve risk-adjusted returns. Traditional deposit activities are subject to pricing pressures and customer migration as a result of intense competition for consumer investment dollars.


 

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Our subsidiary banks compete for deposits with the following:

   

Other commercial banks,

   

Savings banks,

   

Savings and loan associations,

   

Credit unions,

   

Treasury management service companies,

   

Insurance companies, and

   

Issuers of commercial paper and other securities, including mutual funds.

Our various non-bank businesses engaged in investment banking and private equity activities compete with the following:

   

Commercial banks,

   

Investment banking firms,

   

Merchant banks,

   

Insurance companies,

   

Private equity firms, and

   

Other investment vehicles.

In providing asset management services, our businesses compete with the following:

   

Investment management firms,

   

Large banks and other financial institutions,

   

Brokerage firms,

   

Mutual fund complexes, and

   

Insurance companies.

The fund servicing business is also highly competitive, with a relatively small number of providers. Merger, acquisition and consolidation activity in the financial services industry has also impacted the number of existing or potential fund servicing clients and has intensified competition.

We include here by reference the additional information regarding competition included in the Item 1A Risk Factors section of this Report.

EMPLOYEES Period-end employees totaled 59,595 at December 31, 2008. This total includes 25,313 full-time and 2,908 part-time PNC legacy employees and 27,112 full-time and 4,262 part-time National City employees.

SEC REPORTS AND CORPORATE GOVERNANCE 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. Our SEC File Number is 001-09718. You may read and copy this information at the SEC’s Public Reference Room located at 100 F Street NE, Room 1580, Washington, D.C. 20549. You can obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.

You can also obtain copies of this information by mail from the Public Reference Section of the SEC, 100 F Street, NE, Washington, D.C. 20549, at prescribed rates.

 

The SEC also maintains an internet website that contains reports, proxy and information statements, and other information about issuers, like us, who file electronically with the SEC. The address of that site is www.sec.gov. You can also inspect reports, proxy statements and other information about us at the offices of the New York Stock Exchange, 20 Broad Street, New York, New York 10005.

We also make our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished to the SEC pursuant to Section 13(a) or 15(d) of the Exchange Act available free of charge on or through our internet website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. PNC’s corporate internet address is www.pnc.com and you can find this information at www.pnc.com/secfilings. Shareholders and bondholders 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, or by contacting Shareholder Relations at 800- 843-2206 or via e-mail at investor.relations@pnc.com for copies of exhibits.

We filed the certifications of our Chairman and Chief Executive Officer and our Chief Financial Officer required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 with respect to our Annual Report on Form 10-K for 2007 with the SEC as exhibits to that report and have filed the CEO and CFO certifications required by Section 302 of that Act with respect to this Form 10-K as exhibits to this Report.

Information about our Board 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 the PNC Code of Business Conduct and Ethics or our Corporate Governance Guidelines or the charters of our Board’s Audit, Nominating and Governance, or Personnel and Compensation Committees (all of which are posted on the PNC corporate website) may do so by sending their requests to George P. Long, III, Corporate Secretary, at corporate headquarters at One PNC Plaza, 249 Fifth Avenue, Pittsburgh, Pennsylvania 15222-2707. Copies will be provided without charge to shareholders.

Our common stock is listed on the New York Stock Exchange (“NYSE”) under the symbol “PNC.” Our Chairman and Chief Executive Officer submitted the required annual CEO Certification regarding the NYSE’s corporate governance listing standards (a Section 12(a) CEO Certification) to the NYSE within 30 days after our 2008 annual shareholders meeting.

INTERNET INFORMATION

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investors in portions of our corporate website, such as the Investor Events and Financial Information areas that you can find under “About PNC – Investor Relations”. In this section, 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 section above 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.

ITEM 1ARISK FACTORS

We are subject to a number of risks potentially impacting our business, financial condition, results of operations and cash flows. Indeed, as a financial services organization, certain elements of risk are inherent in every one of our transactions and are present in every business decision we make. Thus, we encounter risk as part of the normal course of our business, and we design risk management processes to help manage these risks.

There are risks that are known to exist at the outset of a transaction. For example, every loan transaction presents credit risk (the risk that the borrower may not perform in accordance with contractual terms) and interest rate risk (a potential loss in earnings or economic value due to adverse movement in market interest rates or credit spreads), with the nature and extent of these risks principally depending on the identity of the borrower and overall economic conditions. These risks are inherent in every loan transaction; if we wish to make loans, we must manage these risks through the terms and structure of the loans and through management of our deposits and other funding sources.

Risk management is an important part of our business model. The success of our business is dependent on our ability to identify, understand and manage the risks presented by our business activities so that we can balance appropriately revenue generation and profitability with these inherent risks. Our shareholders have been well served by our focus on maintaining a moderate risk profile. With an economy in severe recession and our recent acquisition of National City,

our Consolidated Balance Sheet at December 31, 2008 did not reflect that desired risk profile. However, we remain committed to a moderate risk profile and we are working hard to bring our risk issues back into alignment. We discuss our principal risk management processes and, in appropriate places, related historical performance in the Risk Management section included in Item 7 of this Report.

The following are the key risk factors that affect us. These risk factors and other risks are also discussed further in other parts of this Report.

Risks related to current economic conditions

The continuation or worsening of current recessionary conditions, as well as continued turmoil in the financial markets, would likely have an adverse effect on our business, financial position and results of operations.

The economy in the United States and globally is currently in the midst of a severe recession. This economic situation has been accompanied by disruption and turmoil in financial markets around the world. Throughout much of the United States, the past two years have seen dramatic declines in the housing market, with falling home prices and increasing foreclosures. The deepening recession has led to increased unemployment and underemployment. Businesses across many industries are showing reduced earnings or in some cases losses, with reduced investments in growth.

For the financial services industry, this overall environment has resulted in significant write-downs of asset values, initially of mortgage-backed securities but spreading to other derivative and cash securities. Affected institutions include commercial and investment banks as well as government-sponsored entities. The impact of this situation has led to distress in credit markets, reduced liquidity for many types of securities, and concerns regarding the financial strength and adequacy of the capitalization of financial institutions. Some financial institutions around the world have failed, some have needed significant additional capital, and others have been forced to seek acquisition partners.

Reflecting concern about the stability of the financial markets generally and the strength of counterparties, as well as concern about their own capital and liquidity positions, many lenders and institutional investors have reduced or ceased providing funding to borrowers. The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets has exacerbated the state of economic distress and hampered efforts to bring about an economic recovery and restore stability to financial markets.

The United States and other governments have taken unprecedented steps to try to stabilize the financial system, including making significant investments in financial institutions and guaranteeing or otherwise supporting troubled assets held by financial institutions. The new Obama administration and the U.S. Congress are actively seeking


 

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ways of providing economic stimulus and financial market stability, including the recent enactment of the Recovery Act.

These economic conditions have had an adverse effect on our business and financial performance. We do not expect that the weakened economy or difficult conditions in the financial markets are likely to improve meaningfully in the near future, and we expect those conditions to have an ongoing negative impact on us. A worsening or prolonged continuation of these conditions would likely aggravate the adverse effects of these difficult economic and market conditions on us and on others in the financial institutions industry.

In particular, we may face the following risks in connection with the current economic and market environment:

   

Proposals to permit bankruptcy courts to adjust the terms of home mortgage obligations of people in proceedings before them may adversely impact the value of mortgages and mortgage-backed securities held by us, including, in the case of securities, by affecting the protections offered by subordination provisions.

   

We expect to face increased regulation of our industry, including as a result of the EESA, the Recovery Act and other current or future initiatives to provide economic stimulus, financial market stability and enhanced regulation of financial services companies. Compliance with such regulation may increase our costs and limit our ability to pursue business opportunities.

   

Investors may have less confidence in the equity markets in general and in financial services industry stocks in particular, which could place downward pressure on PNC’s stock price and resulting market valuation.

   

Market developments may further affect consumer and business confidence levels and may cause declines in credit usage and adverse changes in payment patterns, causing increases in delinquencies and default rates.

   

Our ability to assess the creditworthiness of our customers may be impaired if the models and approaches we use to select, manage, and underwrite our customers become less predictive of future behaviors.

   

The process we use to estimate losses inherent in our credit exposure requires difficult, subjective, and complex judgments, including the review of economic conditions and how these economic conditions might impair the ability of our borrowers to repay their loans, which may no longer be capable of accurate estimation, which may, in turn, impact the reliability of the process.

   

We could suffer decreases in customer desire to do business with us, whether as a result of a decreased demand for loans or other financial products and services or decreased deposits or other investments in accounts with PNC.

   

Competition in our industry could intensify as a result of the increasing consolidation of financial services companies in connection with current market conditions. Governmental support provided to financial institutions could alter the competitive landscape.

   

Increased regulation of compensation at financial services companies as part of government efforts to reform the industry may hinder our ability to attract and retain well-qualified individuals in key positions.

   

We may be required to pay significantly higher Federal Deposit Insurance Corporation premiums because market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits.

Some of these risks are discussed in more detail below.

The continuation of current recessionary conditions would likely adversely affect our lending businesses and the value of the loans and debt securities we hold.

Given the high percentage of our assets represented, directly or indirectly, by loans and the importance of lending to our overall business, continued recessionary conditions are likely to have a negative impact on our business, our ability to serve our customers and our results of operations. Such conditions are likely to lead to increases in the number of borrowers who become delinquent or default or otherwise demonstrate a decreased ability to meet their obligations under their loans. This would result in higher levels of non-performing loans, net charge-offs, provision for credit losses and valuation adjustments on loans held for sale. The value to us of other assets such as investment securities, most of which are debt securities or represent securitizations of loans, similarly would be negatively impacted by widespread decreases in credit quality resulting from a weak economy.

Our regional concentration makes us particularly at risk for economic conditions in our primary retail banking footprint.

Although many of our businesses are national and some are international in scope, our retail banking business is concentrated within our retail branch network footprint (for the past several years, Delaware, Indiana, Kentucky, Maryland, New Jersey, Ohio, Pennsylvania, Virginia and Washington, D.C., and, with our recent acquisition of National City, now including Florida, Illinois, Michigan, Missouri and Wisconsin). Thus, we are particularly vulnerable to adverse changes in economic conditions in these states or the Mid-Atlantic and Midwest regions more generally.

Our business and performance are vulnerable to the impact of continued volatility in debt and equity markets.

As most of our assets and liabilities are financial in nature, we tend to be particularly sensitive to the performance of the


 

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financial markets. Starting in the middle of 2007, there has been significant turmoil and volatility in worldwide financial markets, which is, at present, ongoing. This turmoil and volatility are a contributory factor to overall economic conditions, leading to some of the risks discussed above, including impairing the ability of borrowers and other counterparties to meet obligations to us. Financial market volatility also can have some of the following adverse effects on PNC and our business and financial performance:

   

It can affect the value or liquidity of our on-balance sheet and off-balance sheet financial instruments.

   

It can affect the value of servicing rights that we acquire and carry at fair value, such as the residential mortgage servicing rights acquired in the National City transaction.

   

It can affect, to the extent we access capital markets to raise funds to support our business and overall liquidity position, the cost of such funds or our ability to raise such funds. The inability to access capital markets at a desirable cost could affect our liquidity or results of operations.

   

It can affect the value of the assets that we manage or otherwise administer for others or the assets for which we provide processing and information services. Although we are not directly impacted by changes in the value of assets that we manage or administer for others or for which we provide processing and information services, decreases in the value of those assets would affect our fee income relating to those assets and could result in decreased demand for our services.

   

It can affect the required funding of our pension obligations to the extent that the value of the assets supporting those obligations drops below minimum levels.

   

In general, it can impact the nature, profitability or risk profile of the financial transactions in which we engage.

Volatility in the markets for real estate and other assets commonly securing financial products has been and is likely to continue to be a significant contributor to overall volatility in financial markets.

Our business and financial performance is impacted significantly by market interest rates and movements in those rates. The monetary, tax and other policies of governmental agencies, including the Federal Reserve, have a significant impact on interest rates and overall financial market performance over which we have no control and which we may not be able to predict adequately.

As a result of the high percentage of our assets and liabilities that are in the form of interest-bearing or interest-related instruments, changes in interest rates, in the shape of the yield curve or in spreads between different market interest rates can

have a material effect on our business, our profitability and the value of our financial assets and liabilities. For example:

   

Movements in interest rates affect mortgage prepayment speeds and could result in impairments of mortgage servicing assets.

   

Changes in interest rates or interest rate spreads can affect the difference between the interest that we earn on assets and the interest that we pay on liabilities, which impacts our overall net interest income.

   

Such changes can affect the ability of borrowers to meet obligations under variable or adjustable rate debt instruments.

   

Such changes may decrease the demand for interest-rate based products and services, including loans and deposit accounts.

   

Such changes can also affect our ability to hedge various forms of market and interest rate risk and may decrease the profitability or increase the risk associated with such hedges.

The monetary, tax and other policies of the government and its agencies, including the Federal Reserve, have a significant impact on interest rates and overall financial market performance. These governmental policies can thus affect the activities and results of operations of banking companies such as PNC. An important function of the Federal Reserve is to regulate the national supply of bank credit and market interest rates. The actions of the Federal Reserve influence the rates of interest that we charge on loans and that we pay on borrowings and interest-bearing deposits and can also affect the value of our on-balance sheet and off-balance sheet financial instruments. Both due to the impact on rates and by controlling access to direct funding from the Federal Reserve Banks, the Federal Reserve’s policies also influence, to a significant extent, our cost of funding. We cannot predict the nature or timing of future changes in monetary, tax and other policies or the effect that they may have on our activities and results of operations.

The soundness of other financial institutions could adversely affect us.

Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual and hedge funds, and other institutional clients. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure due us. There can be no assurance that any such losses would not materially and adversely affect our results of operations or earnings.


 

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Actions taken by the federal government to stabilize the U.S. financial system and provide economic stimulus may not succeed.

Given the recent financial market turmoil, particularly in the last several months, the federal government has taken numerous steps to stabilize the US financial system, both through legislative and regulatory action. The steps include passage of EESA and actions taken by the US Department of the Treasury thereafter to implement EESA, as well as the recent enactment of the Recovery Act. Legislative and regulatory initiatives to provide economic stimulus, financial market stability and financial market regulatory reform have been proposed or are pending (including some that have modified or would modify EESA), and more are anticipated going forward. What steps the government will take, the manner in which they will be implemented and the actual impact they will have on the economy and financial markets are uncertain. The failure of these governmental actions to help stabilize the financial markets and the U.S. economy, and the potential impact of compliance with government regulations undertaken in connection with such actions on our costs and our ability to pursue business opportunities, could materially and adversely affect our business, financial condition, results of operations, access to credit, or the trading price of our common stock.

Risks resulting from recent transactions

Our acquisition of National City presents substantial risks and uncertainties, which could limit our ability to realize the anticipated benefits from this transaction.

On December 31, 2008, we acquired National City through a merger in which PNC continued as the surviving entity. We provide additional information about this acquisition in Note 2 Acquisitions and Divestitures included in the Notes To Consolidated Financial Statements in Item 8 of this Report.

This acquisition presents the following risks to PNC:

   

Like PNC, National City was a large financial institution and has retail and other banking operations in numerous markets in which PNC had little or no experience. National City also had major operations in areas in which PNC did not have a significant presence, including residential mortgage lending, residential mortgage servicing, credit card lending and equipment leasing. As a result of these factors, there are significant integration-related risks, which are greater than in other recent acquisitions by PNC.

   

Prior to completion of the merger, PNC and National City operated as separate independent entities. The integration process may result in the loss of key employees, the disruption of either company’s ongoing businesses or inconsistencies in standards, controls, procedures, and policies that adversely affect our ability to maintain relationships with clients, customers, depositors, and employees or to

 

achieve the anticipated benefits of the merger. Integration efforts between the two companies will also divert management attention and resources. Successful integration may also be hampered by cultural differences between the two organizations. Further, PNC agreed, in connection with obtaining regulatory approvals for the National City acquisition, to divest 61 of National City Bank’s branches in Western Pennsylvania and this process is also underway.

   

In recent periods, National City’s results had been impacted negatively by a significant amount of asset impairments. Our results following the acquisition will depend on our ability to manage these assets, which require special servicing and management oversight, including disposition if appropriate. As the integration process develops, we may identify other issues with respect to National City’s asset valuation or accounting procedures that may lead to further impairments or write-downs.

   

National City’s pre-acquisition financial performance and resulting stock price performance and other pre-acquisition activities have led to several lawsuits and governmental investigations, and more may be commenced in the future. As a result of this acquisition, we now bear the risks associated with lawsuits and governmental investigations relating to National City, the full extent of the potential adverse impact of which cannot currently be predicted with reasonable certainty. See Note 24 Legal Proceedings in the Notes to Consolidated Financial Statements in Item 8 of this Report for additional information.

Our issuance of securities to the US Department of the Treasury may limit our ability to return capital to our shareholders and is dilutive to our common shares. Also, the dividend rate increases substantially after five years if we are unable to redeem the shares by that time.

In connection with our sale of $7.6 billion of senior preferred stock to the US Department of the Treasury on December 31, 2008, we also issued the US Department of the Treasury a warrant to purchase approximately 17 million shares of our common stock at $67.33 per share. The terms of the transaction with the Department of the Treasury result in limitations on our ability to pay dividends and repurchase our shares. For three years after issuance or until the Department of the Treasury no longer holds any preferred shares, we will not be able to increase our dividends above the most recent level prior to October 14, 2008 ($.66 per common share on a quarterly basis) nor repurchase any of our shares without the Department of the Treasury’s approval with limited exceptions, most significantly purchases in connection with benefit plans. Also, we will not be able to pay any dividends at all unless we are current on our dividend payments on the preferred shares. These restrictions, as well as the dilutive impact of the warrant, may have an adverse effect on the market price of our common stock.


 

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Unless we are able to redeem the preferred stock during the first five years, the dividends on this capital will increase substantially at that point, from 5% (almost $400 million annually) to 9% (almost $700 million annually). Depending on market conditions and our financial performance at the time, this increase in dividends could significantly impact our capital and liquidity.

The US Department of the Treasury has the unilateral ability to change some of the restrictions imposed on us by virtue of our sale of securities to it.

Our agreement with the US Department of the Treasury under which it purchased our securities imposes restrictions on our conduct of our business, including restrictions related to our payment of dividends and repurchase of our stock and related to our executive compensation and governance. The US Department of the Treasury has the right under this agreement to unilaterally amend it to the extent required to comply with any future changes in federal statutes. The Recovery Act amended provisions of EESA relating to compensation and governance as they affect companies such as PNC that have sold securities to the US Department of the Treasury. In some cases, these amendments require action by the US Department of the Treasury to implement them. These amendments could have an adverse impact on the conduct of our business, as could additional amendments in the future that impose further requirements or amend existing requirements.

Risks related to the ordinary course of PNC’s business

We operate in a highly competitive environment, both in terms of the products and services we offer, the geographic markets in which we conduct business, as well as our labor markets and competition for talented employees. Competition could adversely impact our customer acquisition, growth and retention, as well as our credit spreads and product pricing, causing us to lose market share and deposits and revenues.

We are subject to intense competition from various financial institutions as well as from non-bank entities that engage in similar activities without being subject to bank regulatory supervision and restrictions. This competition is described in Item 1 of this Report under “Competition.”

In all, the principal bases for competition are pricing (including the interest rates charged on loans or paid on interest-bearing deposits), product structure, the range of products and services offered, and the quality of customer service (including convenience and responsiveness to customer needs and concerns). The ability to access and use technology is an increasingly important competitive factor in the financial services industry. Technology is important not only with respect to delivery of financial services but also in processing information. Each of our businesses consistently must make significant technological investments to remain competitive.

 

A failure to address adequately the competitive pressures we face could make it harder for us to attract and retain customers across our businesses. On the other hand, meeting these competitive pressures could require us to incur significant additional expenses or to accept risk beyond what we would otherwise view as desirable under the circumstances. In addition, in our interest sensitive businesses, pressures to increase rates on deposits or decrease rates on loans could reduce our net interest margin with a resulting negative impact on our net interest income. Any of these results would likely have an adverse effect on our overall financial performance.

We grow our business in part by acquiring from time to time other financial services companies, and these acquisitions present us with a number of risks and uncertainties related both to the acquisition transactions themselves and to the integration of the acquired businesses into PNC after closing.

Acquisitions of other financial services companies in general present risks to PNC in addition to those presented by the nature of the business acquired. We describe some of the integration risks presented by our recent acquisition of National City above. Many of these risks are common to some extent in acquisition transactions.

In general, acquisitions may be substantially more expensive to complete (including as a result of 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. In some cases, acquisitions involve our entry into new businesses or new geographic or other markets, and these situations also present risks resulting from our inexperience in these 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. 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.

The performance of our asset management businesses may be adversely affected by the relative performance of our products compared with alternative investments as well as by overall economic and market conditions.

Asset management revenue is primarily based on a percentage of the value of assets under management and, in some cases, performance fees, in most cases expressed as a percentage of the returns realized on assets under management, and thus is impacted by general changes in capital markets valuations as well as by customer preferences and needs. In addition, investment performance is an important factor influencing the level of assets under management. Poor investment performance could impair revenue and growth as existing


 

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clients might withdraw funds in favor of better performing products. Also, performance fees could be lower or nonexistent. Additionally, the ability to attract funds from existing and new clients might diminish. Overall economic conditions may limit the amount that customers are able or willing to invest.

The failure or negative performance of products of other financial institutions could lead to a loss of confidence in similar products offered by us without regard to the performance of our products. Such a negative contagion could lead to withdrawals, redemptions and liquidity issues in such products and have a material adverse impact on our assets under management and asset management revenues and earnings.

