PNC FINANCIAL SERVICES GROUP INC 10-Q 2009
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
For the quarterly period ended March 31, 2009
For the transition period from to
Commission file number 001-09718
The PNC Financial Services Group, Inc.
(Exact name of registrant as specified in its charter)
One PNC Plaza, 249 Fifth Avenue, Pittsburgh, Pennsylvania 15222-2707
(Address of principal executive offices, including zip code)
(Registrants telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes ¨ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨ Smaller reporting company ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨ No x
As of April 30, 2009, there were 445,278,707 shares of the registrants common stock ($5 par value) outstanding.
The PNC Financial Services Group, Inc.
Cross-Reference Index to First Quarter 2009 Form 10-Q
CONSOLIDATED FINANCIAL HIGHLIGHTS
THE PNC FINANCIAL SERVICES GROUP, INC.
See page 48 for a glossary of certain terms used in this Report.
Certain prior period amounts have been reclassified to conform with the current period presentation, which we believe is more meaningful to readers of our consolidated financial statements.
CONSOLIDATED FINANCIAL HIGHLIGHTS (CONTINUED) (a)
THE PNC FINANCIAL SERVICES GROUP, INC.
This Financial Review should be read together with our unaudited Consolidated Financial Statements and unaudited Statistical Information included elsewhere in this Report and with Items 6, 7, 8 and 9A of our 2008 Annual Report on Form 10-K (2008 Form 10-K). We have reclassified certain prior period amounts to conform with the current period presentation, which we believe is more meaningful to readers of our consolidated financial statements. For information regarding certain business and regulatory risks, see the Risk Management section in this Financial Review and Items 1A and 7 of our 2008 Form 10-K and Item 1A included in Part II of this Report. Also, see the Cautionary Statement Regarding Forward-Looking Information and Critical Accounting Policies And Judgments sections in this Financial Review for certain other factors that could cause actual results or future events to differ, perhaps materially, from historical performance and those anticipated in the forward-looking statements included in this Report. See Note 19 Segment Reporting in the Notes To Consolidated Financial Statements included in Part I, Item 1 of this Report for a reconciliation of total business segment earnings to total PNC consolidated net income as reported on a generally accepted accounting principles (GAAP) basis.
THE PNC FINANCIAL SERVICES GROUP, INC.
PNC is one of the largest diversified financial services companies in the United States and is headquartered in Pittsburgh, Pennsylvania.
As further described in Note 2 Acquisitions and Divestitures in our 2008 Form 10-K, on December 31, 2008, PNC acquired National City Corporation (National City). Our consolidated financial statements for the first three months of 2009 reflect the impact of National City.
PNC has businesses engaged in retail banking, corporate and institutional banking, asset management, residential mortgage banking and global investment servicing, providing many of its products and services nationally and others in PNCs primary geographic markets located in Pennsylvania, New Jersey, Washington, DC, Maryland, Virginia, Ohio, Kentucky, Delaware, Florida, Illinois, Indiana, Michigan, Missouri, and Wisconsin. PNC also provides certain investment servicing internationally and also conducts selected consumer and commercial lending businesses and other financial services on a nationwide basis.
We expect to incur total merger and integration costs of approximately $1.2 billion pretax in connection with the acquisition of National City. This total includes $575 million pretax recognized in the fourth quarter of 2008 and $51 million pretax recognized in the first quarter of 2009. 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.
We are 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 pre-tax, pre-provision earnings that exceed credit costs by achieving growth in revenue from our balance sheet and diverse business mix that exceeds growth in expenses controlled through disciplined cost management. The primary drivers of revenue growth are the acquisition, expansion and retention of customer relationships. We strive to expand our customer base by offering convenient banking options and leading technology solutions, providing a broad range of fee-based and credit products and services, focusing on customer service, and through a significantly enhanced branding initiative. 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 also continue to be focused on building capital in the current environment characterized by economic and regulatory uncertainty. 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 PNCs participation on December 31, 2008 in the US Treasurys Troubled Asset Relief Program (TARP) Capital Purchase Program and other regulatory restrictions on dividend capacity.
On April 2, 2009 the Board declared a quarterly common stock dividend of $.10 per share, a reduction from the prior quarterly dividend of $.66 per share. 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 by approximately $1 billion annually, further strengthen our balance sheet and continue to serve our customers.
SUPERVISORY CAPITAL ASSESSMENT PROGRAM (STRESS TESTS)
On May 7, 2009, the Board of Governors of the Federal Reserve System announced the results of the stress tests conducted by banking regulators under the Supervisory Capital Assessment Program with respect to the 19 largest bank holding companies. As a result of this test, the Federal Reserve concluded that PNC is currently well capitalized but that, in order to provide a greater cushion against the risk that economic conditions over the next two years are worse than currently anticipated, PNC needed to augment the composition of its capital by increasing the common shareholders equity component of Tier 1 capital by $600 million by November 9, 2009. This amount represents one-quarter of 1% of our risk-weighted assets as of March 31, 2009. PNC intends to satisfy this requirement through a combination of growth in retained earnings and the pursuit of other capital raising alternatives.
RECENT MARKET AND INDUSTRY DEVELOPMENTS
Since the middle of 2007 and with a heightened level of activity during the second half of 2008 and into 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 Treasurys TARP and TARP Capital Purchase Program, the FDICs Temporary Liquidity Guarantee Program (TLGP) and the Federal Reserves Commercial Paper Funding Facility (CPFF).
These programs, some of which are further described in Item 7 of our 2008 Form 10-K, include the following:
TARP Capital Purchase Program 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. 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 its issuance. After December 31, 2013, if these shares are still outstanding, the annual dividend rate will increase to 9% per year. We plan to redeem the US Treasurys investment as soon as appropriate, subject to approval by our primary banking regulators. We do not contemplate exchanging any of the shares of preferred stock issued to the US Treasury under the TARP Capital Purchase Program for shares of mandatorily convertible preferred stock.
Further information on these securities is included in Note 19 Shareholders Equity included in our Notes to Consolidated Financial Statements within Item 8 of the 2008 Form 10-K.
FDIC Temporary Liquidity Guarantee Program (TLGP) In December 2008, PNC Funding Corp issued fixed and floating rate senior notes totaling $2.9 billion under the FDICs TLGP-Debt Guarantee Program. In March 2009, PNC Funding Corp issued floating rate senior notes totaling $1.0 billion under this program. 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.
Since October 14, 2008, both PNC Bank, National Association (PNC Bank, N.A.) and National City Bank have participated 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 FDICs general deposit insurance rules.
Commercial Paper Funding Facility Effective October 28, 2008, Market Street Funding LLC (Market Street) was approved to participate in the Federal Reserves CPFF. The CPFF commitment to purchase up to $5.4 billion of three-month Market Street commercial paper expires on October 30, 2009. Market Street had no borrowings under this facility at March 31, 2009.
Public-Private Investment Programs On March 23, 2009, the US Treasury and the FDIC announced that they will establish the Legacy Loans Program (LLP) to remove troubled loans and other assets from banks. The FDIC will provide oversight for the formation, funding, and operation of new public-private investment funds (PPIFs) that will purchase loans and other assets from depository institutions. The LLP will attract private capital through an FDIC debt guarantee and Treasury equity co-investment. All FDIC-insured depository institutions will be eligible to participate in the program.
On March 23, 2009, the US Treasury also announced the establishment of the Legacy Securities PPIFs, which are designed to address issues raised by troubled assets. These Legacy Securities PPIFs are specifically focused on legacy securities and are part of a plan that directs both equity capital and debt financing into the market for legacy assets. This program is designed to draw in private capital to these markets by providing matching equity capital from the US Treasury and debt financing from the Federal Reserve via the TALF and the US Treasury.