The performance of our fund servicing business may be adversely affected by changes in investor preferences, or changes in existing or potential fund servicing clients or alternative providers.

Fund servicing fees are primarily derived from the market value of the assets and the number of shareholder accounts that we administer for our clients. The performance of our fund processing business is thus partially dependent on the underlying performance of its fund clients and, in particular, their ability to attract and retain customers. Changes in interest rates or a sustained weakness, weakening or volatility in the debt and equity markets could (in addition to affecting directly the value of assets administered as discussed above) influence an investor’s decision to invest or maintain an investment in a particular mutual fund or other pooled investment product. Other factors beyond our control may impact the ability of our fund clients to attract or retain customers or customer funds, including changes in preferences as to certain investment styles. Further, to the extent that our fund clients’ businesses are adversely affected by ongoing governmental investigations into the practices of the mutual and hedge fund industries, our fund processing business’ results also could be adversely impacted. As a result of these types of factors, fluctuations may occur in the level or value of assets for which we provide processing services. In addition, this regulatory and business environment is likely to continue to result in operating margin pressure for our various services.

As a regulated financial services firm, we are subject to numerous governmental regulations and to comprehensive examination and supervision by regulators, which affects our business as well as our competitive position.

PNC is a bank and financial holding company and is subject to numerous governmental regulations involving both its business and organization. PNC services its obligations primarily with dividends and advances that it receives from its subsidiaries.

Our businesses are subject to regulation by multiple bank regulatory bodies as well as multiple securities industry regulators. Applicable laws and regulations restrict our ability

to repurchase stock or to receive dividends from subsidiaries that operate in the banking and securities business and impose capital adequacy requirements. They also restrict permissible activities and investments and require compliance with protections for loan, deposit, brokerage, fiduciary, mutual fund and other customers, and for the protection of customer information, among other things. The consequences of noncompliance can include substantial monetary and nonmonetary sanctions as well as damage to our reputation and businesses.

In addition, we are subject to comprehensive examination and supervision by banking and other regulatory bodies. Examination reports and ratings (which often are not publicly available) and other aspects of this supervisory framework can materially impact the conduct, growth, and profitability of our businesses.

Due to the current economic environment and issues facing the financial services industry, as well as the effect of the change from the Bush to the Obama administration, we anticipate new legislative and regulatory initiatives over the next several years, including many focused specifically on banking and other financial services in which we are engaged. These initiatives will be in addition to the actions already taken by Congress and the regulators, including EESA and the Recovery Act. Developments to date, as well as those that come in the future, have had and are likely to continue to have an impact on the conduct of our business. This impact could include rules and regulations that affect the nature and profitability of our business activities, how we use our capital, how we compensate and incent our employees and other matters potentially having a negative effect on our overall business results and prospects.

Under the regulations of the Federal Reserve, a bank holding company is expected to act as a source of financial strength for its subsidiary banks. As a result of this regulatory policy, the Federal Reserve might require PNC to commit resources to its subsidiary banks when doing so is not otherwise in the interests of PNC or its shareholders or creditors.

Our ability to pay dividends to shareholders is largely dependent on dividends from our operating subsidiaries, principally our banking subsidiaries. Banks are subject to regulation on the amount and circumstances of dividends they can pay to their holding companies. At present, National City Bank does not have any ability to pay dividends, so we are primarily relying on PNC Bank, N.A.’s dividend capacity to support our external dividends.

We discuss these and other regulatory issues applicable to PNC in the Supervision and Regulation section included in Item 1 of this Report and in Note 23 Regulatory Matters in the Notes To Consolidated Financial Statements in Item 8 of this Report and here by reference.


 

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Over the last several years, there has been an increasing regulatory focus on compliance with anti-money laundering laws and regulations, resulting in, among other things, several significant publicly-announced enforcement actions. There has also been a heightened focus recently, by customers and the media as well as by regulators, on the protection of confidential customer information. A failure to have adequate procedures to comply with anti-money laundering laws and regulations or to protect the confidentiality of customer information could expose us to damages, fines and regulatory penalties, which could be significant, and could also injure our reputation with customers and others with whom we do business.

We must comply with generally accepted accounting principles established by the Financial Accounting Standards Board, accounting, disclosure and other rules set forth by the SEC, income tax and other regulations established by the US Department of the Treasury, and revenue rulings and other guidance issued by the Internal Revenue Service, which affect our financial condition and results of operations.

Changes in accounting standards, or interpretations of those standards, can impact our revenue recognition and expense policies and affect our estimation methods used to prepare the consolidated financial statements. Changes in income tax regulations, revenue rulings, revenue procedures, and other guidance can impact our tax liability and alter the timing of cash flows associated with tax deductions and payments. New guidance often dictates how changes to standards and regulations are to be presented in our consolidated financial statements, as either an adjustment to beginning retained earnings for the period or as income or expense in current period earnings. In some cases, changes may be applied to previously reported disclosures.

The determination of the amount of loss allowances and impairments taken on our assets is highly subjective and could materially impact our results of operations or financial position.

The determination of the amount of loss allowances and asset impairments varies by asset type and is based upon our periodic evaluation and assessment of known and inherent risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available. Management updates its evaluations regularly and reflects changes in allowances and impairments in operations as such evaluations are revised. There can be no assurance that our management has accurately assessed the level of impairments taken and allowances reflected in our financial statements. Furthermore, additional impairments may need to be taken or allowances provided for in the future. Historical trends may not be indicative of future impairments or allowances.

 

Our asset valuation may include methodologies, estimations and assumptions that are subject to differing interpretations and could result in changes to asset valuations that may materially adversely affect our results of operations or financial condition.

We must use estimates, assumptions, and judgments when financial assets and liabilities are measured and reported at 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 quoted market prices and/or other observable inputs provided by independent third-party sources, when available. When such third-party information is not available, we estimate fair value primarily by using cash flows and other financial modeling techniques utilizing assumptions such as credit quality, liquidity, interest rates and other relevant inputs. Changes in underlying factors, assumptions, or estimates in any of these areas could materially impact our future financial condition and results of operations.

During periods of market disruption, including periods of significantly rising or high interest rates, rapidly widening credit spreads or illiquidity, it may be difficult to value certain of our assets if trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes that were in active markets with significant observable data that become illiquid due to the current financial environment. In such cases, certain asset valuations may require more subjectivity and management judgment. As such, valuations may include inputs and assumptions that are less observable or require greater estimation. Further, rapidly changing and unprecedented credit and equity market conditions could materially impact the valuation of assets as reported within our consolidated financial statements, and the period-to-period changes in value could vary significantly. Decreases in value may have a material adverse effect on our results of operations or financial condition.

Our business and financial performance could be adversely affected, directly or indirectly, by natural disasters, by terrorist activities or by international hostilities.

The impact of natural disasters, terrorist activities and international hostilities cannot be predicted with respect to severity or duration. However, any of these could impact us directly (for example, by causing significant damage to our facilities or preventing us from conducting our business in the ordinary course), or could impact us indirectly through a direct impact on our borrowers, depositors, other customers, suppliers or other counterparties. We could also suffer adverse consequences to the extent that natural disasters, terrorist activities or international hostilities affect the economy and capital and other financial markets generally. These types of impacts could lead, for example, to an increase in delinquencies, bankruptcies or defaults that could result in our experiencing higher levels of nonperforming assets, net charge-offs and provisions for credit losses.


 

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Our ability to mitigate the adverse consequences of such occurrences is in part dependent on the quality of our resiliency planning, including our ability to anticipate the nature of any such event that occurs. The adverse impact of natural disasters or terrorist activities or international hostilities also could be increased to the extent that there is a lack of preparedness on the part of national or regional emergency responders or on the part of other organizations and businesses that we deal with, particularly those that we depend upon.

ITEM 1BUNRESOLVED STAFF COMMENTS

There are no SEC staff comments regarding PNC’s periodic or current reports under the Exchange Act that are pending resolution.

ITEM 2 – PROPERTIES

Our executive and administrative offices are located at One PNC Plaza, Pittsburgh, Pennsylvania. The thirty-story structure is owned by PNC Bank, N. A. We occupy the entire building. In addition, PNC Bank, N.A. owns a thirty-four story structure adjacent to One PNC Plaza, known as Two PNC Plaza, that houses additional office space.

We own or lease numerous other premises for use in conducting business activities, including operations centers, offices, and branch and other facilities. We consider the facilities owned or occupied under lease by our subsidiaries to be adequate. We include here by reference the additional information regarding our properties in Note 11 Premises, Equipment and Leasehold Improvements in the Notes To Consolidated Financial Statements in Item 8 of this Report.

ITEM 3 – LEGAL PROCEEDINGS

See the information set forth in Note 24 Legal Proceedings included in the Notes to Consolidated Financial Statements in Item 8 of this Report, which is incorporated here by reference.

National City has agreed to pay a penalty of $200,000 imposed under section 6707 A(b)(2) of the Internal Revenue Code for failure to include certain reportable transaction information in its 2004 federal income tax return related to a listed transaction. We expect to pay the penalty in 2009.

ITEM 4 – SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

A special meeting of shareholders of The PNC Financial Services Group, Inc. was held on December 23, 2008 for the purpose of considering and acting upon the following matters: (1) a proposal to approve the issuance of shares of PNC common stock as contemplated by the Agreement and Plan of Merger, dated as of October 24, 2008, by and between The PNC Financial Services Group, Inc. and National City Corporation, as such agreement may be amended from time to time; and (2) a proposal to approve the adjournment of the

special meeting, if necessary or appropriate, to solicit additional proxies, in the event that there were not sufficient votes at the time of the special meeting to approve the proposal described under (1) above.

Based on a total of approximately 348.5 million eligible votes, approximately 266 million votes, or 76% of the total, were cast. The votes cast included votes for or against either proposal, as well as abstentions.

The proposal to approve the issuance of shares of PNC common stock in connection with PNC’s acquisition of National City was ratified and the aggregate votes cast for or against and the abstentions were as follows:

 

Aggregate Votes

For

  Against   Abstain

262,287,739

  3,057,391   634,073

The proposal to approve the adjournment of the special meeting, if necessary, was ratified and the aggregate votes cast for or against and the abstentions were as follows (there were also 1,550 non-votes):

 

Aggregate Votes

For

  Against   Abstain

240,665,800

  24,585,286   726,567

With respect to all of the preceding matters, holders of our common and voting preferred stock voted together as a single class. The following table sets forth, as of the November 14, 2008 record date, the number of shares of each class or series of stock that were issued and outstanding and entitled to vote, the voting power per share, and the aggregate voting power of each class or series:

 

Title of Class or Series   

Voting Rights

Per Share

  

Number of

Shares Entitled

to Vote

  

Aggregate

Voting Power

 
        

Common Stock

   1    347,960,466    347,960,466  

$1.80 Cumulative Convertible Preferred Stock – Series A

   8    6,540    52,320  

$1.80 Cumulative Convertible Preferred Stock – Series B

   8    1,137    9,096  

$1.60 Cumulative Convertible Preferred Stock – Series C

   4/2.4    119,126    198,543  

$1.80 Cumulative Convertible Preferred Stock – Series D

   4/2.4    170,761    284,602  
            

Total possible votes

             348,505,027 *
* Represents greatest number of votes possible. Actual aggregate voting power was less since each holder of voting preferred stock was entitled to a number of votes equal to the number of full shares of common stock into which such holder’s preferred stock was convertible.

 

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EXECUTIVE OFFICERS OF THE REGISTRANT Information regarding each of our executive officers as of February 17, 2009 is set forth below. Executive officers do not have a stated term of office. Each executive officer has held the position or positions indicated or another executive position with the same entity or one of its affiliates for the past five years unless otherwise indicated below.

 

Name   Age    Position with PNC   

Year

Employed (1)

James E. Rohr

  60   

Chairman and Chief Executive Officer (2)

   1972

Joseph C. Guyaux

  58   

President

   1972

William S. Demchak

  46   

Senior Vice Chairman

   2002

Timothy G. Shack

  58   

Vice Chairman

   1976

Thomas K. Whitford

  52   

Vice Chairman

   1983

Joan L. Gulley

  61   

Executive Vice President and Chief Human Resources Officer

   1986

Michael J. Hannon

  52   

Executive Vice President and Chief Risk Officer

   1982

Richard J. Johnson

  52   

Executive Vice President and Chief Financial Officer

   2002

Helen P. Pudlin

  59   

Executive Vice President and General Counsel

   1989

Robert Q. Reilly

  44   

Executive Vice President

   1987

Samuel R. Patterson

  50   

Senior Vice President and Controller

   1986

John J. Wixted, Jr.

  57   

Senior Vice President

   2002
(1) Where applicable, refers to year employed by predecessor company.
(2) Also serves as a director of PNC.

William S. Demchak was appointed Senior Vice Chairman in February 2009. He joined PNC as Vice Chairman and Chief Financial Officer in September 2002. Since August 2005, he has had oversight responsibilities for the Corporation’s Corporate & Institutional Banking business. He also oversees PNC’s asset and liability management and equity management activities.

Timothy G. Shack was appointed Vice Chairman in February 2009. He was Executive Vice President from July 1991 to February 2009, and also served as Chief Information Officer from April 1998 to May 2008.

Thomas K. Whitford was appointed Vice Chairman in February 2009. He was appointed Chief Administrative Officer in May 2007. From April 2002 through May 2007, he served as Chief Risk Officer.

Joan L. Gulley was Chief Executive Officer for PNC’s wealth management business from 2002 to 2006. In 2006 she was appointed Executive Vice President of PNC Bank, N.A. and was responsible for product and segment management, as well as advertising and brand management for PNC. In April 2008 she was appointed Senior Vice President and Chief Human Resources Officer for PNC and in February 2009 she was appointed Executive Vice President of PNC.

 

Michael J. Hannon was appointed Executive Vice President and Chief Risk Officer in February 2009 and was previously Senior Vice President and Chief Credit Officer.

Richard J. Johnson joined PNC in December 2002 and served as Senior Vice President and Director of Finance until his appointment as Chief Financial Officer of the Corporation effective in August 2005. He was appointed Executive Vice President in February 2009.

Helen P. Pudlin was appointed Executive Vice President and General Counsel in February 2009 and was previously Senior Vice President and General Counsel.

Robert Q. Reilly joined PNC Bank, N.A. in September 1987. He serves as the lead of PNC’s wealth management business, and in February 2009 he was appointed Executive Vice President of PNC.

John J. Wixted, Jr. joined PNC as Senior Vice President and Chief Regulatory Officer in August 2002. From May 2007 until February 2009, he also served as Chief Risk Officer.

DIRECTORS OF THE REGISTRANT The name, age and principal occupation of each of our directors as of February 17, 2009, and the year he or she first became a director is set forth below:

   

Richard O. Berndt, 66, Managing Partner of Gallagher, Evelius & Jones LLP (law firm) (2007)

   

Charles E. Bunch, 59, Chairman and Chief Executive Officer of PPG Industries, Inc. (coatings, sealants and glass products) (2007)

   

Paul W. Chellgren, 66, Operating Partner, SPG Partners, LLC, (private equity) (1995)

   

Robert N. Clay, 62, President and Chief Executive Officer of Clay Holding Company (investments) (1987)

   

George A. Davidson, Jr., 70, Retired Chairman of Dominion Resources, Inc. (public utility holding company) (1988)

   

Kay Coles James, 59, President and Founder of The Gloucester Institute (non-profit) (2006)

   

Richard B. Kelson, 62, Operating Advisor, Pegasus Capital Advisors, L.P., (private equity) (2002)

   

Bruce C. Lindsay, 67, Chairman and Managing Member of 2117 Associates, LLC (advisory company) (1995)

   

Anthony A. Massaro, 64, Retired Chairman and Chief Executive Officer of Lincoln Electric Holdings, Inc. (manufacturer of welding and cutting products) (2002)

   

Jane G. Pepper, 63, President of Pennsylvania Horticultural Society (non-profit) (1997)

   

James E. Rohr, 60, Chairman and Chief Executive Officer of PNC (1990)

   

Donald J. Shepard, 62, Retired Chairman of the Executive Board and Chief Executive Officer, AEGON N.V. (insurance) (2007)


 

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Lorene K. Steffes, 63, Independent Business Advisor (technology and technical services) (2000)

   

Dennis F. Strigl, 62, President and Chief Operating Officer of Verizon Communications Inc. (telecommunications) (2001)

   

Stephen G. Thieke, 62, Retired Chairman, Risk Management Committee of JP Morgan Incorporated (financial and investment banking services) (2002)

   

Thomas J. Usher, 66, Chairman of Marathon Oil Corporation (oil and gas industry) (1992)

   

George H. Walls, Jr., 66, former Chief Deputy Auditor of the State of North Carolina (2006)

   

Helge H. Wehmeier, 66, Retired President and Chief Executive Officer of Bayer Corporation (healthcare, crop protection, and chemicals) (1992)

PART II

ITEM 5 – MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

(a) Our common stock is listed on the New York Stock Exchange and is traded under the symbol “PNC.” At the close of business on February 17, 2009, there were 79,036 common shareholders of record.

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. However, on March 1, 2009, the Board decided to reduce PNC’s quarterly common stock dividend from $0.66 to $0.10 per share. The next dividend is expected to be declared in early April 2009. 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).

The Risk Factors section of Item 1A of this Report and Note 19 Shareholders’ Equity in the Notes To Consolidated Financial Statements in Item 8 of this Report, which we include here by reference, describe restrictions on dividends and common share repurchases associated with our December 31, 2008 issuance of preferred stock to the US Department of the Treasury under the TARP Capital Purchase Program. In addition, the Federal Reserve has the power to prohibit us from paying dividends without its approval. For further information concerning dividend restrictions and restrictions on loans, dividends or advances from bank subsidiaries to the parent company, you may review

“Supervision and Regulation” in Item 1 of this Report, “Funding and Capital Sources” in the Consolidated Balance Sheet Review section, “Liquidity Risk Management” in the Risk Management section, and “Perpetual Trust Securities”, “PNC Capital Trust E Trust Preferred Securities” and “Acquired Entity Trust Preferred Securities” in the Off-Balance Sheet Arrangements and VIEs section of Item 7 of this Report, and Note 23 Regulatory Matters in the Notes To Consolidated Financial Statements in Item 8 of this Report, which we include here by reference.

We include here by reference additional information relating to PNC common stock under the caption “Common Stock Prices/Dividends Declared” in the Statistical Information (Unaudited) section of Item 8 of this Report.

We include here by reference the information regarding our compensation plans under which PNC equity securities are authorized for issuance as of December 31, 2008 in the table (with introductory paragraph and notes) that appears under Item 12 of this Report.

Our registrar, stock transfer agent, and dividend disbursing agent is:

Computershare Investor Services, LLC

250 Royall Street

Canton, MA 02021

800-982-7652

We include here by reference the information that appears under the caption “Common Stock Performance Graph” at the end of this Item 5.

(b) Not applicable.

(c) Details of our repurchases of PNC common stock during the fourth quarter of 2008 are included in the following table:

In thousands, except per share data

 

2008 period   Total shares
purchased
(a) (b)
  Average
price
paid per
share
  Total shares
purchased as
part of
publicly
announced
programs (c)
  Maximum
number of
shares that
may yet be
purchased
under the
programs (c)

October 1 –

October 31

  247   $ 67.37       24,710

November 1 –

November 30

  186   $ 62.13       24,710

December 1 –

December 31

  143   $ 49.13       24,710

Total

  576   $ 61.16        
(a)

Under the US Treasury’s TARP Capital Purchase Program, there are restrictions on dividends and common share repurchases associated with the preferred stock that we issued to the US Treasury under that program on December 31, 2008. As is typical with cumulative preferred stocks, dividend payments for this preferred must be current before dividends can be paid on junior shares, including our common stock, or junior shares can be repurchased or redeemed. Also, the US Treasury’s consent will be required for any increase in common dividends per share above the most recent level prior to October 14, 2008 until the third anniversary of the preferred issuance unless all of that preferred has been redeemed or is no longer held by the US Treasury. Further, during that same period, the US Treasury’s consent will be


 

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required, unless the preferred stock is no longer held by the US Treasury, for any share repurchases with limited exceptions, most significantly purchases of common shares in connection with any benefit plan in the ordinary course of business consistent with past practice.

(b) Reflects PNC common stock purchased in connection with our various employee benefit plans. No shares were purchased under the program referred to in note (c) to this table during the fourth quarter of 2008.
(c) 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.

Common Stock Performance Graph

This graph shows the cumulative total shareholder return (i.e., price change plus reinvestment of dividends) on our common stock during the five-year period ended December 31, 2008, as compared with: (1) a selected peer group of our competitors, called the “Peer Group;” (2) an overall stock market index, the S&P 500 Index; and (3) a published industry index, the S&P 500 Banks. The yearly points marked on the horizontal axis of the graph correspond to December 31 of that year. The stock performance graph assumes that $100 was invested on January 1, 2004 for the five-year period and that any dividends were reinvested. The table below the graph shows the resultant compound annual growth rate for the performance period.