PNC is in the process of determining to what extent, if any, it will participate in these programs.
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 include 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 PNCs 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 such as those outlined above:
In addition, our success will depend, among other things, upon:
SUMMARY FINANCIAL RESULTS
Highlights of the first quarter of 2009 included the following:
Our Consolidated Income Statement Review section of this Financial Review describes in greater detail the various items that impacted our results for the first quarters of 2009 and 2008.
AVERAGE CONSOLIDATED BALANCE SHEET HIGHLIGHTS
Various seasonal and other factors impact our period-end balances whereas average balances are generally more indicative of underlying business trends apart from the impact of recent acquisitions.
Our Average Consolidated Balance Sheet for the first quarter of 2009 included the impact of National City, which was the primary driver of increases compared with the first quarter of 2008. The Consolidated Balance Sheet Review section of this Financial Review provides information on changes in selected Consolidated Balance Sheet categories at March 31, 2009 compared with December 31, 2008.
Total average assets were $280.9 billion for the first three months of 2009 compared with $140.6 billion for the first three months of 2008. Total average assets for the first three months of 2009 included $134.9 billion related to National City.
Average interest-earning assets were $244.2 billion for the first quarter of 2009, including $123.5 billion related to National City, compared with $111.3 billion in the first quarter of 2008. An increase of $104.5 billion in loans, including $98.2 billion related to National City, and a $16.2 billion increase in securities available for sale, including $13.1 billion related to National City, were reflected in the increase in average interest-earning assets. In addition, securities held to maturity, including those transferred by PNC in the fourth quarter of 2008 from the available for sale portfolio, averaged $3.4 billion in the first quarter of 2009.
Average noninterest-earning assets totaled $36.6 billion in the first quarter of 2009 compared with $29.2 billion in the prior year quarter.
The increase in average total loans, which includes the impact of National City as indicated above, reflected growth in commercial loans of $37.7 billion, consumer loans of $33.7 billion, commercial real estate loans of $16.6 billion and residential mortgage loans of $12.5 billion. Loans represented 71% of average interest-earning assets for the first three months of 2009 and 62% for the first three months of 2008.
Average residential mortgage-backed securities increased $15.7 billion compared with the first quarter of 2008. Average US Treasury and government agencies securities increased $1.1 billion and average state and municipal securities increased $.9 billion in the comparison. These increases were largely as a result of the National City acquisition and were partially offset by declines of $1.3 billion in average commercial mortgage-backed securities and $.8 billion in average asset-backed securities compared with the prior year quarter. Investment securities comprised 20% of average interest-earning assets for the first three months of 2009 and 27% for the first three months of 2008.
Average total deposits were $192.2 billion for the first three months of 2009, including $104.0 billion related to National City, compared with $81.6 billion for the first three months of 2008. Average deposits grew from the prior year period primarily as a result of increases in money market balances, retail certificates of deposit, and demand and other noninterest-bearing deposits. Average total deposits represented 68% of average total assets for the first three months of 2009 and 58% for the first three months of 2008.
Average transaction deposits were $113.5 billion for the first three months of 2009, including $49.6 billion related to National City, compared with $52.5 billion for the first three months of 2008.
Average borrowed funds were $47.9 billion for the first quarter of 2009, including $21.1 billion related to National City, compared with $32.1 billion for the first quarter of 2008.
BUSINESS SEGMENT HIGHLIGHTS
In the first quarter of 2009, we made changes to our business organization structure and management reporting in conjunction with the acquisition of National City. As a result, we now have seven reportable business segments which include:
Business segment results for the first quarter of 2008 have been reclassified to present prior periods on the same basis.
Total business segment earnings were $750 million for the first three months of 2009 and $289 million for the first three months of 2008. Highlights of results for the first quarters of 2009 and 2008 are included below. The Business Segments Review section of this Financial Review includes further analysis of our business segment results over these periods.