LOGO

 

   

Base

Period

 

Assumes $100 investment at Close of

Market on December 31, 2002

Total Return = Price change plus

reinvestment of dividends

 

5-Year
Compound
Growth

Rate

 
     Dec 03   Dec 04   Dec 05   Dec 06   Dec 07   Dec 08       

PNC

  $ 100   108.92   121.63   150.33   137.87   107.29   1.42 %

S&P 500 Index

  $ 100   110.88   116.32   134.69   142.09   89.52   (2.19 )%

S&P 500 Banks

  $ 100   114.44   112.80   130.99   91.98   48.29   (13.55 )%

Peer Group

  $ 100   112.86   113.85   133.00   94.06   45.03   (14.75 )%

 

The Peer Group for the preceding chart and table consists of the following companies: BB&T Corporation; Comerica Inc.; Fifth Third Bancorp; KeyCorp; National City Corporation; The PNC Financial Services Group, Inc.; SunTrust Banks, Inc.; U.S. Bancorp.; Wachovia Corporation; Regions Financial Corporation; and Wells Fargo & Co. This Peer Group was approved by the Board’s Personnel and Compensation Committee (the “Committee”) for 2008. As of December 31, 2008, Wells Fargo & Co. acquired Wachovia Corporation and PNC acquired National City Corporation. Typically, the Committee reviews the makeup of the peer group annually. Due to the many changes in the financial industry generally, PNC’s substantially increased size and scope at the beginning of 2009, and a significant number of mergers and other changes with respect to PNC’s 2008 peers and other industry leaders, the Committee has changed the peer group for 2009 to consist of the following companies: BB&T Corporation; Bank of America Corporation; Capital One Financial, Inc.; Comerica Inc.; Fifth Third Bancorp; JPMorgan Chase; KeyCorp; M&T Bank; Regions Financial Corporation; SunTrust Banks, Inc.; U.S. Bancorp; and Wells Fargo & Co.

Each yearly point for the Peer Group is determined by calculating the cumulative total shareholder return for each company in the Peer Group from December 31, 2003 to December 31 of that year (End of Month Dividend Reinvestment Assumed) and then using the median of these returns as the yearly plot point.

In accordance with the rules of the SEC, this section, captioned “Common Stock Performance Graph,” shall not be incorporated by reference into any of our future filings made under the Securities Exchange Act of 1934 or the Securities Act of 1933. The Common Stock Performance Graph, including its accompanying table and footnotes, is not deemed to be soliciting material or to be filed under the Exchange Act or the Securities Act.


 

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ITEM 6 – SELECTED FINANCIAL DATA

 

Dollars in millions, except per share data    Year ended December 31  
     2008 (a)          2007       2006 (b)       2005       2004  
   

SUMMARY OF OPERATIONS

                 

Interest income

   $ 6,313        $     6,166     $ 4,612     $     3,734     $     2,752  

Interest expense

     2,490          3,251       2,367       1,580       783  

Net interest income

     3,823          2,915       2,245       2,154       1,969  

Noninterest income

     3,367          3,790       6,327       4,173       3,572  

Total revenue

     7,190          6,705       8,572       6,327       5,541  

Provision for credit losses (c)

     1,517          315       124       21       52  

Noninterest expense

     4,430          4,296       4,443       4,306       3,712  

Income before minority interests and income taxes

     1,243          2,094       4,005       2,000       1,777  

Minority interest in income of BlackRock

              47       71       42  

Income taxes

     361          627       1,363       604       538  

Net income

   $ 882        $ 1,467     $ 2,595     $ 1,325     $ 1,197  
   

PER COMMON SHARE

                 

Basic earnings

   $ 2.50        $ 4.43     $ 8.89     $ 4.63     $ 4.25  

Diluted earnings

   $ 2.46        $ 4.35     $ 8.73     $ 4.55     $ 4.21  

Book value (d)

   $ 39.44        $ 43.60     $ 36.80     $ 29.21     $ 26.41  

Cash dividends declared

   $ 2.61        $ 2.44     $ 2.15     $ 2.00     $ 2.00  
   

SELECTED RATIOS

                 

Net interest margin (e)

     3.37 %        3.00 %     2.92 %     3.00 %     3.22 %

Noninterest income to total revenue

     47          57       74       66       64  

Efficiency

     62          64       52       68       67  

Return on

                 

Average tangible common shareholders’ equity

     17.70          22.65       48.74       30.64       29.90  

Average common shareholders’ equity

     6.28          10.53       27.97       16.58       16.82  

Average assets

     .62          1.19       2.73       1.50       1.59  

Loans to deposits (d)

     91          83       76       81       82  

Dividend payout

     104.6          55.0       24.4       43.4       47.2  

Tier 1 risk-based capital (d)

     9.7          6.8       10.4       8.3       9.0  

Common shareholders’ equity to total assets (d)

     6.0          10.7       10.6       9.3       9.4  

Average common shareholders’ equity to average assets

     9.6          11.3       9.8       9.0       9.4  
(a) The 2008 Consolidated Income Statement does not include operating results of National City.
(b) The 2007 Versus 2006 Consolidated Income Statement Review section of Item 7 of this Report describes certain items impacting 2006 results.
(c) Amount for 2008 included $504 million conforming provision for credit losses related to our National City acquisition.
(d) At December 31.
(e) Calculated as annualized taxable-equivalent net interest income divided by average earning assets. The interest income earned on certain earning assets is completely or partially exempt from federal income tax. As such, these tax-exempt instruments typically yield lower returns than taxable investments. To provide more meaningful comparisons of margins for all earning assets, we use net interest income on a taxable-equivalent basis in calculating net interest margin by increasing the interest income earned on tax-exempt assets to make it fully equivalent to interest income earned on taxable investments. This adjustment is not permitted under GAAP in the Consolidated Income Statement. The taxable-equivalent adjustments to net interest income for the years 2008, 2007, 2006, 2005 and 2004 were $36 million, $27 million, $25 million, $33 million and $20 million, respectively.

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. See Note 2 Acquisitions and Divestitures in the Notes To Consolidated Financial Statements in Item 8 of this Report for information on significant recent business acquisitions and divestitures, including our December 31, 2008 acquisition of National City Corporation. For information regarding certain business risks, see Item 1A Risk Factors and the Risk Management section of Item 7 of this Report. Also, see our Cautionary Statement Regarding Forward-Looking Information included in Item 7 of this Report for certain risks and uncertainties that could cause actual results to differ materially from those anticipated in forward-looking statements or from historical performance.

 

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December 31

Dollars in millions, except as noted

   2008 (a)            2007    2006    2005    2004
   

BALANCE SHEET HIGHLIGHTS

                     

Assets

   $ 291,081       $ 138,920    $ 101,820    $ 91,954    $ 79,723

Loans

     175,489         68,319      50,105      49,101      43,495

Allowance for loan and lease losses

     3,917         830      560      596      607

Investment securities

     43,473         30,225      23,191      20,710      16,761

Loans held for sale

     4,366         3,927      2,366      2,449      1,670

Goodwill

     8,868         8,405      3,402      3,619      3,001

Equity investments (b)

     8,554         6,045      5,330      1,323      1,058

Deposits

     192,865         82,696      66,301      60,275      53,269

Borrowed funds (c)

     52,240         30,931      15,028      16,897      11,964

Shareholders’ equity

     25,422         14,854      10,788      8,563      7,473

Common shareholders’ equity

     17,490         14,847      10,781      8,555      7,465
   

ASSETS ADMINISTERED (in billions)

                     

Managed (d)

   $ 110       $ 74    $ 55    $ 495    $ 383

Nondiscretionary

     125         112      85      83      93
   

FUND ASSETS SERVICED (in billions)

                     

Accounting/administration net assets

   $ 839       $ 990    $ 837    $ 835    $ 721

Custody assets

     379         500      427      476      451
   

SELECTED STATISTICS

                     

Period-end employees

     59,595         28,320      23,783      25,348      24,218

Branches

     2,589         1,109      852      839      776

ATMs

     6,232         3,900      3,581      3,721      3,581

Residential mortgage servicing portfolio (in billions)

   $ 187                 

Commercial mortgage servicing portfolio (in billions)

   $ 286       $ 243    $ 200    $ 136    $ 98
(a) Information at December 31, 2008 includes the impact of National City Corporation, which we acquired as of that date.
(b) The balances at December 31, 2008, 2007 and 2006 include our investment in BlackRock. BlackRock was a consolidated entity at December 31, 2005 and 2004.
(c) Includes long-term borrowings of $35 billion, $12.6 billion, $6.6 billion, $6.8 billion, and $5.7 billion for 2008, 2007, 2006, 2005, and 2004, respectively. Borrowings which mature more than one year after December 31, 2008 are considered to be long-term.
(d) Assets under management at December 31, 2008, 2007 and 2006 do not include BlackRock’s assets under management as we deconsolidated BlackRock effective September 29, 2006.

 

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ITEM 7 – MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

EXECUTIVE SUMMARY

THE PNC FINANCIAL SERVICES GROUP, INC.

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

As described further below, on December 31, 2008, PNC acquired National City Corporation (“National City”), nearly doubling our assets to a total of $291 billion and expanding our total consolidated deposits to $193 billion. Our Consolidated Balance Sheet includes the impact of National City as of December 31, 2008.

Prior to the acquisition, PNC had businesses engaged in retail banking, corporate and institutional banking, asset management, and global investment servicing, providing many of its products and services nationally and others in PNC’s primary geographic markets located in Pennsylvania, New Jersey, Washington, DC, Maryland, Virginia, Ohio, Kentucky and Delaware. PNC also provided certain investment servicing internationally.

National City’s primary businesses prior to its acquisition by PNC included commercial and retail banking, mortgage financing and servicing, consumer finance and asset management, operating through an extensive network in Ohio, Florida, Illinois, Indiana, Kentucky, Michigan, Missouri, Pennsylvania and Wisconsin. National City also conducted selected consumer lending businesses and other financial services on a nationwide basis.

PNC is now in the process of integrating the business and operations of National City with those of PNC.

KEY STRATEGIC GOALS

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

Our strategy to enhance shareholder value centers on driving positive operating leverage by achieving growth in revenue from our balance sheet and diverse business mix that exceeds growth in expenses controlled through disciplined cost management. In each of our current business segments, the primary drivers of revenue growth are the acquisition, expansion and retention of customer relationships. We strive to expand our customer base by offering convenient banking options and leading technology solutions, providing a broad range of fee-based and credit products and services, focusing on customer service, and through a significantly enhanced branding initiative. We may also grow revenue through

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

We are focused on our strategies for quality growth. We are committed to returning to a moderate risk profile characterized by disciplined credit management and limited exposure to earnings volatility resulting from interest rate fluctuations and the shape of the interest rate yield curve. Our actions have created a well-positioned and strong balance sheet, ample liquidity and investment flexibility to adjust, where appropriate and permissible, to changing interest rates and market conditions.

We continue to be disciplined in investing capital in our businesses while returning a portion to shareholders through dividends and share repurchases when appropriate and permissible. See the Funding and Capital Sources section of the Consolidated Balance Sheet Review section and the Liquidity Risk Management section of this Financial Review regarding certain restrictions on dividends and common share repurchases resulting from PNC’s participation in the US Treasury’s Troubled Asset Relief Program (“TARP”) Capital Purchase Program and dividend capacity.

On March 1, 2009, the Board decided to reduce PNC’s quarterly common stock dividend from $0.66 to $0.10 per share. The next dividend is expected to be declared in early April 2009. Our Board recognizes the importance of the dividend to our shareholders. While our overall capital and liquidity positions are strong, extreme economic and market deterioration and the changing regulatory environment drove this difficult but prudent decision. This proactive measure will help us build capital, further strengthen our balance sheet and continue to serve our customers.

ACQUISITION OF NATIONAL CITY CORPORATION

On December 31, 2008, we acquired National City for approximately $6.1 billion. The total consideration included approximately $5.6 billion of PNC common stock, $150 million of preferred stock, and cash paid to warrant holders by National City.

We completed the acquisition primarily by issuing approximately 95 million shares of PNC common stock. In accordance with purchase accounting methodologies, National City Bank’s balance sheet was adjusted to fair value at which time the bank was under-capitalized from a regulatory perspective. However, PNC’s Consolidated Balance Sheet remained well-capitalized and liquid.

Following the closing, PNC received $7.6 billion from the US Department of the Treasury under the Emergency Economic Stabilization Act of 2008 in exchange for the issuance of preferred stock and a warrant. These proceeds were used to enhance National City Bank’s regulatory capital position to well-capitalized in order to continue serving the credit and deposit needs of existing and new customers. On a consolidated basis, these proceeds resulted in further improvement to our capital and liquidity positions.


 

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National City, based in Cleveland, Ohio, was one of the nation’s largest commercial banking organizations based on assets. We expect to incur total merger and integration costs of approximately $1.2 billion in connection with the acquisition of National City, including $575 million recognized in the fourth quarter of 2008. The transaction is expected to result in the reduction of approximately $1.2 billion of combined company annualized noninterest expense through the elimination of operational and administrative redundancies.

Other than the merger and integration costs discussed above, our acquisition of National City did not impact our 2008 Consolidated Income Statement, nor did it impact our 2008 Average Consolidated Balance Sheet. Note 2 Acquisitions and Divestitures included in our Notes To Consolidated Financial Statements within Item 8 of this Report and our Current Reports on Form 8-K filed October 24, 2008, October 30, 2008, December 23, 2008, and January 2, 2009 provide additional information regarding our acquisition of National City.

RECENT MARKET AND INDUSTRY DEVELOPMENTS

Starting in the middle of 2007 and with a heightened level of activity during the second half of 2008 and into early 2009, there has been unprecedented turmoil, volatility and illiquidity in worldwide financial markets, accompanied by uncertain prospects for the overall national economy, which is currently in the midst of a severe recession. In addition, there have been dramatic changes in the competitive landscape of the financial services industry during this time.

Recent efforts by the Federal government, including the US Department of the Treasury, the Federal Reserve, the FDIC, and the Securities and Exchange Commission, to stabilize and restore confidence in the financial services industry have impacted and will likely continue to impact PNC and our stakeholders. These efforts, which will continue to evolve, include the Emergency Economic Stabilization Act of 2008, the American Recovery and Reinvestment Act of 2009, and other legislative, administrative and regulatory initiatives, including the US Treasury’s TARP and TARP Capital Purchase Program, the FDIC’s Temporary Liquidity Guarantee Program (“TLGP”) and the Federal Reserve’s Commercial Paper Funding Facility (“CPFF”).

Beginning in the fourth quarter of 2008, PNC participated in several of these programs as further described below:

TARP CAPITAL PURCHASE PROGRAM

The TARP Capital Purchase Program encourages US financial institutions to build capital through the sale to the US Treasury of senior preferred shares of stock to increase the flow of financing to US businesses and consumers and to support the US economy.

On December 31, 2008, PNC issued to the US Treasury $7.6 billion of preferred stock together with a related warrant to purchase shares of common stock of PNC, in accordance with

the terms of the TARP Capital Purchase Program. Funds from this sale count as Tier 1 capital and the warrant qualifies as tangible common equity.

Holders of this preferred stock are entitled to a cumulative cash dividend at the annual rate per share of 5% of the liquidation preference per year for the first five years after the closing date. Afterward, the annual dividend rate will increase, to 9% per year. PNC’s intent is to redeem this preferred stock prior to the escalation of the dividend rate.

Note 19 Shareholders’ Equity included in our Notes to Consolidated Financial Statements within Item 8 of this Report includes additional information regarding the preferred stock and the related warrant that we issued under this program.

FDIC TEMPORARY LIQUIDITY GUARANTEE PROGRAM

The FDIC’s TLGP is designed to strengthen confidence and encourage liquidity in the banking system by:

   

Guaranteeing newly issued senior unsecured debt of eligible institutions, including FDIC-insured banks and thrifts, as well as certain holding companies (“TLGP-Debt Guarantee Program”), and

   

Providing full deposit insurance coverage for non-interest bearing transaction accounts in FDIC-insured institutions, regardless of the dollar amount (“TLGP -Transaction Account Guarantee Program”).

In December 2008, PNC Funding Corp issued at the holding company level fixed and floating rate senior notes totaling $2.9 billion under the FDIC’s TLGP-Debt Guarantee Program as more fully described within the Liquidity Risk Management section of this Item 7. Each of these series of senior notes is guaranteed by the FDIC and is backed by the full faith and credit of the United States through June 30, 2012.

As of October 14, 2008, PNC Bank, N.A. and National City Bank have been participating in the TLGP-Transaction Account Guarantee Program. Under this program, through December 31, 2009, all non-interest bearing transaction accounts are fully guaranteed by the FDIC for the entire amount in the account. Coverage under this program is in addition to, and separate from, the coverage available under the FDIC’s general deposit insurance rules.

COMMERCIAL PAPER FUNDING FACILITY

The Federal Reserve established the CPFF to provide a liquidity backstop to US issuers of commercial paper and thereby improve liquidity in short-term funding markets and thus increase the availability of credit for businesses and households. Effective October 28, 2008, Market Street Funding LLC (“Market Street”) was approved to participate in the Federal Reserve’s CPFF. The CPFF commitment to purchase up to $5.4 billion of three-month Market Street commercial paper expires on October 30, 2009. As of December 31, 2008, Market Street’s participation in this


 

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program totaled $445 million. These trades matured at the end of January 2009 and were replaced with commercial paper sold to investors.

****

It is also possible that the US Congress and federal banking agencies, as part of their efforts to provide economic stimulus and financial market stability, to enhance the liquidity and solvency of financial institutions and markets, and to enhance the regulation of financial institutions and markets, will announce additional legislation, regulations or programs. These additional actions may take the form of changes in or additions to the statutes or regulations related to existing programs, including those described above. It is not possible at this time to predict the ultimate impact of these actions on PNC’s business plans and strategies.

KEY FACTORS AFFECTING FINANCIAL PERFORMANCE

Our financial performance is substantially affected by several external factors outside of our control including the following, some of which may be affected by legislative, regulatory and administrative initiatives of the Federal government outlined above:

   

General economic conditions, including the length and severity of the current recession,

   

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

   

Movement of customer deposits from lower to higher rate accounts or to investment alternatives, 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,

   

Progress toward integrating the National City acquisition,

   

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

   

Revenue growth,

   

A sustained focus on expense management, including achieving our cost savings targets associated with our National City integration, and creating positive operating leverage,

   

Managing the distressed assets portfolio,

   

Maintaining solid overall asset quality,

   

Continuing to maintain our solid deposit base,

   

Prudent risk and capital management leading to a return to our desired moderate risk profile, and

   

Actions we take within the capital and other financial markets.

See also Item 1A Risk Factors and the Cautionary Statement Regarding Forward-Looking Information section of Item 7 of this Report.

OTHER 2008 ACQUISITION AND DIVESTITURE ACTIVITY

On April 4, 2008, we acquired Lancaster, Pennsylvania-based Sterling Financial Corporation (“Sterling”) for approximately 4.6 million shares of PNC common stock and $224 million in cash. Sterling was a banking and financial services company with approximately $3.2 billion in assets, $2.7 billion in deposits, and 65 branches in south-central Pennsylvania, northern Maryland and northern Delaware. The Sterling technology systems and bank charter conversions were completed during the third quarter of 2008 and we realized the anticipated cost savings related to these activities.

On March 31, 2008, we sold J.J.B. Hilliard, W.L. Lyons, LLC (“Hilliard Lyons”), a Louisville, Kentucky-based wholly-owned subsidiary of PNC and a full-service brokerage and financial services provider, to Houchens Industries, Inc. We recognized an after-tax gain of $23 million in the first quarter of 2008 in connection with this divestiture. Business segment information for the periods presented in this Item 7 reflects the reclassification of results for Hilliard Lyons, including the gain on the sale of this business, from the Retail Banking business segment to “Other.”

Summary Financial Results

     Year ended December 31  

In millions, except

per share data

   2008     2007  

Net income

   $ 882     $ 1,467  

Diluted earnings per share

   $ 2.46     $ 4.35  

Return on

      

Average common shareholders’ equity

     6.28 %     10.53 %

Average assets

     .62 %     1.19 %

Our earnings and related per share amounts for 2008 do not include the impact of National City, which we acquired effective December 31, 2008, other than a conforming adjustment to our provision for credit losses of $504 million and other integration costs of $71 million, both of which were recognized in the fourth quarter.

Our performance in 2008 included the following:

   

At December 31, 2008 we had total assets of $291 billion, including loans of $175 billion, and total deposits of $193 billion, reflecting the acquisition of National City.

   

We significantly strengthened capital. The Tier 1 risk-based capital ratio was 9.7% at December 31,


 

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2008 compared with 6.8% at December 31, 2007. We issued $7.6 billion of preferred stock and a common stock warrant to the US Department of the Treasury under the TARP Capital Purchase Program on December 31, 2008, which qualified as Tier 1 capital.

   

Our tangible common equity ratio was 2.9% at December 31, 2008. We expect our tangible common equity ratio to be less sensitive to the impact of widening credit spreads on accumulated other comprehensive loss going forward primarily due to the composition of the securities available for sale portfolio acquired from National City and a substantially higher level of tangible common equity in the combined company.

   

We maintained a strong liquidity position and continued to generate deposits. The loan to deposit ratio was 91% at December 31, 2008, reflecting the acquisition of National City. Average deposits for 2008 increased 10% compared with 2007.

   

Credit quality migration reflected a rapidly weakening economy, but remained manageable as PNC was able to maintain a strong capital position and generate positive operating leverage. The allowance for loan and lease losses increased to $3.9 billion at December 31, 2008 from $830 million at December 31, 2007 primarily as a result of the National City acquisition and related conforming credit adjustment. The ratio of allowance for loan and lease losses to total loans was strengthened to 2.23% at December 31, 2008 compared with 1.21% at December 31, 2007. This ratio excluding the impact of the National City acquisition was 1.77% at December 31, 2008. We provide a reconciliation of this ratio excluding the National City impact to the GAAP-basis ratio in the Statistical Information (Unaudited) section in Item 8 of this Report.

   

Average loans for 2008 increased 16% over 2007.