We provide a reconciliation of total business segment earnings to total PNC consolidated net income as reported on a GAAP basis in Note 19 Segment Reporting.
Retail Banking earned $56 million for the first quarter of 2009. Results for the quarter were challenged in this environment by ongoing credit deterioration, a lower value assigned to deposits in a declining rate environment, reduced consumer spending and increased FDIC insurance costs. Retail Banking continues to maintain its focus on customer growth, employee and customer satisfaction, investing in the business for future growth, as well as disciplined expense management during this period of market and economic uncertainty.
Corporate & Institutional Banking
Corporate & Institutional Banking earned $374 million in the first quarter of 2009. Total revenue of $1.3 billion was strong given the current environment, driven primarily by net interest income. Noninterest expense was tightly managed, and earnings were impacted by the provision for credit losses, indicative of deteriorating credit quality occurring throughout the economy.
Asset Management Group
Earnings from the Asset Management Group totaled $38 million in the first quarter of 2009 compared with $37 million in the prior year first quarter. The current period earnings reflects new business obtained from National City offset by lower noninterest income and higher provision for credit losses stemming from the depressed equity markets and continued economic challenges. This business segment was formed in the first quarter of 2009.
Residential Mortgage Banking
Residential Mortgage Banking earned $226 million for the first quarter of 2009 driven by strong loan origination activity and income from servicing rights. This business segment was formed in the first quarter of 2009 and consists primarily of activities acquired with National City.
Our BlackRock business segment earned $23 million for the first quarter of 2009 compared with $60 million for the first quarter of 2008. Lower equity markets in the first quarter of 2009 impacted BlackRocks results.
Global Investment Servicing
Global Investment Servicing earned $10 million for the first quarter of 2009 compared with $30 million for the same period of 2008. Results for 2009 were negatively impacted by continued declines in asset values and fund redemptions as a result of the deterioration of the financial markets that began in the fourth quarter of 2008 and the establishment of a legal contingency reserve.
Distressed Assets Portfolio
This business segment was formed in the first quarter of 2009 and consists primarily of assets acquired with National City. The Distressed Assets Portfolio had earnings of $23 million for the first quarter of 2009. Earnings were mainly driven by net interest income of $364 million. Further deterioration of credit quality occurred on the loans in this segment during the quarter.
Other reported a net loss of $220 million for the first quarter of 2009 compared with earnings of $95 million for the first quarter of 2008. The loss for the first quarter of 2009 included the after-tax impact of other-than-temporary impairment charges and alternative investment writedowns, equity management losses and integration costs. These items were somewhat offset by a gain related to PNCs BlackRock LTIP shares obligation and net gains on sales of securities. Earnings for the first quarter of 2008 reflected net securities gains and the partial reversal of the Visa indemnification liability, partially offset by trading losses.
CONSOLIDATED INCOME STATEMENT REVIEW
Our Consolidated Income Statement is presented in Part I, Item 1 of this Report. Net income for the first three months of 2009 was $530 million and for the first three months of 2008 was $384 million. Our Consolidated Income Statement for the first quarter of 2009 includes operating results of National City. As a result, the substantial increase in all income statement comparisons to the first quarter of 2008, except as noted, are primarily due to the operating results of National City.
NET INTEREST INCOME AND NET INTEREST MARGIN
In addition to the first quarter 2009 impact of National City, changes in net interest income and margin result from the interaction of the volume and composition of interest-earning assets and related yields, interest-bearing liabilities and related rates paid, and noninterest-bearing sources of funding. See the Statistical Information Average Consolidated Balance Sheet And Net Interest Analysis section of this Report for additional information.
The increase in net interest income for the first three months of 2009 compared with the first three months of 2008 reflected the increase in average interest-earning assets due to National City and the improvement in the net interest margin described below.