   

We are committed to supporting the objectives of the Emergency Economic Stabilization Act of 2008. To that end, we are continuing to make credit available to qualified borrowers including enhanced calling efforts on small businesses and corporations, promotions offered with special financing rates and responding to increased loan demand for first mortgages. We have reaffirmed and renewed loans and lines of credit, focused on early identification of loan modification candidates and are working closely where appropriate with customers who are experiencing financial hardship to set up new repayment schedules, loan modifications and forbearance programs. We plan to enhance these efforts over time to improve the effectiveness of our broad-reaching initiatives.

   

Investment securities were $43.5 billion at December 31, 2008, or 15% of total assets. The portfolio was primarily comprised of well-diversified, high quality securities with US

 

government agency residential mortgage-backed securities representing 53% of the portfolio. Of the remaining portfolio, approximately 80% of the securities had AAA-equivalent ratings.

   

PNC created positive operating leverage for the year of 4%, or $351 million. Total revenue for 2008 grew 7% compared with 2007, driven by growth in net interest income, and exceeded year-over-year noninterest expense growth of 3%.

   

With the acquisition of National City, our retail banks now serve over 6 million consumer and business customers. Comprehensive two-year integration plans are being implemented with a goal of eliminating $1.2 billion of annualized expenses, including the reduction of approximately 5,800 positions across the combined 59,595 employee base by 2011. The first regional branch conversion is planned for the second half of 2009.

Our Consolidated Income Statement Review section of this Item 7 describes in greater detail the various items that impacted our results for 2008 and 2007.

BALANCE SHEET HIGHLIGHTS

Total assets were $291.1 billion at December 31, 2008 compared with $138.9 billion at December 31, 2007. Total assets at December 31, 2008 included $133.7 billion related to National City. Our acquisition of National City did not impact our 2008 Average Consolidated Balance Sheet.

Total average assets were $142.0 billion for 2008 compared with $123.4 billion for 2007. This increase reflected a $16.5 billion increase in average interest-earning assets and a $2.1 billion increase in average noninterest-earning assets. An increase of $10.2 billion in loans and a $6.2 billion increase in investment securities were the primary factors for the increase in average interest-earning assets.

The increase in average noninterest-earning assets for 2008 reflected an increase in average goodwill of $1.6 billion primarily related to the acquisition of Sterling on April 4, 2008, Yardville National Bancorp (“Yardville”) on October 26, 2007 and Mercantile Bankshares Corporation (“Mercantile”) on March 2, 2007.

The impact of the Sterling, Yardville and Mercantile acquisitions is also reflected in our year-over-year increases in average total loans, average securities available for sale and average total deposits as described further below.

Average total loans were $72.7 billion for 2008 and $62.5 billion for 2007. The increase in average total loans included growth in commercial loans of $5.5 billion, consumer loans of $2.8 billion, commercial real estate loans of $1.7 billion and residential mortgage loans of $.5 billion. Loans represented 64% of average interest-earning assets for both 2008 and 2007.


 

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Average investment securities totaled $32.7 billion for 2008 and $26.5 billion for 2007. Average residential and commercial mortgage-backed securities increased $4.5 billion on a combined basis in the comparison. Average investment securities for 2008 included $.4 billion of held to maturity securities that we transferred from available for sale status during the fourth quarter of 2008. Investment securities comprised 29% of average interest-earning assets for 2008 and 27% for 2007.

Average total deposits were $84.5 billion for 2008, an increase of $7.7 billion over 2007. Average deposits grew from the prior year period primarily as a result of increases in money market balances and other time deposits.

Average total deposits represented 60% of average total assets for 2008 and 62% for 2007. Average transaction deposits were $55.7 billion for 2008 compared with $50.7 billion for 2007.

Average borrowed funds were $31.3 billion for 2008 and $23.0 billion for 2007. Increases of $7.1 billion in Federal Home Loan Bank borrowings and $1.4 billion in other borrowed funds drove the increase compared with 2007.

Shareholders’ equity totaled $25.4 billion at December 31, 2008 compared with $14.9 billion at December 31, 2007 and reflected the issuance of securities under the TARP Capital Purchase Program and the impact of National City. See the Consolidated Balance Sheet Review section of this Item 7 for additional information.

LINE OF BUSINESS HIGHLIGHTS

We refer you to Item 1 of this Report under the captions Business Overview and Review of Lines of Business for an overview of our business segments and to the Business Segments Review section of this Item 7 for a Results Of Businesses – Summary table and further analysis of business segment results for 2008 and 2007, including presentation differences from Note 27 Segment Reporting in the Notes To Consolidated Financial Statements in Item 8 of this Report.

Total business segment earnings were $983 million for 2008 and $1.7 billion for 2007. We provide a reconciliation of total business segment earnings to total PNC consolidated net income as reported on a GAAP basis in Note 27.

Retail Banking

Retail Banking’s earnings were $429 million for 2008 compared with $876 million for 2007. The decline in earnings over the prior year was primarily driven by increases in the provision for credit losses and noninterest expense. The 2008 revenue growth was negatively impacted by a lower interest credit attributed to deposits in the declining rate environment and was therefore not reflective of the solid growth in customers and deposits.

 

Corporate & Institutional Banking

Corporate & Institutional Banking earned $225 million in 2008 compared with $432 million in 2007. The 48% decline in earnings over 2007 was primarily driven by an increase in the provision for credit losses and by higher valuation losses on commercial mortgage loans held for sale, net of hedges.

BlackRock

Our BlackRock business segment earned $207 million in 2008 and $253 million in 2007. These results reflect our approximately 33% share of BlackRock’s reported GAAP earnings during both periods and the additional income taxes on these earnings incurred by PNC.

Global Investment Servicing

Global Investment Servicing earned $122 million for 2008 and $128 million for 2007. Results for 2008 were negatively impacted by declines in asset values and fund redemptions as a result of severe deterioration of the financial markets during the fourth quarter.

Other

“Other” incurred a loss of $101 million in 2008 and a loss of $222 million in 2007.

“Other” for 2008 included the impact of integration costs, including the National City conforming provision for credit losses, totaling $422 million after taxes, of which $380 million after taxes were recognized in the fourth quarter of 2008. In addition, net securities losses in 2008 totaled $134 million after taxes. These factors were partially offset by strong growth in net interest income related to asset and liability management activities in 2008, and the after-tax impact of the following:

   

After-tax gains totaling $160 million from PNC’s remaining BlackRock long-term incentive plan programs (“LTIP”) shares obligation,

   

The $23 million after-tax gain on the sale of Hilliard Lyons in the first quarter,

   

The $40 million after-tax third quarter reversal of a legal contingency reserve established in connection with an acquisition due to a settlement, and

   

The $30 million after-tax partial reversal of the Visa indemnification liability.

“Other” for 2007 included the after-tax impact of the following:

   

Integration costs totaling $99 million after taxes,

   

A net after-tax charge of $83 million representing the net mark-to-market adjustment on our remaining BlackRock LTIP shares obligation partially offset by the gain recognized in connection with PNC’s first quarter transfer of BlackRock shares to satisfy a portion of our BlackRock LTIP shares obligation, and

   

A $53 million after-tax charge for an indemnification obligation related to certain Visa litigation.


 

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CONSOLIDATED INCOME STATEMENT REVIEW

Our Consolidated Income Statement is presented in Item 8 of this Report. Net income for 2008 was $882 million and for 2007 was $1.467 billion. Total revenue for 2008 increased 7% compared with 2007. We created positive operating leverage in the year-to-date comparison as total noninterest expense increased 3% in the comparison.

NET INTEREST INCOME AND NET INTEREST MARGIN

 

Year ended December 31

Dollars in millions

   2008     2007  

Net interest income

   $ 3,823     $ 2,915  

Net interest margin

     3.37 %     3.00 %

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 Statistical Information – Analysis Of Year-To-Year Changes In Net Interest (Unaudited) Income And Average Consolidated Balance Sheet and Net Interest Analysis in Item 8 of this Report for additional information.

The 31% increase in net interest income for 2008 compared with 2007 was favorably impacted by the $16.5 billion, or 17%, increase in average interest-earning assets and a decrease in funding costs. The 2008 net interest margin was positively affected by declining rates paid on deposits and borrowings compared with the prior year. The reasons driving the higher interest-earning assets in these comparisons are further discussed in the Balance Sheet Highlights portion of the Executive Summary section of this Item 7.

The net interest margin was 3.37% for 2008 and 3.00% for 2007. The following factors impacted the comparison:

   

A decrease in the rate paid on interest-bearing liabilities of 140 basis points. The rate paid on interest-bearing deposits, the single largest component, decreased 123 basis points.

   

These factors were partially offset by a 77 basis point decrease in the yield on interest-earning assets. The yield on loans, the single largest component, decreased 109 basis points.

   

In addition, the impact of noninterest-bearing sources of funding decreased 26 basis points due to lower interest rates and a lower proportion of noninterest-bearing sources of funding to interest-earning assets.

For comparing to the broader market, during 2008 the average federal funds rate was 1.94% compared with 5.03% for 2007.

We expect our full-year 2009 net interest income to benefit from the impact of interest accretion of discounts resulting from purchase accounting marks and deposit pricing

alignment related to our National City acquisition. We also currently expect our 2009 net interest margin to improve on a year-over-year basis.

NONINTEREST INCOME

Summary

Noninterest income was $3.367 billion for 2008 and $3.790 billion for 2007.

Noninterest income for 2008 included the following:

   

Gains of $246 million related to the mark-to-market adjustment on our BlackRock LTIP shares obligation,

   

Losses related to our commercial mortgage loans held for sale of $197 million, net of hedges,

   

Impairment and other losses related to alternative investments of $179 million,

   

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

   

Net securities losses of $206 million,

   

A first quarter gain of $95 million related to the redemption of a portion of our Visa Class B common shares related to Visa’s March 2008 initial public offering,

   

A third quarter $61 million reversal of a legal contingency reserve established in connection with an acquisition due to a settlement,

   

Trading losses of $55 million,

   

A $35 million impairment charge on commercial mortgage servicing rights, and

   

Equity management losses of $24 million.

Noninterest income for 2007 included the following:

   

The impact of $82 million gain recognized in connection with our transfer of BlackRock shares to satisfy a portion of PNC’s LTIP obligation and a $209 million net loss on our LTIP shares obligation,

   

Income from Hilliard Lyons totaling $227 million,

   

Trading income of $104 million,

   

Equity management gains of $102 million, and

   

Gains related to our commercial mortgage loans held for sale of $3 million, net of hedges.

Apart from the impact of these items, noninterest income increased $16 million in 2008 compared with 2007.

Additional analysis

Fund servicing fees increased $69 million in 2008, to $904 million, compared with $835 million in 2007. The impact of the December 2007 acquisition of Albridge Solutions Inc. (“Albridge Solutions”) and growth in Global Investment Servicing’s offshore operations were the primary drivers of this increase.

Global Investment Servicing provided fund accounting/ administration services for $839 billion of net fund investment assets and provided custody services for $379 billion of fund


 

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investment assets at December 31, 2008, compared with $990 billion and $500 billion, respectively, at December 31, 2007. The decrease in assets serviced was due to declines in asset values and fund outflows resulting primarily from market conditions in the second half of 2008.

Asset management fees totaled $686 million in 2008, a decline of $98 million compared with 2007. The effect on fees of lower equity earnings from BlackRock, a $12 billion decrease in assets managed due to equity values related to wealth management, and the Hilliard Lyons divestiture were reflected in the decline compared with 2007. Excluding $53 billion of assets acquired on December 31, 2008 resulting from our acquisition of National City, assets managed at December 31, 2008 totaled $57 billion compared with $74 billion at December 31, 2007. The Hilliard Lyons sale and the impact of comparatively lower equity markets in 2008 drove the decline in assets managed. The Retail Banking section of the Business Segments Review section of this Item 7 includes further discussion of assets under management.

Consumer services fees declined $69 million, to $623 million, for 2008 compared with 2007. The sale of Hilliard Lyons more than offset the benefits of increased volume-related fees, including debit card, credit card, bank brokerage and merchant revenues.

Corporate services revenue totaled $704 million in 2008 compared with $713 million in 2007. Higher revenue from treasury management and other fees were more than offset by lower merger and acquisition advisory fees and commercial mortgage servicing fees, net of amortization.

Service charges on deposits grew $24 million, to $372 million, in 2008 compared with 2007. The impact of our expansion into new markets contributed to the increase during 2008.

Net securities losses totaled $206 million in 2008 compared with net securities losses of $5 million in 2007. Losses for 2008 included other-than-temporary impairment charges of $312 million, including $74 million on our investment in preferred stock of FHLMC and FNMA that were partially offset by securities gains.

Other noninterest income totaled $284 million for 2008 compared with $423 million for 2007. Other noninterest income for 2008 included gains of $246 million related to our BlackRock LTIP shares adjustment, the $114 million gain from the sale of Hilliard Lyons, the $95 million gain from the redemption of a portion of our investment in Visa related to its March 2008 initial public offering, and the $61 million reversal of a legal contingency reserve referred to above. The impact of these items was partially offset by losses related to our commercial mortgage loans held for sale of $197 million, net of hedges, trading losses of $55 million and equity management losses of $24 million.

 

Other noninterest income for 2007 included a net loss related to our BlackRock investment of $127 million (the net of the two items described within the Summary section above), trading income of $104 million, equity management gains of $102 million and gains related to our commercial mortgage loans held for sale, net of hedges, of $3 million.

See the BlackRock portion of the Business Segments Review section of Item 7 of this Report for further information regarding LTIP. Additional information regarding our transactions related to Visa is included in Note 25 Commitments And Guarantees in the Notes To Consolidated Financial Statements included in Item 8 of this Report. Further details regarding our trading activities are included in the Market Risk Management – Trading Risk portion of the Risk Management section of this Item 7 and information regarding equity management are included in the Market Risk Management-Equity and Other Investment Risk section.

Other noninterest income typically fluctuates from period to period depending on the nature and magnitude of transactions completed.

We expect noninterest income in 2009 to reflect customer growth, offset by softening consumer fees and by ongoing volatility of the more market-related categories.

PRODUCT REVENUE

In addition to credit and deposit products for commercial customers, Corporate & Institutional Banking offers other services, including treasury management and capital markets-related products and services and commercial mortgage loan servicing, that are marketed by several businesses to commercial and retail customers across PNC.

Treasury management revenue, which includes fees as well as net interest income from customer deposit balances, increased 14% to $545 million in 2008 compared with $476 million in 2007. The increase was primarily related to the impact of our expansion into new markets and strong growth in commercial payment card services and in cash and liquidity management products.

Revenue from capital markets-related products and services totaled $336 million in 2008 compared with $290 million in 2007. This increase was primarily driven by strong customer interest rate derivative and foreign exchange activity partially offset by a decline in merger and acquisition advisory fees.

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


 

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Commercial mortgage banking activities resulted in revenue of $65 million in 2008 compared with $252 million in 2007. Revenue for 2008 reflected losses of $197 million on commercial mortgage loans held for sale, net of hedges, due to the impact of an illiquid market during most of 2008. The comparable amount for 2007 was a gain of $3 million. Revenue for 2007 also reflected significant securitization activity. In addition, commercial mortgage servicing revenue declined $53 million primarily due to a $35 million impairment charge on commercial mortgage servicing rights while net interest income from commercial mortgage loans held for sale increased $61 million in 2008 compared with 2007 due to higher loans held for sale balances.

PROVISION FOR CREDIT LOSSES

The provision for credit losses totaled $1.517 billion for 2008 compared with $315 million for 2007. Of the total 2008 provision, $990 million was recorded in the fourth quarter, including $504 million of additional provision recorded on December 31, 2008 to conform the National City loan reserving methodology with ours. The differences in methodology include granularity of loss computations, statistical and quantitative factors rather than qualitative assessment, and the extent of current appraisals and risk assessments.

In addition to the impact of National City, the higher provision in 2008 compared with the prior year was driven by general credit quality migration, including residential real estate development and commercial real estate exposure, an increase in net charge-offs, and growth in nonperforming loans. Growth in our total credit exposure also contributed to the higher provision amounts in both comparisons.

With a deteriorating economy, we expect credit migration will continue throughout 2009 as credit quality improvements will lag any economic turnaround. The Credit Risk Management portion of the Risk Management section of this Item 7 includes additional information regarding factors impacting the provision for credit losses.

 

See also Item 1A Risk Factors and the Cautionary Statement Regarding Forward-Looking Information section of Item 7 of this Report.

NONINTEREST EXPENSE

Total noninterest expense was $4.430 billion for 2008 and $4.296 billion for 2007, an increase of $134 million, or 3%. Higher noninterest expense in 2008 compared with 2007 primarily resulted from investments in growth initiatives, including acquisitions, partially offset by the impact of the sale of Hilliard Lyons and disciplined expense management.

Integration costs included in noninterest expense totaled $122 million for 2008, including $81 million in the fourth quarter, and $102 million for 2007. Integration costs for the fourth quarter of 2008 included $71 million related to our National City acquisition.

Noninterest expense for 2008 included the benefit of the reversal of $46 million of the $82 million Visa indemnification liability that we established in the fourth quarter of 2007. Additional information regarding our transactions related to Visa is included in Note 25 Commitments And Guarantees in the Notes To Consolidated Financial Statements included in Item 8 of this Report.

Expense management will be a key driver in 2009 as we intend to maintain our focus on continuous improvement and to achieve cost savings targets associated with our National City integration. We currently expect FDIC deposit insurance costs to increase significantly in 2009.

EFFECTIVE TAX RATE

Our effective tax rate was 29.1% for 2008 and 29.9% for 2007.


 

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CONSOLIDATED BALANCE SHEET REVIEW

SUMMARIZED BALANCE SHEET DATA

 

December 31 - in millions    2008    2007

Assets

       

Loans

   $ 175,489    $ 68,319

Investment securities

     43,473      30,225

Cash and short-term investments

     23,936      10,425

Loans held for sale

     4,366      3,927

Equity investments

     8,554      6,045

Goodwill

     8,868      8,405

Other intangible assets

     2,820      1,146

Other

     23,575      10,428

Total assets

   $ 291,081    $ 138,920

Liabilities

       

Deposits

   $ 192,865    $ 82,696

Borrowed funds

     52,240      30,931

Other

     18,328      8,785

Total liabilities

     263,433      122,412

Minority and noncontrolling interests in consolidated entities

     2,226      1,654

Total shareholders’ equity

     25,422      14,854

Total liabilities, minority and noncontrolling interests, and shareholders’ equity

   $ 291,081    $ 138,920

The summarized balance sheet data above is based upon our Consolidated Balance Sheet in Item 8 of this Report.

Our Consolidated Balance Sheet at December 31, 2008 included National City’s assets and liabilities at estimated fair value as of that date. This acquisition added approximately $134 billion of assets, including $99.7 billion of loans, after giving effect to purchase accounting adjustments, eliminations and reclassifications.

Various seasonal and other factors impact our period-end balances whereas average balances (discussed under the Balance Sheet Highlights section of this Item 7 and included in the Statistical Information section of Item 8 of this Report) are generally more indicative of underlying business trends apart from the impact of recent acquisitions.

An analysis of changes in selected balance sheet categories follows.

LOANS

A summary of the major categories of loans outstanding is shown in the following table. Outstanding loan balances reflect unearned income, unamortized discount and premium, and purchase discounts and premiums totaling $4.1 billion and $990 million at December 31, 2008 and 2007, respectively.

Loans increased $107.2 billion as of December 31, 2008 compared with December 31, 2007. Our National City

acquisition added $99.7 billion of loans, including $34.3 billion of commercial, $16.0 billion of commercial real estate, $30.5 billion of consumer and $10.6 billion of residential mortgage loans.

In February 2008, we transferred the education loans in our held for sale portfolio to the loan portfolio as further described in the Loans Held For Sale section of this Consolidated Balance Sheet Review.

Details Of Loans

 

December 31 - in millions

   2008    2007

Commercial

       

Retail/wholesale

   $ 11,482    $ 6,013

Manufacturing

     13,263      4,814

Other service providers

     9,038      3,639

Real estate related (a)

     9,107      5,556

Financial services

     5,194      1,419

Health care

     3,201      1,464

Other

     16,034      5,634

Total commercial

     67,319      28,539

Commercial real estate

       

Real estate projects

     17,176      6,111

Commercial mortgage

     8,560      2,792

Total commercial real estate

     25,736      8,903

Equipment lease financing

     6,461      2,514

TOTAL COMMERCIAL LENDING

     99,516      39,956

Consumer

       

Home equity

       

Lines of credit

     24,024      6,811

Installment

     14,252      7,636

Education

     4,211      132

Automobile

     1,667      1,513

Credit card and other unsecured lines of credit

     3,163      462

Other

     5,172      1,839

Total consumer

     52,489      18,393

Residential real estate

       

Residential mortgage

     18,783      9,046

Residential construction

     2,800      511

Total residential real estate

     21,583      9,557

TOTAL CONSUMER LENDING

     74,072      27,950

Other

     1,901      413

Total loans

   $ 175,489    $ 68,319
(a) Includes loans to customers in the real estate and construction industries.

Total loans represented 60% of total assets December 31, 2008 and 49% of total assets at December 31, 2007.

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. See Note 4 Loans, Commitments To Extend Credit and Concentrations of Credit Risk in the Notes To Consolidated Financial Statements in Item 8 of this Report for additional information.


 

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The following table presents the valuation adjustments applied against National City loans as part of the purchase accounting process at December 31, 2008.

National City Loan Portfolio Assessment

 

Dollars in billions    December 31, 2008  
   Principal
Balance
   Valuation
Adjustment
   Fair
Value
    Valuation
Adjustment
as % of
Principal
Balance
 

Valuation Adjustments By Loan Classification

            

Commercial/Commercial real estate

   $ 56.5    $ 4.7    $ 51.8     8.3 %

Consumer

     31.4      3.5      27.9     11.1 %

Residential real estate

     19.2      4.4      14.8     22.9 %

Other

     .9         .9      

Total

   $ 108.0    $ 12.6    $ 95.4 (a)   11.7 %

Valuation Adjustments By Type

            

Impaired loans

            

Commercial/Commercial real estate

   $ 4.0    $ 2.2    $ 1.8     55.0 %

Consumer

     5.8      1.9      3.9     32.8 %

Residential real estate

     9.5      3.3      6.2     34.7 %

Total impaired loans

     19.3      7.4      11.9     38.3 %

Performing loans

     88.7      5.2      83.5     5.9 %

Total

   $ 108.0    $ 12.6    $ 95.4 (a)   11.7 %

Valuation Adjustments By Component

            

Fair value mark – impaired loans

      $ 7.4       

Fair value mark – performing loans

            2.4               

Subtotal – fair value marks

        9.8       

National City reserve carryover on performing loans

        2.3       

Conforming credit reserve on performing loans

            .5       

Total

          $ 12.6               
(a) Represents total adjusted loans of $99.7 billion from the National City acquisition, net of $2.8 billion of loan loss reserves, $1.1 billion of loans previously classified as held for sale by National City, and $.4 billion of other purchase accounting adjustments.

 

Our home equity loan outstandings totaled $38.3 billion at December 31, 2008. In this portfolio, we consider the higher risk loans to be those with a recent FICO credit score of less than or equal to 660 and a loan-to-value ratio greater than or equal to 90%. We had $1.2 billion or approximately 3% of the total portfolio in this grouping at December 31, 2008. In our $18.8 billion residential mortgage portfolio, loans with a recent FICO credit score of less than or equal to 660 and a loan-to-value ratio greater than 90% totaled $2.5 billion and comprised approximately 14% of this portfolio at December 31, 2008.

Commercial lending outstandings are the largest category and are the most sensitive to changes in assumptions and judgments underlying the determination of the allowance for

loan and lease losses. We have allocated $2.6 billion, or 67%, of the total allowance for loan and lease losses at December 31, 2008 to these loans. We allocated $1.2 billion, or 32%, of the remaining allowance at that date to consumer lending outstandings and $47 million, or 1%, to all other loans. This allocation also considers other relevant factors such as:

   

Actual versus estimated losses,

   

Regional and national economic conditions,

   

Business segment and portfolio concentrations,

   

Industry conditions,

   

The impact of government regulations, and

   

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


 

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Included in total loans at December 31, 2008 were $27.2 billion of distressed loans. These loans include residential real estate development loans, cross-border leases, subprime residential mortgage loans, brokered home equity loans and certain other residential real estate loans. These loans require special servicing and management oversight given current market conditions or, in the case of cross-border leases, are tax and yield challenged. The majority of the distressed loans were from acquisitions, including $24.6 billion from National City. An allowance for loan and lease losses of $927 million was allocated to the distressed loans at December 31, 2008. A total of $537 million of the distressed loans were classified as nonperforming at that date. Details of distressed loans follow:

Details of Distressed Loan Portfolio

 

In millions    Dec. 31, 2008

Commercial

     $28

Commercial real estate

    

Real estate projects

     2,847

Commercial mortgage

     510

Total commercial real estate

     3,357

Equipment lease financing

     858

TOTAL COMMERCIAL LENDING

     4,243

Consumer

    

Home equity

    

Lines of credit

     5,474

Installment

     2,877

Total home equity

     8,351

Residential real estate

    

Residential mortgage

     10,198

Residential construction

     2,603

Total residential real estate

     12,801

TOTAL CONSUMER LENDING

     21,152

Other

     1,761

Total (a)

   $ 27,156
(a) Includes impaired loans attributable to National City totaling $10.3 billion, net of valuation adjustments. The pre-adjusted principal balance was $15.3 billion and represented the majority of the total $19.3 billion principal balance of total impaired loans included in the National City Loan Portfolio Assessment table on page 32.

Net unfunded credit commitments are comprised of the following:

Net Unfunded Credit Commitments

 

December 31 - in millions    2008 (a)    2007

Commercial and commercial real estate

   $ 59,982    $ 42,021

Home equity lines of credit

     23,195      8,680

Consumer credit card lines

     19,028      969

Other

     2,683      1,677

Total

   $ 104,888    $ 53,347
(a) Includes $53.9 billion related to National City.

Unfunded commitments are concentrated in our primary geographic markets. Commitments to extend credit represent arrangements to lend funds or provide liquidity subject to

specified contractual conditions. Commercial commitments are reported net of participations, assignments and syndications, primarily to financial institutions, totaling $8.6 billion at December 31, 2008 and $8.9 billion at December 31, 2007.

Unfunded liquidity facility commitments and standby bond purchase agreements totaled $7.0 billion at December 31, 2008 and $9.4 billion at December 31, 2007 and are included in the preceding table primarily within the “Commercial” and “Consumer” categories. The decrease from December 31, 2007 was due to a $2.5 billion decline in Market Street commitments.

In addition to credit commitments, our net outstanding standby letters of credit totaled $10.3 billion at December 31, 2008 and $4.8 billion at December 31, 2007. Standby letters of credit commit us to make payments on behalf of our customers if specified future events occur.

INVESTMENT SECURITIES

Details Of Investment Securities

 

In millions    Amortized
Cost
  

Fair

Value

December 31, 2008

       

SECURITIES AVAILABLE FOR SALE

       

Debt securities

       

Residential mortgage-backed

       

Agency

   $ 22,744    $ 23,106

Nonagency

     13,205      8,831

Commercial mortgage-backed

     4,305      3,446

Asset-backed

     2,069      1,627
 

US Treasury and government agencies

     738      739

State and municipal

     1,326      1,263

Other debt

     563      559

Corporate stocks and other

     575      571

Total securities available for sale

   $ 45,525    $ 40,142

SECURITIES HELD TO MATURITY

       

Debt securities

       

Commercial mortgage-backed

   $ 1,945    $ 1,896

Asset-backed

     1,376      1,358

Other debt

     10      10

Total securities held to maturity

   $ 3,331    $ 3,264

December 31, 2007

       

SECURITIES AVAILABLE FOR SALE

       

Debt securities

       

Residential mortgage-backed

       

Agency

   $ 9,218    $ 9,314

Nonagency

     11,929      11,638

Commercial mortgage-backed

     5,227      5,264

Asset-backed

     2,878      2,770

U.S. Treasury and government agencies

     151      155

State and municipal

     340      336

Other debt

     85      84

Corporate stocks and other

     662      664

Total securities available for sale

   $ 30,490    $ 30,225

 

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Investment securities totaled $43.5 billion at December 31, 2008, including $13.3 billion from the National City acquisition that were primarily US government agency residential mortgage-backed securities. Securities represented 15% of total assets at December 31, 2008 and 22% of total assets at December 31, 2007.

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. During the fourth quarter of 2008, we transferred $3.2 billion of securities available for sale to securities held to maturity status and transferred $599 million of proprietary trading securities to the available for sale portfolio.

The transfer of available for sale securities to held to maturity involved short-duration, high quality securities where management’s intent to hold changed. In reassessing the classification of these securities, management also considered the current and ongoing illiquidity in the capital markets and that securities prices are under increasing downward pressure, even where there is no indication of credit impairment.

The transfer of trading securities to available for sale occurred against the backdrop of events occurring in the market that management determined to be unusual and highly unlikely to recur in the near term. As a result of these events, which included the unprecedented market illiquidity and related volatility, PNC’s economic hedges associated with these trading positions become increasingly ineffective, resulting in increasing and unexpected earnings volatility. Coincident with the transfer of trading securities to available for sale, all hedging instruments were terminated.

At December 31, 2008, the investment securities balance included a net unrealized loss of $5.4 billion, which represented the difference between fair value and amortized cost. The comparable amount at December 31, 2007 was a net unrealized loss of $265 million. The fair value of investment securities is impacted by interest rates, credit spreads, and market volatility and illiquidity. We believe that a substantial portion of the decline in value of these securities is attributable to changes in market credit spreads and market illiquidity and not from deterioration in the credit quality of individual securities or underlying collateral, where applicable. The net unrealized losses at December 31, 2008 did not reflect credit quality concerns of any significance with the underlying assets, which represented an overall well-diversified, high quality portfolio. US government agency residential mortgage-backed securities represented 53% of the investment securities portfolio at December 31, 2008.

During 2008, we recorded other-than-temporary impairment charges totaling $312 million, of which $151 million related to residential mortgage-backed securities, $87 million related to asset-backed securities collateralized by first- and second-lien residential mortgage loans and $74 million related to our investment in preferred securities of FHLMC and FNMA.

 

At least quarterly we conduct a comprehensive security-level impairment assessment. Our process and methods have evolved as market conditions have deteriorated and as more research and other analyses have become available. We expect that our process and methods will continue to evolve. Our assessment considers the security structure, recent security collateral performance metrics, our judgment and expectations of future performance, and relevant industry research and analysis. We also consider the magnitude of the impairment and the amount 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, Balance Sheet Risk Management, and Credit Policy. The senior management team considers the results of the assessments, as well as other factors, in determining whether the impairment is other-than-temporary.

One of the key inputs into our impairment assessment process is the level of delinquencies (i.e., 60 days and more) for any given security. In February 2009, we received updated delinquency information through January 31, 2009 for our residential mortgage-backed and asset-backed securities positions collateralized by first- and second-lien residential mortgage loans. Delinquencies have generally increased in the January 2009 versus December 2008 month-over-month comparison and, based upon our evaluation of these updated delinquency statistics, we currently expect that we will record additional other-than-temporary impairment charges in the first quarter of 2009. We currently do not expect that these charges will be material to our capital position.

If the current issues affecting the US housing market were to continue for the foreseeable future or worsen, or if market volatility and illiquidity were to continue or worsen, or if market interest rates were to increase appreciably, the valuation of our available for sale securities portfolio could continue to be adversely affected. See Note 7 Investment Securities in the Notes To Consolidated Financial Statements in Item 8 of this Report for additional information.

Net unrealized gains and losses in the securities available for sale portfolio are included in shareholders’ equity as accumulated other comprehensive income or loss, net of tax. The 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 expected weighted-average life of investment securities (excluding corporate stocks and other) was 3 years and 1 month at December 31, 2008 and 3 years and 6 months at December 31, 2007.

We estimate that at December 31, 2008 the effective duration of investment securities was 3.7 years for an immediate 50 basis points parallel increase in interest rates and 3.1 years for


 

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an immediate 50 basis points parallel decrease in interest rates. Comparable amounts at December 31, 2007 were 2.8 years and 2.5 years, respectively.

Loans Held For Sale

 

December 31 - in millions  

2008

   2007

Commercial mortgage

  $ 2,158    $ 2,116

Residential mortgage

    1,962      117

Education

       1,525

Other

    246      169

Total

  $ 4,366    $ 3,927

The acquisition of National City added approximately $2.2 billion of loans held for sale, primarily 1-4 family conforming residential mortgages. The residential mortgage loans held for sale will be accounted for at fair value.

PNC adopted SFAS 159 beginning January 1, 2008 and elected to account for certain commercial mortgage loans held for sale at fair value. The balance of these assets was $1.4 billion at December 31, 2008. We stopped originating these types of loans during the first quarter of 2008. We intend to continue pursuing opportunities to reduce our commercial mortgage loans held for sale position at appropriate prices. We sold and/or securitized $.6 billion of commercial mortgage loans held for sale carried at fair value in 2008. Losses of $197 million on commercial mortgage loans held for sale, net of hedges, were included in other noninterest income for 2008 compared with gains of $3 million in 2007. Net interest income on commercial mortgage loans held for sale was $76 million in 2008 compared with $15 million in 2007. The non-cash losses reflected illiquid market conditions which began in the latter part of 2007.

We previously classified substantially all of our education loans as loans held for sale as we sold education loans to issuers of asset-backed paper when the loans were placed into repayment status. During 2008, the secondary markets for education loans have been impacted by liquidity issues similar to those for other asset classes. In February 2008, given this outlook and the economic and customer relationship value inherent in this product, we transferred these loans at lower of cost or market value from held for sale to the loan portfolio. We did not sell education loans during the remainder of 2008 and do not anticipate sales of these transferred loans in the foreseeable future.

 

FUNDING AND CAPITAL SOURCES

Details Of Funding Sources

 

December 31 - in millions    2008    2007

Deposits

       

Money market

   $ 67,678    $ 32,785

Demand

     43,212      20,861

Retail certificates of deposit

     58,315      16,939

Savings

     6,056      2,648

Other time

     13,620      2,088

Time deposits in foreign offices

     3,984      7,375

Total deposits

     192,865      82,696

Borrowed funds

       

Federal funds purchased and repurchase agreements

     5,153      9,774

Federal Home Loan Bank borrowings

     18,126      7,065

Bank notes and senior debt

     13,664      6,821

Subordinated debt

     11,208      4,506

Other

     4,089      2,765

Total borrowed funds

     52,240      30,931

Total

   $ 245,105    $ 113,627

Total funding sources increased $131.5 billion at December 31, 2008 compared with the balance at December 31, 2007.

Deposits totaled $192.9 billion at December 31, 2008, including $104 billion from the National City acquisition, compared with $82.7 billion at December 31, 2007. Interest-bearing deposits represented 81% of total deposits at December 31, 2008 compared with 76% at December 31, 2007. The change in deposit composition reflected the higher proportion of certificates of deposit and other interest-bearing deposits associated with National City. Borrowed funds totaled $52.2 billion at December 31, 2008 compared with $30.9 billion at December 31, 2007. Borrowed funds at December 31, 2008 included $18.2 billion of National City obligations and $2.9 billion of senior notes guaranteed under the FDIC’s TLGP-Debt Guarantee Program that PNC issued in December 2008.

The Liquidity Risk Management section of this Item 7 contains further details regarding actions we have taken which impacted our borrowed funds balances during 2008.


 

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Table of Contents

Capital

We manage our capital position by making adjustments to our balance sheet size and composition, issuing debt, equity or hybrid instruments, executing treasury stock transactions, managing dividend policies and retaining earnings. On March 1, 2009, we took a proactive step to build capital and further strengthen our balance sheet as the Board of Directors decided to reduce PNC’s quarterly common stock dividend from $0.66 to $0.10 per share.

Total shareholders’ equity increased $10.6 billion, to $25.4 billion, at December 31, 2008 compared with December 31, 2007 and reflected the following:

   

The December 2008 issuance of $7.6 billion of preferred stock and a common stock warrant to the US Department of Treasury under the TARP Capital Purchase Program,

   

The December 2008 issuance of $5.6 billion of common stock in connection with the National City acquisition,

   

The May 2008 issuance of $500 million of Series K preferred stock,

   

The April 2008 issuance of $312 million of common stock in connection with the Sterling acquisition, and

   

The December 2008 issuance of $150 million of Series L preferred stock in connection with the National City acquisition.

These factors were partially offset by the $3.8 billion increase from December 31, 2007 in accumulated other comprehensive loss which included $3.5 billion of net unrealized securities losses. The Investment Securities section of this Consolidated Balance Sheet Review includes additional information regarding these unrealized losses.

Common shares outstanding were 443 million at December 31, 2008 and 341 million at December 31, 2007. PNC issued approximately 95 million common shares in December 2008 and 4.6 million common shares in April 2008 in connection with the closings of the National City and Sterling acquisitions, respectively.

Our current common stock repurchase program permits us to purchase up to 25 million shares of PNC common stock on the open market or in privately negotiated transactions. This program will remain in effect until fully utilized or until modified, superseded or terminated. The extent and timing of share repurchases under this program will depend on a number of factors including, among others, market and general economic conditions, economic and regulatory capital considerations, alternative uses of capital, regulatory and contractual limitations, and the potential impact on our credit ratings. We did not purchase any shares during 2008 under this program. During 2007, we purchased 11 million common shares under our current and prior common stock repurchase programs at a total cost of approximately $800 million.

Under the TARP Capital Purchase Program, there are restrictions on dividends and common share repurchases associated with the preferred stock that we issued to the US Treasury in accordance with that program. As is typical with

cumulative preferred stock, dividend payments for this preferred stock must be current before dividends can be paid on junior shares, including our common stock, or junior shares can be repurchased or redeemed. Also, the US Treasury’s consent will be required for any increase in common dividends per share above the most recent level prior to October 14, 2008 until the third anniversary of the preferred stock issuance as long as the US Treasury continues to hold any of the preferred stock. Further, during that same period, the US Treasury’s consent will be required, unless the preferred stock is no longer held by the US Treasury, for any share repurchases with limited exceptions, most significantly purchases of common shares in connection with any benefit plan in the ordinary course of business consistent with past practice.

Risk-Based Capital

 

December 31 - dollars in millions   2008     2007  

Capital components

     

Shareholders’ equity

     

Common

  $ 17,490     $ 14,847  

Preferred

    7,932       7  

Trust preferred capital securities

    2,898       572  

Minority interest

    1,506       985  

Goodwill and other intangible assets

    (9,800 )     (8,853 )

Eligible deferred income taxes on goodwill and other intangible assets

    594       119  

Pension, other postretirement benefit plan adjustments

    666       177  

Net unrealized securities losses, after-tax

    3,618       167  

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

    (374 )     (175 )

Other

    (243 )     (31 )

Tier 1 risk-based capital

    24,287       7,815  

Subordinated debt

    5,676       3,024  

Eligible allowance for credit losses

    3,153       964  

Total risk-based capital

  $ 33,116     $ 11,803  

Assets

     

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

  $ 251,106     $ 115,132  

Adjusted average total assets

    138,689       126,139  

Capital ratios

     

Tier 1 risk-based

    9.7 %     6.8 %

Total risk-based

    13.2       10.3  

Leverage

    17.5       6.2  

Tangible common equity

     

Common shareholders’ equity

  $ 17,490     $ 14,847  

Goodwill and other intangible assets

    (9,800 )     (8,853 )

Total deferred income taxes on goodwill and other intangible assets (a)

    594       119  

Tangible common equity

  $ 8,284     $ 6,113  

Total assets excluding goodwill and other intangible assets, net of deferred income taxes

  $ 281,874     $ 130,185  

Tangible common equity ratio

    2.9 %     4.7 %
(a) As of December 31, 2008, deferred taxes on taxable combinations were added to eligible deferred income taxes for non-taxable combinations that are used in the calculation of the tangible common equity ratio.

 

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PNC’s Tier 1 risk-based capital ratio was 9.7% at December 31, 2008 compared with 6.8% at December 31, 2007. The increase in the ratio from December 31, 2007 included the issuance of Tier 1 eligible securities during the first half of 2008 totaling $1.3 billion, including REIT preferred, noncumulative perpetual preferred, and trust preferred securities. The “Perpetual Trust Securities” and “PNC Capital Trust E Trust Preferred Securities” portions of the Off-Balance Sheet Arrangements and VIEs section of this Item 7 and Note 19 Shareholders’ Equity in Item 8 of this Report have additional information regarding these securities.

In addition, $7.6 billion of preferred stock and a common stock warrant was issued to the US Department of the Treasury under the TARP Capital Purchase Program on December 31, 2008. Tier 1 risk-based capital further increased as a result of $5.6 billion of common stock issued in the National City acquisition and PNC’s assumption of $2.6 billion of Tier 1 qualifying capital securities previously issued by National City. These increases in capital were partially offset by the deduction of higher acquisition-related intangible assets. The positive effect on the Tier 1 ratio of the net increase in capital was somewhat offset by an increase in risk-weighted assets primarily related to acquisitions, including National City.

The leverage ratio at December 31, 2008 reflected the favorable impact on Tier 1 risk-based capital from the issuance of securities under TARP and the issuance of PNC common stock in connection with the National City acquisition, both of which occurred on December 31, 2008. In addition, the ratio as of that date did not reflect any impact of National City on PNC’s adjusted average total assets.

PNC’s tangible common equity ratio was 2.9% at December 31, 2008 compared with 4.7% at December 31, 2007. The decrease in the ratio from the prior year was the result of the decline in the value of the securities available for sale portfolio and the value of assets in our pension plan. We expect PNC’s tangible common equity ratio to be less sensitive to the impact of widening credit spreads on accumulated other comprehensive loss going forward primarily due to the composition of the securities available for sale portfolio acquired from National City and a substantially higher level of common equity in the combined company.

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

At December 31, 2008 and December 31, 2007, each of our domestic bank subsidiaries was considered “well capitalized” based on US regulatory capital ratio requirements. See the Supervision And Regulation section of Item 1 of this Report

and Note 23 Regulatory Matters in the Notes To Consolidated Financial Statements in Item 8 of this Report for additional information. We believe our bank subsidiaries will continue to meet these requirements in 2009.

OFF-BALANCE SHEET ARRANGEMENTS AND VIES

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.” The following sections of this Report provide further information on these types of activities:

   

Commitments, including contractual obligations and other commitments, included within the Risk Management section of this Item 7, and

   

Note 10 Securitization Activity and Note 25 Commitments and Guarantees in the Notes To Consolidated Financial Statements included in Item 8 of this Report.

The following provides a summary of variable interest entities (“VIEs”), including those that we have consolidated and those in which we hold a significant variable interest but have not consolidated into our financial statements as of December 31, 2008 and December 31, 2007.

Consolidated VIEs – PNC Is Primary Beneficiary

 

In millions   

Aggregate

Assets

   Aggregate
Liabilities

Partnership interests in low
income housing
projects (a)

       

December 31, 2008

   $ 1,499    $ 1,455

December 31, 2007

   $ 1,108    $ 1,108
 

Credit Risk Transfer Transaction (b)

       

December 31, 2008

   $ 1,070    $ 1,070
(a) Amounts for December 31, 2008 include National City, which PNC acquired on that date.
(b) National City-related transaction.