We expect net interest income and net interest margin for the remainder of 2009 to be flat to down compared with the first quarter of 2009 as the maturity of higher-yielding assets will be partially offset by interest-bearing deposit re-pricing, assuming our current expectations for interest rates and economic conditions. We include our current economic assumptions underlying our forward-looking statements in the Cautionary Statement Regarding Forward-Looking Information section of this Financial Review.
The net interest margin was 3.81% for the first three months of 2009 and 3.09% for the first three months of 2008. The following factors impacted the comparison:
For comparing to the broader market, during the first three months of 2009 the average federal funds rate was .19% compared with 3.17% for the first three months of 2008.
Noninterest income totaled $1.566 billion for the first three months of 2009 compared with $967 million for the first three months of 2008. Noninterest income for the first quarter of 2009 included $945 million of noninterest income related to National City.
First quarter 2009 noninterest income included the following:
Noninterest income for the first three months of 2008 included the impact of the following:
Fund servicing fees totaled $199 million in the first three months of 2009 compared with $228 million in the first three months of 2008. Asset management revenue was $189 million in the first three months of 2009 compared with $212 million in the first three months of 2008. Fund servicing fees and asset management revenue were negatively impacted by declines in asset values associated with the lower equity markets during the first three months of 2009. We believe that the equity markets may rebound in 2009 in advance of an economic recovery resulting in improvement to these components of our fee-based income.
Assets managed at March 31, 2009 totaled $96 billion, including National City assets under management, compared with $66 billion at March 31, 2008.
Global Investment Servicing provided fund accounting/ administration services for $712 billion of net fund investment assets and provided custody services for $361 billion of fund investment assets at March 31, 2009, compared with $1.0 trillion and $476 billion, respectively, at March 31, 2008. The decrease in assets serviced in the comparison was due to declines in asset values and fund outflows resulting from market conditions.
For the first quarter of 2009, consumer services fees totaled $316 million, including $180 million related to National City, compared with $170 million in the first quarter of 2008. Consumer service fees in the 2009 period reflected higher card-related revenue more than offset by reduced consumer transaction volumes related to the economy.
Corporate services revenue totaled $245 million in the first three months of 2009, including $73 million related to
National City, and $164 million in the first quarter of 2008. Corporate services fees include treasury management fees, which continued to be a strong contributor to revenue.
Residential mortgage revenue totaled $431 million in the first quarter of 2009. Substantially all of this revenue is associated with National Citys business. Strong mortgage refinancing volumes and $202 million of net hedging gains of mortgage servicing rights occurred in the first quarter of 2009. It is unlikely that we will repeat this strong performance in future periods, particularly the servicing rights hedging gains.
Service charges on deposits totaled $224 million for the first three months of 2009, including $137 million related to National City, and $82 million for the first three months of 2008. Service charges on deposits increased despite declining customer transaction amounts and volumes.
Net gains on sales of securities totaled $56 million for the first quarter of 2009 and $41 million for the first quarter of 2008.
The net credit component of other-than-temporary impairments of securities recognized in earnings was a loss of $149 million in the first three months of 2009. The non-credit component of the fair value mark on these securities of $537 million, which related to market factors, was included in accumulated other comprehensive loss in shareholders equity at March 31, 2009. There were no other-than-temporary impairments recognized in the first three months of 2008.
Other noninterest income totaled $55 million for the first quarter of 2009 compared with $70 million for the first quarter of 2008. Other noninterest income for 2009 included gains of $103 million related to our equity investment in BlackRock and net losses on private equity and alternative investments of $122 million as referred to above.
Other noninterest income for 2008 included 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 gains of $40 million related to our equity investment in BlackRock as described above. The impact of these items was more than offset by losses related to our commercial mortgage loans held for sale, net of hedges, of $166 million, and trading losses of $76 million.