Non-Consolidated VIEs – Significant Variable Interests

 

In millions   

Aggregate

Assets

   Aggregate
Liabilities
   PNC Risk
of Loss
 

December 31, 2008

          

Market Street

   $ 4,916    $ 5,010    $ 6,965 (a)

Collateralized debt obligations

     20         2  

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

     1,095      652      920  

Total (c)

   $ 6,031    $ 5,662    $ 7,887  

December 31, 2007

          

Market Street

   $ 5,304    $ 5,330    $ 9,019 (a)

Collateralized debt obligations

     255      177      6  

Partnership interests in low income housing projects

     298      184      155  

Total

   $ 5,857    $ 5,691    $ 9,180  

 

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(a) PNC’s risk of loss consists of off-balance sheet liquidity commitments to Market Street of $6.4 billion and other credit enhancements of $.6 billion at December 31, 2008. The comparable amounts were $8.8 billion and $.2 billion at December 31, 2007. These liquidity commitments are included in the Net Unfunded Credit Commitments table in the Consolidated Balance Sheet Review section of this Report.
(b) Amounts reported primarily represent low income housing projects.
(c) Amounts include the impact of National City.
(d) Aggregate assets and aggregate liabilities at December 31, 2008 represent approximate balances due to limited availability of financial information associated with the acquired National City partnerships that we did not sponsor.

Market Street

Market Street Funding LLC (“Market Street”) is a multi-seller asset-backed commercial paper conduit that is owned by an independent third party. Market Street’s activities primarily involve purchasing assets or making loans secured by interests in pools of receivables from US corporations that desire access to the commercial paper market. Market Street funds the purchases of assets or loans by issuing commercial paper which has been rated A1/P1 by Standard & Poor’s and Moody’s, respectively, and is supported by pool-specific credit enhancements, liquidity facilities and program-level credit enhancement. Generally, Market Street mitigates its potential interest rate risk by entering into agreements with its borrowers that reflect interest rates based upon its weighted average commercial paper cost of funds. During 2007 and 2008, Market Street met all of its funding needs through the issuance of commercial paper.

Market Street commercial paper outstanding was $4.4 billion at December 31, 2008 and $5.1 billion at December 31, 2007. The weighted average maturity of the commercial paper was 24 days at December 31, 2008 compared with 32 days at December 31, 2007.

Effective October 28, 2008, Market Street was approved to participate in the Federal Reserve’s CPFF authorized under Section 13(3) of the Federal Reserve Act. The CPFF commitment to purchase up to $5.4 billion of three-month Market Street commercial paper expires on October 30, 2009. As of December 31, 2008, Market Street’s participation in this program totaled $445 million. These trades matured at the end of January 2009 and were replaced with commercial paper sold to investors.

In the ordinary course of business during 2008, PNC Capital Markets, acting as a placement agent for Market Street, held a maximum daily position in Market Street commercial paper of $75 million with an average of $12 million. This compares with a maximum daily position of $113 million with an average of $27 million for the year ended December 31, 2007. PNC Capital Markets owned no Market Street commercial paper at December 31, 2008 and owned less than $1 million of such commercial paper at December 31, 2007. PNC Bank, National Association (“PNC Bank, N.A.”) purchased overnight maturities of Market Street commercial paper on two days during September 2008 in the amounts of $197 million and $531 million and one day during October 2008 in

the amount of $278 million due to illiquidity in the commercial paper market. We considered these transactions as part of our evaluation of Market Street described below to determine that we are not the primary beneficiary. PNC made no other purchases of Market Street commercial paper during 2007 or 2008.

PNC Bank, N.A. provides certain administrative services, the program-level credit enhancement and 99% of liquidity facilities to Market Street in exchange for fees negotiated based on market rates. PNC recognized program administrator fees and commitment fees related to PNC’s portion of the liquidity facilities of $21 million and $4 million, respectively, for the year ended December 31, 2008. The comparable amounts were $13 million and $4 million for the year ended December 31, 2007.

The commercial paper obligations at December 31, 2008 and December 31, 2007 were effectively collateralized by Market Street’s assets. While PNC may be obligated to fund under the $6.4 billion of liquidity facilities for events such as commercial paper market disruptions, borrower bankruptcies, collateral deficiencies or covenant violations, our credit risk under the liquidity facilities is secondary to the risk of first loss provided by the borrower or another third party in the form of deal-specific credit enhancement, such as by the over collateralization of the assets. Deal-specific credit enhancement that supports the commercial paper issued by Market Street is generally structured to cover a multiple of expected losses for the pool of assets and is sized to generally meet rating agency standards for comparably structured transactions. In addition, PNC would be required to fund $1.0 billion of the liquidity facilities if the underlying assets are in default. See Note 25 Commitments And Guarantees included in the Notes To Consolidated Financial Statements of this Report for additional information.

PNC provides program-level credit enhancement to cover net losses in the amount of 10% of commitments, excluding explicitly rated AAA/Aaa facilities. PNC provides 100% of the enhancement in the form of a cash collateral account funded by a loan facility. This facility expires in March 2013. Until November 25, 2008, PNC provided only 25% of the enhancement in the form of a cash collateral account funded by a loan facility and provided a liquidity facility for the remaining 75% of program-level enhancement.

Market Street has entered into a Subordinated Note Purchase Agreement (“Note”) with an unrelated third party. The Note provides first loss coverage whereby the investor absorbs losses up to the amount of the Note, which was $6.6 million as of December 31, 2008. Proceeds from the issuance of the Note are held by Market Street in a first loss reserve account that will be used to reimburse any losses incurred by Market Street, PNC Bank, N.A. or other providers under the liquidity facilities and the credit enhancement arrangements.


 

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Assets of Market Street Funding LLC

 

In millions    Outstanding    Commitments    Weighted
Average
Remaining
Maturity In
Years

December 31, 2008 (a)

          

Trade receivables

   $ 1,516    $ 3,370    2.34

Automobile financing

     992      992    3.94

Collateralized loan obligations

     306      405    1.58

Credit cards

     400      400    .19

Residential mortgage

     14      14    27.00

Other

     1,168      1,325    1.76

Cash and miscellaneous receivables

     520            

Total

   $ 4,916    $ 6,506    2.34

December 31, 2007 (a)

          

Trade receivables

   $ 1,375    $ 2,865    2.63

Automobile financing

     1,387      1,565    4.06

Collateralized loan obligations

     519      1,257    2.54

Credit cards

     769      775    .26

Residential mortgage

     37      720    .90

Other

     1,031      1,224    1.89

Cash and miscellaneous receivables

     186            

Total

   $ 5,304    $ 8,406    2.41
(a) Market Street did not recognize an asset impairment charge or experience any material rating downgrades during 2007 or 2008.

Market Street Commitments by Credit Rating (a)

 

     December 31, 2008     December 31, 2007  

AAA/Aaa

   19 %   19 %

AA/Aa

   6     6  

A/A

   72     72  

BBB/Baa

   3     3  

Total

   100 %   100 %
(a) The majority of our facilities are not explicitly rated by the rating agencies. All facilities are structured to meet rating agency standards for applicable rating levels.

We evaluated the design of Market Street, its capital structure, the Note, and relationships among the variable interest holders under the provisions of FASB Interpretation No. 46, (Revised 2003) “Consolidation of Variable Interest Entities” (“FIN 46R”). Based on this analysis, we are not the primary beneficiary as defined by FIN 46R and therefore the assets and liabilities of Market Street are not reflected in our Consolidated Balance Sheet.

We would consider changes to the variable interest holders (such as new expected loss note investors and changes to program-level credit enhancement providers), terms of expected loss notes, and new types of risks related to Market Street as reconsideration events. We review the activities of Market Street on at least a quarterly basis to determine if a reconsideration event has occurred.

 

Based on current accounting guidance, we are not required to consolidate Market Street into our consolidated financial statements. However, if PNC would be determined to be the primary beneficiary under FIN 46R, we would consolidate the commercial paper conduit at that time. Based on current accounting guidance, to the extent that the par value of the assets in Market Street exceeded the fair value of the assets upon consolidation, the difference would be recognized by PNC as a loss in our Consolidated Income Statement in that period. Based on the fair value of the assets held by Market Street at December 31, 2008, the consolidation of Market Street would not have had a material impact on our risk-based capital ratios or debt covenants.

Low Income Housing Projects

We make certain equity investments in various limited partnerships that sponsor affordable housing projects utilizing the Low Income Housing Tax Credit (“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 limited partnerships 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.

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 and sell limited partnership interests to third parties, and in some cases may also purchase a limited partnership interest in the fund. The purpose of this business is to generate income from the syndication of these funds and to generate servicing fees by managing the funds. General partner activities include selecting, evaluating, structuring, negotiating, and closing the fund investments in operating limited partnerships, as well as oversight of the ongoing operations of the fund portfolio.

We evaluate our interests and third party interests in the limited partnerships in determining whether we are the primary beneficiary. The primary beneficiary determination is based on which party absorbs a majority of the variability. The primary sources of variability in LIHTC investments are the tax credits, tax benefits of losses on the investments and development and operating cash flows. We have consolidated LIHTC investments in which we absorb a majority of the variability and thus are considered the primary beneficiary. The assets are primarily included in Equity Investments and Other Assets on our Consolidated Balance Sheet with the liabilities primarily classified in Other Liabilities and Minority


 

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Interest. Neither creditors nor equity investors in the LIHTC investments have any recourse to our general credit. The consolidated aggregate assets and liabilities of these LIHTC investments are provided in the Consolidated VIEs – PNC Is Primary Beneficiary table and reflected in the “Other” business segment.

We also have LIHTC investments in which we are not the primary beneficiary, but are considered to have a significant variable interest based on our interests in the partnership. These investments are disclosed in the Non-Consolidated VIEs – Significant Variable Interests 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 and cost methods 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.

Credit Risk Transfer Transaction

National City Bank (“NCB”) sponsored a special purpose entity (“SPE”) trust and concurrently entered into a credit risk transfer agreement with an independent third-party to mitigate credit losses on a pool of nonconforming mortgage loans originated by its former First Franklin business unit. The SPE was formed with a small contribution from NCB and was structured as a bankruptcy-remote entity so that its creditors have no recourse to NCB. In exchange for a perfected security interest in the cash flows of the nonconforming mortgage loans, the SPE issued to NCB asset-backed securities in the form of senior, mezzanine, and subordinated equity notes. NCB has incurred credit losses equal to the subordinated equity notes. NCB currently holds the right to put the mezzanine notes to the independent third-party at par. As of December 31, 2008, the value of the mezzanine notes was $169 million. NCB holds the senior notes and will be responsible for credit losses in excess of this amount.

The SPE was deemed to be a VIE as its equity was not sufficient to finance its activities. NCB was determined to be the primary beneficiary of the SPE as it would absorb the majority of the expected losses of the SPE through its holding of all of the asset-backed securities. Accordingly, this SPE was consolidated and all of the entity’s assets, liabilities, and equity are intercompany balances and are eliminated in consolidation. Nonconforming mortgage loans, including foreclosed properties, pledged as collateral to the SPE remain on the balance sheet and totaled $719 million at December 31, 2008 reflecting the impact of fair value adjustments recorded by PNC in conjunction with the acquisition.

 

In January 2009, cumulative credit losses in the mortgage loan pool surpassed the principal balance of subordinated equity notes, giving PNC the right to put the first mezzanine note to the independent third party in accordance with the credit risk transfer agreement. In February 2009, PNC exercised its put option and received $16 million for the mezzanine note. Prior to this reconsideration event, management evaluated what impact this transaction would have on determining whether we would remain the primary beneficiary of the SPE. Management concluded, through reassessment of the expected losses and residual returns of the SPE, that we would remain the primary beneficiary and accordingly should continue to consolidate the SPE.

Perpetual Trust Securities

We issue certain hybrid capital vehicles that qualify as capital for regulatory and rating agency purposes.

In February 2008, PNC Preferred Funding LLC (the “LLC”), one of our indirect subsidiaries, sold $375 million of 8.700% Fixed-to-Floating Rate Non-Cumulative Exchangeable Perpetual Trust Securities of PNC Preferred Funding Trust III (“Trust III”) to third parties in a private placement. In connection with the private placement, Trust III acquired $375 million of Fixed-to-Floating Rate Non-Cumulative Perpetual Preferred Securities of the LLC (the “LLC Preferred Securities”). The sale was similar to the March 2007 private placement by the LLC of $500 million of 6.113% Fixed-to-Floating Rate Non-Cumulative Exchangeable Trust Securities (the “Trust II Securities”) of PNC Preferred Funding Trust II (“Trust II”) in which Trust II acquired $500 million of LLC Preferred Securities and to the December 2006 private placement by PNC REIT Corp. of $500 million of 6.517% Fixed-to-Floating Rate Non-Cumulative Exchangeable Perpetual Trust Securities (the “Trust I Securities”) of PNC Preferred Funding Trust I (“Trust I”) in which Trust I acquired $500 million of LLC Preferred Securities.

Each Trust III Security is automatically exchangeable into a share of Series J Non-Cumulative Perpetual Preferred Stock of PNC, each Trust II Security is automatically exchangeable into a share of Series I Non-Cumulative Perpetual Preferred Stock of PNC (“Series I Preferred Stock”), and each Trust I Security is automatically exchangeable into a share of Series F Non-Cumulative Perpetual Preferred Stock of PNC Bank, N.A. (“PNC Bank Preferred Stock”), in each case under certain conditions relating to the capitalization or the financial condition of PNC Bank, N.A. and upon the direction of the Office of the Comptroller of the Currency.

We entered into a replacement capital covenant in connection with the closing of the Trust I Securities sale (the “Trust RCC”) whereby we agreed that neither we nor our subsidiaries (other than PNC Bank, N.A. and its subsidiaries) would


 

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purchase the Trust Securities, the LLC Preferred Securities or the PNC Bank Preferred Stock unless such repurchases or redemptions are made from the proceeds of the issuance of certain qualified securities and pursuant to the other terms and conditions set forth in the replacement capital covenant with respect to the Trust RCC.

We also entered into a replacement capital covenant in connection with the closing of the Trust II Securities sale (the “Trust II RCC”) whereby we agreed until March 29, 2017 that neither we nor our subsidiaries would purchase or redeem the Trust II Securities, the LLC Preferred Securities or the Series I Preferred Stock unless such repurchases or redemptions are made from the proceeds of the issuance of certain qualified securities and pursuant to the other terms and conditions set forth in the replacement capital covenant with respect to the Trust RCC.

As of December 31, 2008, each of the Trust RCC and the Trust II RCC are for the benefit of holders of our $200 million of Floating Rate Junior Subordinated Notes issued in June 1998. We filed a copy of each of the Trust RCC and the Trust II RCC with the SEC as Exhibit 99.1 to PNC’s Form 8-K filed on December 8, 2006 and as Exhibit 99.1 to PNC’s Form 8-K filed on March 30, 2007, respectively.

PNC has contractually committed to Trust II and Trust III that if full dividends are not paid in a dividend period on the Trust II Securities or the Trust III Securities, as applicable, or the LLC Preferred Securities held by Trust II or Trust III, as applicable, PNC will not declare or pay dividends with respect to, or redeem, purchase or acquire, any of its equity capital securities during the next succeeding dividend period, other than: (i) purchases, redemptions or other acquisitions of shares of capital stock of PNC in connection with any employment contract, benefit plan or other similar arrangement with or for the benefit of employees, officers, directors or consultants, (ii) purchases of shares of common stock of PNC pursuant to a contractually binding requirement to buy stock existing prior to the commencement of the extension period, including under a contractually binding stock repurchase plan, (iii) any dividend in connection with the implementation of a shareholders’ rights plan, or the redemption or repurchase of any rights under any such plan, (iv) as a result of an exchange or conversion of any class or series of PNC’s capital stock for any other class or series of PNC’s capital stock, (v) the purchase of fractional interests in shares of PNC capital stock pursuant to the conversion or exchange provisions of such stock or the security being converted or exchanged or (vi) any stock dividends paid by PNC where the dividend stock is the same stock as that on which the dividend is being paid.

PNC Bank, N.A. has contractually committed to Trust I that if full dividends are not paid in a dividend period on the Trust I Securities, LLC Preferred Securities or any other parity equity securities issued by the LLC, neither PNC Bank, N.A. nor its subsidiaries will declare or pay dividends or other

distributions with respect to, or redeem, purchase or acquire or make a liquidation payment with respect to, any of its equity capital securities during the next succeeding period (other than to holders of the LLC Preferred Securities and any parity equity securities issued by the LLC) except: (i) in the case of dividends payable to subsidiaries of PNC Bank, N.A., to PNC Bank, N.A. or another wholly-owned subsidiary of PNC Bank, N.A. or (ii) in the case of dividends payable to persons that are not subsidiaries of PNC Bank, N.A., to such persons only if, (A) in the case of a cash dividend, PNC has first irrevocably committed to contribute amounts at least equal to such cash dividend or (B) in the case of in-kind dividends payable by PNC REIT Corp., PNC has committed to purchase such in-kind dividend from the applicable PNC REIT Corp. holders in exchange for a cash payment representing the market value of such in-kind dividend, and PNC has committed to contribute such in-kind dividend to PNC Bank, N.A.

PNC Capital Trust E Trust Preferred Securities

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

In connection with the closing of the Trust E Securities sale, we agreed that, if we have given notice of our election to defer interest payments on the JSNs or a related deferral period is continuing, then PNC would be subject during such period to restrictions on dividends and other provisions protecting the status of the JSN debenture holder similar to or in some ways more restrictive than those potentially imposed under the Exchange Agreements with Trust II and Trust III, as described above. PNC Capital Trusts C and D have similar protective provisions with respect to $500 million in principal amount of junior subordinated debentures. Also, in connection with the closing of the Trust E Securities sale, we entered into a replacement capital covenant, a copy of which was attached as Exhibit 99.1 to PNC’s Form 8-K filed on February 13, 2008 and which is described in Note 14 Capital Securities of Subsidiary Trusts in Item 8 of this Report.

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 the Mercantile, Yardville and Sterling acquisitions, we assumed obligations with respect to $158 million in principal amount of junior subordinated debentures issued by the acquired entities. Under the terms of these 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


 

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obligations, PNC would be subject during the period of such default or deferral to restrictions on dividends and other provisions protecting the status of the debenture holders similar to or in some ways more restrictive than those potentially imposed under the Exchange Agreements with Trust II and Trust III, as described above.

We are subject to replacement capital covenants (“RCCs”) with respect to four tranches of junior subordinated debentures inherited from National City, copies of which RCCs were attached, respectively, as Exhibit 99.2 to the National City Form 8-K filed on February 4, 2008 and Exhibit 99.1 to the National City Forms 8-K filed on November 9, 2006, May 25, 2007 and August 30, 2007. See Note 14 Capital Securities of Subsidiary Trusts. Similarly, we are subject to a replacement capital covenant with respect to our Series L Preferred Stock, a copy of which was attached as Exhibit 99.1 to National City’s Form 8-K filed on February 4, 2008. See Note 19 Shareholders’ Equity in Item 8 of this Report.

FAIR VALUE MEASUREMENTS AND FAIR VALUE OPTION

We adopted SFAS 157, “Fair Value Measurements” (“SFAS 157”), and SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities – Including an amendment of FASB Statement No. 115” (“SFAS 159”), on January 1, 2008. SFAS 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. Under SFAS 159, we elected to fair value certain commercial mortgage loans classified as held for sale and certain customer resale agreements and bank notes to align the accounting for the changes in the fair value of these financial instruments with the changes in the value of their related hedges. See Note 8 Fair Value in the Notes To Consolidated Financial Statements under Item 8 of this Report for further information.

At December 31, 2008, fair value assets represented 13% of total assets and fair value liabilities represented 2% of total liabilities. Assets and liabilities measured at fair value on a recurring basis, including instruments for which PNC has elected the fair value option, are summarized below. As prescribed by SFAS 157, the assets and liabilities of National City acquired in a purchase business combination on December 31, 2008 were excluded from the table below and related disclosures.

Fair Value Measurements – Summary

 

In millions    December 31, 2008
   Level 1    Level 2    Level 3    Total Fair
Value

Assets

             

Securities available for sale

   $ 347    $ 21,633    $ 4,837    $ 26,817

Financial derivatives (a)

     16      5,582      125      5,723

Trading securities (b)

     89      529      73      691

Commercial mortgage loans held for sale (c)

           1,400      1,400

Customer resale agreements (d)

        1,072         1,072

Equity investments

           571      571

Other assets

            144      6      150

Total assets

   $ 452    $ 28,960    $ 7,012    $ 36,424

Liabilities

             

Financial derivatives (e)

     $2      $4,387      $22      $4,411

Trading securities sold short (f)

     182      207         389

Other liabilities

            9             9

Total liabilities

   $ 184    $ 4,603    $ 22    $ 4,809
(a) Included in other assets on the Consolidated Balance Sheet.
(b) Included in trading securities on the Consolidated Balance Sheet. Fair value includes net unrealized losses of $27.5 million.
(c) Included in loans held for sale on the Consolidated Balance Sheet. PNC has elected the fair value option under SFAS 159 for certain commercial mortgage loans held for sale.
(d) Included in federal funds sold and resale agreements on the Consolidated Balance Sheet. PNC has elected the fair value option under SFAS 159 for this item.
(e) Included in other liabilities on the Consolidated Balance Sheet.
(f) Included in other borrowed funds on the Consolidated Balance Sheet.

Valuation Hierarchy

The following is an outline of the valuation methodologies used for measuring fair value under SFAS 157 for the major items above. SFAS 157 focuses on the exit price in the principal or most advantageous market for the asset or liability in an orderly transaction between willing market participants and establishes a reporting hierarchy to maximize the use of observable inputs. The fair value hierarchy (i.e., Level 1, Level 2, and Level 3) is described in detail in Note 8 Fair Value in the Notes To Consolidated Financial Statements under Item 8 of this Report.

We characterize active markets as those where transaction volumes are sufficient to provide objective pricing information, with reasonably narrow bid/ask spreads and where dealer quotes received do not vary widely. Inactive markets are characterized by low transaction volumes, price quotations which vary substantially among market participants, or in which minimal information is released publicly. We also consider nonperformance risks including credit risk as part of our valuation methodology for all assets measured at fair value. Any models used to determine fair values or to validate dealer quotes based on the descriptions


 

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below are subject to review and independent testing as part of our model validation and internal control testing processes. Significant models are tested by our Model Validation Committee 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

Securities include both the available for sale and trading portfolios. We use prices sourced from pricing services, dealer quotes or recent trades to determine the fair value of securities. Approximately 75% of our positions are valued using pricing services provided by the Lehman Index and IDC. Lehman Index prices are set with reference to market activity for highly liquid assets such as agency mortgage-backed securities, and matrix priced for other assets, such as CMBS and asset-backed securities. IDC primarily uses matrix pricing for the instruments we value using this service, such as agency adjustable rate mortgage securities, agency CMOs and municipal bonds. Dealer quotes received are typically non-binding and corroborated with other dealers’ quotes, by reviewing valuations of comparable instruments, or by comparison to internal valuations. The majority of our securities are classified as Level 2 in the fair value hierarchy. In circumstances where market prices are limited or unavailable, valuations may require significant management judgments or adjustments to determine fair value. In these cases, the securities are classified as Level 3.

The primary valuation technique for securities classified as Level 3 is to identify a proxy security, market transaction or index. The proxy selected generally has similar credit, tenor, duration, pricing and structuring attributes to the PNC position. The price, market spread, or yield on the proxy is then used to calculate an indicative market price for the security. Depending on the nature of the PNC position and its attributes relative to the proxy, management may make additional adjustments to account for market conditions, liquidity, and nonperformance risk, based on various inputs including recent trades of similar assets, single dealer quotes, and/or other observable and unobservable inputs.

 

    December 31, 2008  
  Agency     Non-Agency  
Dollars in millions   Residential
Mortgage-
Backed
Securities
    Residential
Mortgage-
Backed
Securities
    Commercial
Mortgage-
Backed
Securities
    Other
Asset-
Back
Securities
 

Fair Value

  $ 12,742     $ 7,420     $ 3,419     $ 1,492  

% of Fair Value:

           

By Vintage

           

2008

    36 %     1 %      

2007

    24 %     15 %     10 %     15 %

2006

    23 %     23 %     31 %     30 %

2005

    5 %     35 %     12 %     31 %

2004 and earlier

    12 %     26 %     47 %     24 %

Total

    100 %     100 %     100 %     100 %
   

By Credit rating

           

Agency

    100 %     1 %      

AAA

        82 %     98 %     71 %

AA

        4 %     1 %     7 %

A

        5 %       2 %

BBB

        2 %       8 %

BB

        3 %       6 %

B

        1 %       2 %

Lower than B

        2 %       4 %

No rating

                    1 %        

Total

    100 %     100 %     100 %     100 %
   

By FICO Score

           

>720

        68 %       13 %

<720 or >660

        30 %       47 %

<660

            1 %

No FICO score

    100 %     2 %     100 %     39 %

Total

    100 %     100 %     100 %     100 %

Residential Mortgage-Backed Securities

At December 31, 2008, our residential mortgage-backed securities portfolio was comprised of $12.7 billion fair value of US government agency-backed securities (substantially all classified as available for sale) and $7.4 billion fair value of private-issuer securities (all classified as available for sale). The agency securities are generally collateralized by 1-4 family, conforming, fixed-rate residential mortgages. The private-issuer securities are also generally collateralized by 1-4 family residential mortgages. The mortgage loans underlying the private-issuer securities are generally


 

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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”).

Substantially all of the securities are senior tranches in the subordination structure and have credit protection in the form of credit enhancement, over-collateralization and/or excess spread accounts. At December 31, 2008, $419 million, or 6%, of private-issuer securities were rated below “BBB” by at least one national rating agency or not rated.

For eight securities, we recorded other-than-temporary impairment charges of $151 million in 2008.

Commercial Mortgage-Backed Securities

The commercial mortgage-backed securities portfolio was $3.4 billion fair value at December 31, 2008 (all classified as available for sale), and consisted of fixed-rate, private-issuer securities collateralized by non-residential properties, primarily retail properties, office buildings, and multi-family housing. Substantially all of the securities are the most senior tranches in the subordination structure.

At December 31, 2008, $18 million, or 1%, of the commercial mortgage-backed securities were not rated.

We recorded no other-than-temporary impairment charges on commercial mortgage-backed securities in 2008.

Other Asset-Backed Securities

The asset-backed securities portfolio was $1.5 billion fair value at December 31, 2008 (all classified as available for sale), and consisted of fixed-rate and floating-rate, private-issuer securities collateralized primarily by various consumer credit products, including first-lien residential mortgage loans, credit cards, and automobile loans. Substantially all of the securities are senior tranches in the subordination structure and have credit protection in the form of credit enhancement, over-collateralization and/or excess spread accounts.

At December 31, 2008, $184 million, or 12%, of the asset-backed securities were rated below “BBB” by at least one national rating agency or not rated.

For seven asset-backed securities, we recorded other-than-temporary impairment charges totaling approximately $87 million in 2008.

Financial Derivatives

Exchange-traded derivatives are valued using quoted market prices and are classified as Level 1. However, the majority of derivatives that we enter into are executed over-the-counter and are valued using internal techniques. Readily observable market inputs to these models can be validated to external

sources, including industry pricing services, or corroborated through recent trades, dealer quotes, yield curves, implied volatility or other market related data. Certain derivatives, such as total rate of return swaps, are corroborated to the CMBX index. These derivatives are classified as Level 2. Derivatives priced using significant management judgment or assumptions are classified as Level 3. The fair values of our derivatives are adjusted for nonperformance risk including credit risk as appropriate. Our nonperformance risk adjustment is computed using internal assumptions based primarily on historical default and recovery observations. The credit risk adjustment is not currently material to the overall derivatives valuation.

Commercial Mortgage Loans and Commitments Held for Sale

Effective January 1, 2008, we elected to account for commercial mortgage loans classified as held for sale and intended for securitization at fair value under the provisions of SFAS 159. Based on the significance of unobservable inputs, we classify this portfolio as Level 3. As such, a synthetic securitization methodology was used historically to value the loans and the related unfunded commitments on an aggregate basis based upon current commercial mortgage-backed securities (CMBS) market structures and conditions. The election of the fair value option aligns the accounting for the commercial mortgages with the related hedges. It also eliminates the requirements of hedge accounting under SFAS 133. Due to the inactivity in the CMBS securitization market in 2008, we determined the fair value of commercial mortgage loans held for sale by using a whole loan methodology. Based on the significance of unobservable inputs, we classify this portfolio as Level 3. Valuation assumptions included observable inputs based on whole loan sales, both observed in the market and actual sales from our portfolio and new loan origination spreads during the quarter. Adjustments were made to the assumptions to account for uncertainties, including market conditions, and liquidity. Credit risk was 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.

Customer Resale Agreements

Effective January 1, 2008, we elected to account for structured resale agreements at fair value, which are economically hedged using free-standing financial derivatives. The fair value for structured resale agreements is determined using a model which includes observable market data as inputs such as interest rates. Readily observable market inputs to this model can be validated to external sources, including yield curves, implied volatility or other market related data.

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


 

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direct and affiliated partnership interests reflect the expected exit price and are based on various techniques including publicly traded price, multiples of adjusted earnings of the entity, independent appraisals, anticipated financing and sale transactions with third parties, or the pricing used to value the entity in a recent financing transaction. Indirect investments in private equity funds are valued based on the financial statements that we receive from their managers. Due to the time lag in our receipt of the financial information and based on a review of investments and valuation techniques applied, adjustments to the manager provided value are made when available recent portfolio company information or market information indicates a significant change in value from that provided by the manager of the fund. These investments are classified as Level 3.

Level 3 Assets and Liabilities

Under SFAS 157, financial instruments are considered Level 3 when their values are determined using pricing models, discounted cash flow methodologies or similar techniques and at least one significant model assumption or input is unobservable. At December 31, 2008, Level 3 fair value assets of $7.012 billion represented 19% of total assets at fair value and 2% of total assets. Level 3 fair value liabilities of $22 million at December 31, 2008 represented less than 1% of total liabilities at fair value and less than 1% of total liabilities at that date.

During 2008, securities transferred into Level 3 from Level 2 exceeded securities transferred out by $4.3 billion. These primarily related to private issuer asset-backed securities, auction rate securities, residential mortgage-backed securities and corporate bonds and occurred due to reduced volume of recently executed transactions and the lack of corroborating market price quotations for these instruments. Other Level 3 assets include commercial mortgage loans held for sale, private equity investments and other assets.

Total securities measured at fair value at December 31, 2008 included securities available for sale and trading securities consisting primarily of residential and commercial mortgage-backed securities and other asset-backed securities. 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, other-than-temporary impairments on available for sale securities would reduce our regulatory capital ratios.

 

BUSINESS SEGMENTS REVIEW

In 2008 and 2007, we had four major businesses engaged in providing banking, asset management and global fund processing products and services. Business segment results, including inter-segment revenues, and a description of each business are included in Note 27 Segment Reporting included in the Notes To Consolidated Financial Statements under Item 8 of this Report.

Certain revenue and expense amounts included in this Business Segments Review differ from the amounts shown in Note 27 due to the presentation in this Business Segments Review of business revenue on a taxable-equivalent basis, income statement classification differences related to Global Investment Servicing, the inclusion of the results of Hilliard Lyons, including the March 2008 gain on sale, in the “Other” category, and the inclusion of 2008 Albridge Solutions and Coates Analytics and 2007 BlackRock/MLIM transaction integration costs in the “Other” category.

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 the banking and servicing businesses using our risk-based economic capital model. We have assigned capital equal to 6% of funds to Retail Banking to reflect the capital required for well-capitalized domestic banks and to approximate market comparables for this business. The capital assigned for Global Investment Servicing reflects its legal entity shareholder’s equity.

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


 

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Total business segment financial results differ from total consolidated results. The impact of these differences is reflected in the “Other” category. “Other” for purposes of this Business Segments Review and the Business Segment Highlights in the Executive Summary includes residual activities that do not meet the criteria for disclosure as a separate reportable business, such as gains or losses related to BlackRock transactions including LTIP share distributions and obligations, earnings and gains or losses related to Hilliard Lyons, integration costs, asset and liability management activities including net securities gains or losses and certain trading activities, equity management activities, differences between business segment performance reporting and financial statement reporting (GAAP), intercompany eliminations, and most corporate overhead.

 

Employee data as reported by each business segment in the tables that follow reflect PNC legacy staff directly employed by the respective businesses and excludes corporate and shared services employees. National City legacy employees totaling 31,374 at December 31, 2008 are not included in any of PNC’s business segment tables.

Beginning in the first quarter of 2009, PNC expects to have three new reportable business segments which are described in Note 28 Subsequent Event included in the Notes To Consolidated Financial Statements under Item 8 of this Report.


 

Results Of Businesses – Summary

 

Year ended December 31 - in millions    Earnings     Revenue    Average Assets (a)
   2008     2007     2008    2007    2008    2007

Retail Banking (b)

   $ 429     $ 876     $ 3,608    $ 3,580    $ 46,578    $ 41,943

Corporate & Institutional Banking

     225       432       1,531      1,538      36,994      29,052

BlackRock

     207       253       261      338      4,240      4,259

Global Investment Servicing (c)

     122       128       916      831      5,278      2,476

Total business segments

     983       1,689       6,316      6,287      93,090      77,730

Other (d) (e)

     (101 )     (222 )     874      418      48,930      45,688

Total consolidated

   $ 882     $ 1,467     $ 7,190    $ 6,705    $ 142,020    $ 123,418
(a) Period-end balances for BlackRock and Global Investment Servicing.
(b) Amounts reflect the reclassification of results for Hilliard Lyons, which we sold on March 31, 2008, and the related gain on sale, from Retail Banking to “Other.”
(c) Global Investment Servicing revenue represents the sum of servicing revenue and nonoperating income (expense) less debt financing costs. Global Investment Servicing income classified as net interest income (expense) in Note 27 Segment Reporting in the Notes To Consolidated Financial Statements included in Item 8 of this Report represents the interest components of nonoperating income (net of nonoperating expense) and debt financing.
(d) “Other” for 2008 includes $422 million of after-tax integration costs, including conforming provision for credit losses, primarily related to National City. “Other” for the 2007 includes $99 million of after-tax integration costs and $53 million of after-tax Visa indemnification costs.

 

  “Other” also includes results related to our cross-border lease portfolio for both 2008 and 2007. However, 2006 results for this item are included in Corporate & Institutional Banking in Note 27 Segment Reporting in the Notes To Consolidated Financial Statements included in Item 8 of this Report.
(e) “Other” average assets are comprised primarily of investment securities and residential mortgage loans associated with asset and liability management activities.

 

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RETAIL BANKING (a)

 

Year ended December 31

Dollars in millions except as noted

   2008     2007  

INCOME STATEMENT

      

Net interest income

   $1,992     $2,062  

Noninterest income

      

Asset management

   420     445  

Service charges on deposits

   362     339  

Brokerage

   153     134  

Consumer services

   419     392  

Other

   262     208  

Total noninterest income

   1,616     1,518  

Total revenue

   3,608     3,580  

Provision for credit losses

   612     138  

Noninterest expense

   2,284     2,045  

Pretax earnings

   712     1,397  

Income taxes

   283     521  

Earnings

   $429     $876  

AVERAGE BALANCE SHEET

      

Loans

      

Consumer

      

Home equity

   $14,678     $14,209  

Indirect

   2,050     1,897  

Education

   2,012     110  

Other consumer

   1,761     1,487  

Total consumer

   20,501     17,703  

Commercial and commercial real estate

   14,677     12,534  

Floor plan

   997     978  

Residential mortgage

   2,362     1,992  

Other

   67     70  

Total loans

   38,604     33,277  

Goodwill and other intangible assets

   6,132     4,920  

Loans held for sale

   329     1,564  

Other assets

   1,513     2,182  

Total assets

   $46,578     $41,943  

Deposits

      

Noninterest-bearing demand

   $10,860     $10,513  

Interest-bearing demand

   9,583     8,876  

Money market

   19,677     16,786  

Total transaction deposits

   40,120     36,175  

Savings

   2,701     2,678  

Certificates of deposit

   16,397     16,637  

Total deposits

   59,218     55,490  

Other liabilities

   329     417  

Capital

   3,773     3,481  

Total funds

   $63,320     $59,388  

PERFORMANCE RATIOS

      

Return on average capital

   11 %   25 %

Noninterest income to total revenue

   45     42  

Efficiency

   63     57  
    

OTHER INFORMATION (b) (c)

            

Credit-related statistics:

      

Commercial nonperforming assets

   $540     $187  

Consumer nonperforming assets

   79     38  

Total nonperforming assets (d)

   $619     $225  

Commercial net charge-offs

   $239     $71  

Consumer net charge-offs

   129     60  

Total net charge-offs

   $368     $131  

Commercial net charge-off ratio

   1.52 %   .52 %

Consumer net charge-off ratio

   .56 %   .30 %

Total net charge-off ratio

   .95 %   .39 %

At December 31

Dollars in millions except as noted

  2008     2007  

OTHER INFORMATION CONTINUED (b) (c)

           

Other statistics:

     

Full-time employees

  11,481     11,022  

Part-time employees

  2,363     2,298  

ATMs

  4,041     3,900  

Branches (e)

  1,148     1,109  

ASSETS UNDER ADMINISTRATION
(in billions) (f)

     

Assets under management

     

Personal

  $38     $49  

Institutional

  19     20  

Total

  $57     $69  

Asset Type

     

Equity

  $26     $40  

Fixed income

  19     17  

Liquidity/other

  12     12  

Total

  $57     $69  

Nondiscretionary assets under administration

     

Personal

  $23     $30  

Institutional

  64     82  

Total

  $87     $112  

Asset Type

     

Equity

  $34     $49  

Fixed income

  19     27  

Liquidity/other

  34     36  

Total

  $87     $112  

Home equity portfolio credit statistics:

     

% of first lien positions

  38 %   39 %

Weighted average loan-to-value ratios (g)

  73 %   73 %

Weighted average FICO scores (h)

  727     727  

Annualized net charge-off ratio

  .52 %   .20 %

Loans 90 days past due

  .58 %   .37 %

Checking-related statistics:

     

Retail Banking checking relationships

  2,432,000     2,272,000  

Consumer DDA households using online banking

  1,238,000     1,091,000  

% of consumer DDA households using online banking

  57 %   54 %

Consumer DDA households using online bill payment

  882,000     667,000  

% of consumer DDA households using online bill payment

  41 %   33 %

Small business loans and managed deposits:

     

Small business loans

  $13,483     $13,049  

Managed deposits:

     

On-balance sheet

     

Noninterest-bearing demand (i)

  $8,319     $5,994  

Interest-bearing demand

  2,157     1,873  

Money market

  3,638     3,152  

Certificates of deposit

  880     1,068  

Off-balance sheet (j)

     

Small business sweep checking

  3,140     2,780  

Total managed deposits

  $18,134     $14,867  

Brokerage statistics:

     

Financial consultants (k)

  414     364  

Full service brokerage offices

  23     24  

Brokerage account assets (billions)

  $15     $19  
(a) Information for all periods presented excludes the impact of National City, which PNC acquired on December 31, 2008, and Hilliard Lyons, which was sold on March 31, 2008, and whose results have been reclassified to “Other.”
(b) Presented as of December 31 except for net charge-offs and net charge-off ratio.
(c) Amounts as of and for the year ended December 31, 2008 include the impact of Yardville. Amounts subsequent to April 4, 2008 include the impact of Sterling.

 

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(d) Includes nonperforming loans of $605 million at December 31, 2008 and $215 million at December 31, 2007.
(e) Excludes certain satellite branches that provide limited products and service hours.
(f) Excludes brokerage account assets.
(g) Calculated as of origination date.
(h) Represents the most recent FICO scores that we have on file.
(i) The increase at December 31, 2008 compared with December 31, 2007 reflected large customer deposit activity in the last few days of December 2008.
(j) Represents small business balances. These balances are swept into liquidity products managed by other PNC business segments, the majority of which are off-balance sheet.
(k) Financial consultants provide services in full service brokerage offices and PNC traditional branches.

The acquisition of National City on December 31, 2008 added 1,441 branches, including 61 branches that we committed to divest, and 2,191 ATMs to our distribution network. Including the impact of National City, our network grew to 2,589 branches and 6,232 ATM machines, giving PNC one of the largest distribution networks among US banks. The acquisition also added $53 billion of assets under management to give the combined company $110 billion in assets under management.

All other Retail Banking business segment disclosures in this Item 7 exclude any impact of National City.

Retail Banking’s earnings were $429 million for 2008 compared with $876 million for 2007. The decline in earnings over the prior year was primarily driven by increases in the provision for credit losses and noninterest expense. The 2008 revenue growth was negatively impacted by a lower interest credit attributed to deposits in the declining rate environment and was therefore not reflective of the solid growth in customers and deposits.

Highlights of Retail Banking’s performance during 2008 include the following:

   

Retail Banking expanded the number of customers it serves and grew checking relationships. Total checking relationships increased by a net 160,000 since December 31, 2007, which includes both the conversion of Yardville and Sterling accounts as well as the addition of new relationships through organic growth. Excluding relationships added from acquisitions, net new consumer and business checking relationships grew by 72,000 in 2008 compared with 32,000 a year earlier.

   

Average deposit balances increased $3.7 billion or 7% primarily as a result of strong money market deposit growth and the benefits of the acquisitions.

   

Our investment in online banking capabilities continued to pay off. Since December 31, 2007, the percentage of consumer checking households using online bill payment increased from 33% to 41%. We continue to seek customer growth by expanding our use of technology, such as the recent launch of our “Virtual Wallet” online banking product. Recently, Virtual Wallet received a “Best of the Web” award for 2008 from Online Banking Report.

   

Retail Banking continued to invest in the branch network. During 2008, we opened 19 new branches, consolidated 45 branches, and acquired 65 branches for a total of 1,148 branches at December 31, 2008. We continue to work to optimize our network by opening new branches in high growth areas, relocating branches to areas of higher market opportunity, and consolidating branches in areas of declining opportunity. We relocated 8 branches during 2008.

In October 2008 we announced an exclusive agreement under which we will provide banking services in Giant Food LLC supermarket locations across Virginia, Maryland, Delaware and the District of Columbia. In 2009, we expect to open approximately 40 new in-store branches and install approximately 180 ATMs. Additional locations are expected to open in subsequent years.

Total revenue for 2008 was $3.608 billion, a 1% increase compared with $3.580 billion for 2007. Net interest income of $1.992 billion decreased $70 million, or 3%, compared with 2007. This decline was primarily driven by a lower value attributed to deposits in the declining rate environment partially offset by benefits from earlier acquisitions.

Noninterest income increased $98 million, or 6%, compared with 2007. This growth was attributed primarily to the following:

   

A gain of $95 million from the redemption of a portion of our Visa Class B common shares related to Visa’s March 2008 initial public offering,

   

The Mercantile, Yardville and Sterling acquisitions,

   

Increased volume-related consumer fees including debit card, credit card, and merchant revenue, and

   

Increased brokerage account activities.

These increases were partially offset by lower asset management fees as a result of lower equity markets and by other business gains in the prior year.

The Market Risk Management – Equity and Other Investment Risk section of this Financial Review includes further information regarding Visa.

The provision for credit losses for 2008 was $612 million compared to $138 million for 2007. Net charge-offs were $368 million for 2008 and $131 million in 2007. Asset quality continued to migrate at an accelerated pace in the very challenging economic and credit environment. The increases in provision and net charge-offs were primarily a result of the following:

   

Downward credit migration of residential real estate development and related sectors, commercial real estate, and commercial and industrial loan portfolios, and

   

Increased levels of consumer and commercial charge-offs given the current credit environment.


 

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Based upon the current environment and the acquisition of National City, we believe the provision and nonperforming assets will continue to increase in 2009 versus 2008 levels.

Noninterest expense for 2008 totaled $2.284 billion, an increase of $239 million compared with 2007. Approximately 76% of this increase was attributable to acquisitions and continued investments in the business such as the branch network and innovation.

Full-time employees at December 31, 2008 totaled 11,481, an increase of 459 over the prior year. Part-time employees have increased by 65 since December 31, 2007. The increase in full-time and part-time employees was primarily the result of the Yardville and Sterling acquisitions.

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. Average total deposits increased $3.7 billion, or 7%, compared with 2007.

   

Average money market deposits increased $2.9 billion, and average certificates of deposits declined $.2 billion. Money market deposits experienced core growth and both deposit categories benefited from the acquisitions. The decline in certificates of deposits was a result of a focus on relationship customers rather than pursuing higher-rate single service customers. 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.

   

Average demand deposit growth of $1.1 billion, or 5%, was primarily driven by acquisitions as organic growth was impacted by current economic conditions, such as lower average balances per account.

Currently, we are focused on a relationship-based lending strategy that targets specific customer sectors (homeowners, students, small businesses and auto dealerships) while seeking a moderate risk profile for the loans that we originate.

   

Average commercial and commercial real estate loans grew $2.1 billion, or 17%, compared with 2007. The increase was primarily attributable to acquisitions. Organic loan growth reflecting the

 

strength of increased small business loan demand from existing customers and the acquisition of new relationships through our sales efforts was also a factor in the increase. At December 31, 2008, commercial and commercial real estate loans totaled $14.6 billion. This portfolio included $3.2 billion of commercial real estate loans, of which approximately $2.4 billion were related to our expansion from earlier acquisitions into the greater Maryland and Washington, DC markets. Approximately $.4 billion of the commercial real estate loans were in residential real estate development.

   

Average home equity loans grew $469 million, or 3%, compared with 2007 primarily due to acquisitions. Our home equity loan portfolio is relationship based, with 93% of the portfolio attributable to borrowers in our primary geographic footprint. We monitor this portfolio closely and the nonperforming assets and charge-offs that we have experienced are within our expectations given current market conditions.

   

Average education loans grew $1.9 billion compared with 2007. The increase was primarily the result of the transfer of approximately $1.8 billion of education loans previously held for sale to the loan portfolio during the first quarter of 2008. The Loans Held For Sale portion of the Consolidated Balance Sheet Review section of this Financial Review includes additional information related to this transfer.

   

Average residential mortgage loans increased $370 million primarily due to the addition of loans from acquisitions.

Assets under management of $57 billion at December 31, 2008 decreased $12 billion compared with the balance at December 31, 2007. The decline in assets under management was primarily due to comparatively lower equity markets partially offset by the Sterling acquisition and positive net inflows. New business sales efforts and new client acquisition and growth were ahead of our expectations.

Nondiscretionary assets under administration of $87 billion at December 31, 2008 decreased $25 billion compared with the balance at December 31, 2007. This decline was primarily driven by comparatively lower equity markets and net outflows resulting from the reduction in several significant relationships.


 

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CORPORATE & INSTITUTIONAL BANKING (a)

 

Year ended December 31

Dollars in millions except as noted

  2008     2007  

INCOME STATEMENT

     

Net interest income

  $1,037     $818  

Noninterest income

     

Corporate service fees

  545     564  

Other

  (51 )   156  

Noninterest income

  494     720  

Total revenue

  1,531     1,538  

Provision for credit losses

  366     125  

Noninterest expense

  882     818  

Pretax earnings

  283     595  

Income taxes

  58     163  

Earnings

  $225     $432  

AVERAGE BALANCE SHEET

     

Loans

     

Corporate (b)

  $12,485     $9,930  

Commercial real estate

  5,631     4,408  

Commercial – real estate related

  3,022     2,390  

Asset-based lending

  5,274     4,595  

Total loans (b)

  26,412     21,323  

Goodwill and other intangible assets

  2,247     1,919  

Loans held for sale

  2,053     1,319  

Other assets

  6,282     4,491  

Total assets

  $36,994     $29,052  

Deposits

     

Noninterest-bearing demand

  $7,598     $7,301  

Money market

  5,216     4,784  

Other

  2,286     1,325  

Total deposits

  15,100     13,410  

Other liabilities

  5,479     3,347  

Capital

  2,616     2,152  

Total funds

  $23,195     $18,909  

PERFORMANCE RATIOS

     

Return on average capital

  9 %   20 %

Noninterest income to total revenue

  32     47  

Efficiency

  58     53  

COMMERCIAL MORTGAGE SERVICING PORTFOLIO (in billions)

     

Beginning of period

  $243     $200  

Acquisitions/additions

  31     88  

Repayments/transfers

  (25 )   (45 )

End of period

  $249     $243  

OTHER INFORMATION

     

Consolidated revenue from (c):

     

Treasury management

  $545     $476  

Capital markets

  $336     $290  

Commercial mortgage loan sales and valuations (d)

  $(115 )   $19  

Commercial mortgage loan servicing (e)

  180     233  

Commercial mortgage banking activities

  $65     $252  

Total loans (f)

  $28,996     $23,861  

Nonperforming assets (f) (g)

  $749     $243  

Net charge-offs

  $168     $70  

Full-time employees (f)

  2,294     2,290  

Net carrying amount of commercial mortgage servicing rights (f)

  $654     $694  
(a) Information for all periods presented excludes the impact of National City, which PNC acquired on December 31, 2008.
(b) Includes lease financing.
(c) Represents consolidated PNC amounts.
(d) 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.
(e) Includes net interest income and noninterest income from loan servicing and ancillary services.
(f) At December 31.
(g) Includes nonperforming loans of $747 million at December 31, 2008 and $222 million at December 31, 2007.

Corporate & Institutional Banking earned $225 million in 2008 compared with $432 million in 2007. The 48% decline in earnings over 2007 was primarily driven by an increase in the provision for credit losses and by higher valuation losses on commercial mortgage loans held for sale, net of hedges.

   

Net interest income grew $219 million, or 27%, in 2008 compared with 2007. The increase over the prior year was primarily a result of an increase in commercial mortgage loans held for sale, organic loan growth and acquisitions.

   

Corporate service fees decreased $19 million compared with 2007 to $545 million. The fourth quarter of 2008 included a $35 million impairment charge on commercial mortgage servicing rights due to the effect of lower interest rates. Increases in treasury management, structured finance and syndication fees more than offset declines in commercial mortgage servicing fees, net of amortization, and merger and acquisition advisory fees.

   

Other noninterest income was negative $51 million for 2008 compared with income of $156 million in 2007. Losses of $197 million on commercial mortgage loans held for sale, net of hedges, were included in other noninterest income for 2008 compared with gains of $3 million in 2007. These non-cash valuation losses reflected illiquid market conditions which began in the latter part of 2007.

   

PNC adopted SFAS 159 beginning January 1, 2008 and elected to account for its loans held for sale and intended for securitization at fair value. We stopped originating these loans during the first quarter of 2008. We intend to continue pursuing opportunities to reduce our loans held for sale position at appropriate prices. We sold and/or securitized $.6 billion of commercial mortgage loans held for sale carried at fair value in 2008 reducing these fair value assets to $1.4 billion at December 31, 2008.

   

The provision for credit losses was $366 million in 2008 compared with $125 million in 2007. The increase in the provision was primarily due to credit quality migration mainly related to residential real estate development and related sectors along with growth in total credit exposure. Nonperforming


 

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assets increased $506 million in the comparison. The largest component of the increase was in commercial real estate and commercial real estate related loans. Based upon the current environment and the acquisition of National City, we believe the provision will continue to increase in 2009 versus 2008 levels.

   

Noninterest expense increased $64 million, or 8%, compared with 2007. The increase was primarily due to the impact of the 2007 ARCS Commercial Mortgage and Mercantile acquisitions, expenses associated with revenue-related activities, growth initiatives mainly in treasury management, higher passive losses associated with low income housing tax credit investments, and write-downs of other real estate owned.

   

Average loan balances increased $5.1 billion, or 24%, compared with 2007. The increase in corporate and commercial real estate loans resulted from higher utilization of credit facilities, organic growth from new and existing clients, and the impact of the Mercantile and Yardville acquisitions.

   

Average deposit balances increased $1.7 billion, or 13%, compared with 2007. The increase resulted primarily from higher time deposits and the impact of acquisitions.

   

The commercial mortgage servicing portfolio was $249 billion at December 31, 2008, an increase of $6 billion from December 31, 2007. Servicing portfolio additions were modest during 2008 due to the declining volumes in the commercial mortgage securitization market.

   

Average other assets and other liabilities increased $1.8 billion and $2.1 billion, respectively. These increases were due to customer driven trading and related hedging transactions. In addition, an increase in customer driven money management activities contributed to the higher other liabilities balance.

See the additional revenue discussion regarding treasury management, capital markets-related products and services, and commercial mortgage banking activities on pages 29 and 30.


 

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BLACKROCK

Our BlackRock business segment earned $207 million in 2008 and $253 million in 2007. These results reflect our approximately 33% share of BlackRock’s reported GAAP earnings and the additional income taxes on these earnings incurred by PNC.

PNC’s investment in BlackRock was $4.2 billion at December 31, 2008 and $4.1 billion at December 31, 2007. The book value per share was $98.32 at December 31, 2008.

BLACKROCK LTIP PROGRAMS AND EXCHANGE AGREEMENTS

BlackRock adopted the 2002 LTIP program to help attract and retain qualified professionals. At that time, PNC agreed to transfer up to four million of the shares of BlackRock common stock then held by us to help fund the 2002 LTIP and future programs approved by BlackRock’s board of directors, subject to certain conditions and limitations. Prior to 2006, BlackRock granted awards of approximately $233 million under the 2002 LTIP program, of which approximately $208 million were paid on January 30, 2007. The award payments were funded by 17% in cash from BlackRock and approximately one million shares of BlackRock common stock transferred by PNC and distributed to LTIP participants. We recognized a pretax gain of $82 million in the first quarter of 2007 from the transfer of BlackRock shares. The gain was included in other noninterest income and reflected the excess of market value over book value of the one million shares transferred in January 2007. Additional BlackRock shares were distributed to LTIP participants during the first quarter of 2008, resulting in a $3 million pretax gain in other noninterest income, and during January 2009, resulting in a $1 million pretax gain.

BlackRock granted awards in 2007 under an additional LTIP program, all of which are subject to achieving earnings performance goals prior to the vesting date of September 29, 2011. Of the shares of BlackRock common stock that we have agreed to transfer to fund their LTIP programs, approximately 1.6 million shares have been committed to fund the awards vesting in 2011 and the amount remaining would then be available for future awards.

PNC’s noninterest income for 2008 included a $243 million pretax gain related to our commitment to fund additional BlackRock LTIP programs. This gain represented the mark-to-market adjustment related to our remaining BlackRock LTIP common shares obligation as of December 31, 2008 and resulted from the decrease in the market value of BlackRock common shares for 2008. PNC’s noninterest income for 2007 included a pretax charge of $209 million for an increase in the market value of BlackRock common shares for that period.

 

As further described in PNC’s Current Report on Form 8-K filed December 30, 2008, PNC entered into an Exchange Agreement with BlackRock on December 26, 2008. The transactions contemplated by this agreement will restructure PNC’s ownership of BlackRock equity without altering, to any meaningful extent, PNC’s economic interest in BlackRock. PNC will continue to be subject to the limitations on its voting rights in its existing agreements with BlackRock. These transactions will also allow PNC to reduce its net income volatility associated with the quarterly marking-to-market of obligations related to PNC’s delivery of BlackRock stock under the BlackRock LTIP.

Also on December 26, 2008, BlackRock entered into an Exchange Agreement with Merrill Lynch in anticipation of the consummation of the merger of Bank of America Corporation and Merrill Lynch which was completed on January 1, 2009. The PNC and Merrill Lynch Exchange Agreements restructured PNC’s and Merrill Lynch’s respective ownership of BlackRock common and preferred equity. The exchange was completed on February 27, 2009.

PNC will continue to account for its investment in BlackRock under the equity method of accounting, with its share of BlackRock’s earnings reduced from approximately 33% to 31%, solely as a result of the exchange of 2.9 million of its shares of BlackRock common stock for new BlackRock Series C Preferred Stock. The Series C Preferred Stock will not be taken into consideration in determining PNC’s share of BlackRock earnings under the equity method. PNC’s percentage ownership of BlackRock common stock is expected to increase from approximately 36.5% to 46.5%. The increase will result from a substantial exchange of Merrill Lynch’s BlackRock common stock for BlackRock preferred stock. As a result of the BlackRock preferred stock currently held by Merrill Lynch and the new BlackRock preferred stock being issued to Merrill Lynch and PNC under the Exchange Agreements, PNC’s share of BlackRock common stock has been, and will continue to be, higher than its overall share of BlackRock’s equity and earnings.

On February 27, 2009, PNC’s obligation to deliver BlackRock common shares was replaced with an obligation to deliver shares of BlackRock’s new Series C Preferred Stock. PNC will account for these preferred shares at fair value as permitted under SFAS 159, which will offset the impact of marking-to-market the liability to deliver these shares to BlackRock.

The transactions related to the Exchange Agreements will not affect our right to receive dividends declared by BlackRock.


 

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QUELLOS TRANSACTION

On October 1, 2007, BlackRock acquired the fund of funds business of Quellos Group, LLC (“Quellos”). The combined fund of funds platform operates under the name BlackRock Alternative Advisors and is one of the largest fund of funds platforms in the world. In connection with the acquisition, BlackRock paid $562 million in cash to Quellos and placed 1.2 million shares of BlackRock common stock into an escrow account. The shares of BlackRock common stock will be held in the escrow account for up to three years and will be

available to satisfy certain indemnification obligations of Quellos under the asset purchase agreement. In April 2008, 280,519 common stock shares were released to Quellos in accordance with the Quellos asset purchase agreement, which resulted in an adjustment to the recognized purchase price. In addition, Quellos may be entitled to receive two contingent payments upon achieving certain investment advisory base and performance fee measures through December 31, 2010, totaling up to an additional $969 million in a combination of cash and stock.


 

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GLOBAL INVESTMENT SERVICING

 

Year ended December 31

Dollars in millions except as noted

   2008     2007  

INCOME STATEMENT

      

Servicing revenue (a)

   $947     $863  

Operating expense (a)

   728     637  

Operating income

   219     226  

Debt financing

   34     38  

Nonoperating income (b)

   3     6  

Pretax earnings

   188     194  

Income taxes

   66     66  

Earnings

   $122     $128  

PERIOD-END BALANCE SHEET

      

Goodwill and other intangible assets

   $1,301     $1,315  

Other assets

   3,977     1,161  

Total assets

   $5,278     $2,476  

Debt financing

   $850     $989  

Other liabilities

   3,737     865  

Shareholder’s equity

   691     622  

Total funds

   $5,278     $2,476  

PERFORMANCE RATIOS

      

Return on average equity

   18 %   23 %

Operating margin (c)

   23     26  

SERVICING STATISTICS

(at December 31)

      

Accounting/administration net fund assets
(in billions) (d)

      

Domestic

   $764     $869  

Offshore

   75     121  

Total

   $839     $990  

Asset type (in billions)

      

Money market

   $431     $373  

Equity

   227     390  

Fixed income

   103     123  

Other

   78     104  

Total

   $839     $990  

Custody fund assets (in billions)

   $379     $500  

Shareholder accounts (in millions)

      

Transfer agency

   14     19  

Subaccounting

   58     53  

Total

   72     72  

OTHER INFORMATION

      

Full-time employees (at December 31)

   4,934     4,784  
(a) Certain out-of-pocket expense items which are then client billable are included in both servicing revenue and operating expense above, but offset each other entirely and therefore have no effect on operating income. Distribution revenue and expenses which relate to 12b-1 fees that are received from certain fund clients for payment of marketing, sales and service expenses also entirely offset each other, but are netted for presentation purposes above.
(b) Net of nonoperating expense.
(c) Total operating income divided by total servicing revenue.
(d) Includes alternative investment net assets serviced.

Global Investment Servicing earned $122 million for 2008 and $128 million for 2007. Results for 2008 were negatively impacted by declines in asset values and fund redemptions as a result of severe deterioration of the financial markets during the fourth quarter.

 

Highlights of Global Investment Servicing’s performance for 2008 included:

   

Initiatives in the offshore arena resulted in a 13% increase in offshore servicing revenue. This included the start up of a new servicing location in Poland which employed 69 individuals at year end. Assets serviced, however, decreased by 38% as a direct result of the unsettled global equity markets and the resultant high redemption activity in the latter part of the year.

   

Subaccounting shareholder accounts rose by 5 million, or 9%, to 58 million, as existing clients continued to convert additional fund families to this platform. Global Investment Servicing remains a leading provider of subaccounting services. A prominent new client was won during 2008 due to the combined subaccounting services and wealth reporting capabilities that Global Investment Servicing can now provide as a result of its acquisition of Albridge Solutions in December 2007.

   

Total accounting/administration funds serviced increased 7% over the prior year. However, assets serviced decreased 15% due to declines in asset values and fund outflows resulting from market conditions, primarily in the fourth quarter of 2008.

Servicing revenue for 2008 reached $947 million, an increase of $84 million, or 10%, over 2007. This increase resulted primarily from the acquisitions of Albridge Solutions and Coates Analytics, LP in December 2007, growth in offshore operations, and increased securities lending activities afforded by the volatility in the markets.

Operating expense increased $91 million, or 14%, to $728 million, in 2008 compared with 2007. Investments in technology, a larger employee base to support business growth, and costs related to the acquisitions made in December 2007 drove the higher expense level.

Debt financing costs and nonoperating income were both lower than prior year levels due to the much lower interest rate environment and principal payments on debt during the year.

Global Investment Servicing’s balance sheet was also impacted by the market turmoil at year end as clients chose to leave cash balances uninvested.

Total assets serviced by Global Investment Servicing totaled $2.0 trillion at December 31, 2008 compared with $2.5 trillion at December 31, 2007. The decline in assets serviced was a direct result of global market declines.


 

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CRITICAL ACCOUNTING

ESTIMATES AND JUDGMENTS

Our consolidated financial statements are prepared by applying certain accounting policies. Note 1 Accounting Policies in the Notes To Consolidated Financial Statements in Item 8 of this Report describes the most significant accounting policies that we use. Certain of these policies require us to make estimates and strategic 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.

Fair Value Measurements

We must use estimates, assumptions, and judgments when assets and liabilities are required to be recorded at, or adjusted to reflect, fair value. This includes the initial measurement at fair value of the assets acquired and liabilities assumed in acquisitions qualifying as business combinations under SFAS 141 or SFAS 141(R), “Business Combinations.” The valuation of both financial and nonfinancial assets and liabilities in these transactions require numerous assumptions and estimates and the use of third-party sources including appraisers and valuation specialists.

Assets and liabilities carried at fair value inherently result in a higher degree of financial statement volatility. Assets and liabilities measured at fair value on a recurring basis, including those elected under SFAS 159, include available for sale and trading securities, financial derivatives, certain commercial and residential mortgage loans held for sale, customer resale agreements, private equity investments, and residential mortgage servicing rights. 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 other independent third-party sources, 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 in any of these areas could materially impact our future financial condition and results of operations.

Effective January 1, 2008, PNC adopted SFAS 157. SFAS 157 defines fair value as the price that would be received to sell a financial asset or paid to transfer a financial liability in an orderly transaction between market participants at the measurement date. SFAS 157 established a three level hierarchy for disclosure of assets and liabilities recorded at fair value. The classification of assets and liabilities within the hierarchy is based on whether the inputs to the valuation methodology used in the measurement are observable or unobservable.

 

The following sections of this Report provide further information on this type of activity:

   

Fair Value Measurements and Fair Value Option included within this Item 7, and

   

Note 8 Fair Value included in Notes to Consolidated Financial Statements in Item 8 of this Report.

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

We maintain allowances for loan and lease losses and unfunded loan commitments and letters of credit at levels that we believe to be adequate to absorb estimated probable credit losses inherent in the loan portfolio. We determine the adequacy of the allowances based on periodic evaluations of the loan and lease portfolios and other relevant factors. However, 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,

   

Loss given default,

   

Exposure at date of default,

   

Amounts and timing of expected future cash flows on impaired loans,

   

Value of collateral,

   

Historical loss exposure, and

   

Amounts for changes in economic conditions that may not be reflected in historical results.

In determining the adequacy of the allowance for loan and lease losses, we make specific allocations to impaired loans, allocations to pools of watchlist and non-watchlist loa