Other noninterest income typically fluctuates from period to period depending on the nature and magnitude of transactions completed. Further details regarding our trading activities are included in the Market Risk Management Trading Risk portion of the Risk Management section of this Financial Review, further details regarding private equity and alternative investments are included in the Market Risk Management-Equity and Other Investment Risk section and further details regarding gains or losses related to our equity investment in BlackRock are included in the Business Segments Review section.
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 banking activities, 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, doubled in the first quarter of 2009, to $275 million, compared with $137 million in the first quarter of 2008. In addition to the impact of National City, these increases were primarily related to deposit growth and continued growth in legacy offerings such as lockbox, purchasing cards and services provided to the federal government.
Revenue from capital markets-related products and services totaled $43 million in the first three months of 2009 compared with $76 million in the first three months of 2008. The revenue decline was driven by reduced merger and acquisition revenues reflecting the difficult financing environment along with lower customer trading revenues impacted by reduced derivative activity levels and the impact of counterparty credit on valuations of customer positions. These revenue declines were partially offset by National City-related revenues in 2009.
Commercial mortgage banking activities include revenue derived from commercial mortgage servicing (including net interest income and noninterest income from loan servicing and ancillary services), and revenue derived from commercial mortgage loans intended for sale and related hedges (including loan origination fees, net interest income, valuation adjustments and gains or losses on sales).
Commercial mortgage banking activities resulted in revenue of $94 million in the first quarter of 2009 compared with a $94 million loss for the first quarter of 2008. The loss for the first three months of 2008 reflected losses of $166 million on commercial mortgage loans held for sale, net of hedges, due to the impact of an illiquid market in 2008.
PROVISION FOR CREDIT LOSSES
The provision for credit losses totaled $880 million for the first three months of 2009 compared with $151 million for the first three months of 2008. The provision for credit losses for the first quarter of 2009 was in excess of net charge-offs of $431 million for the period due to a required increase to our allowance for loan and lease losses reflecting continued deterioration in the credit markets and the resulting increase in nonperforming loans.
The Credit Risk Management portion of the Risk Management section of this Financial Review includes additional information regarding factors impacting the provision for credit losses.
Noninterest expense for the first quarter of 2009 was $2.3 billion compared with $1.0 billion in the prior year first quarter, with the increase substantially related to National City. Acquisition cost savings of approximately $400 million annualized were realized in the first quarter of 2009, on plan to reach our goal of annualized cost savings of $1.2 billion at the end of two years.
Integration costs totaled $52 million in the first quarter of 2009 compared with $14 million in the first quarter of 2008.
We expect that the FDIC will enact a special deposit insurance assessment in 2009 that will significantly increase our FDIC deposit insurance costs for the year.
EFFECTIVE TAX RATE
Our effective tax rate was 20.1% for the first three months of 2009 and 39.5% for the first three months of 2008. A favorable agreement to settle with taxing authorities in the first quarter of 2009 contributed to the lower effective tax rate in that period and higher taxes related to the gain on sale of Hilliard Lyons in the first quarter of 2008 contributed to the higher effective tax rate in that period.
SUMMARIZED BALANCE SHEET DATA
The summarized balance sheet data above is based upon our Consolidated Balance Sheet in Part I, Item 1 of this Report.
An analysis of changes in selected balance sheet categories follows.
A summary of the major categories of loans outstanding follows. Outstanding loan balances reflect unearned income, unamortized discount and premium, and purchase discounts and premiums totaling $3.5 billion at March 31, 2009 and $4.1 billion at December 31, 2008, respectively.
Loans decreased $4.1 billion, or 2%, as of March 31, 2009 compared with December 31, 2008. Total loans represented 60% of total assets at both March 31, 2009 and December 31, 2008.
Commercial lending represented 57% of the loan portfolio and consumer lending represented 43% at March 31, 2009. Commercial lending declined 4% at March 31, 2009 compared with December 31, 2008. Commercial loans, which comprised 67% of total commercial lending, declined due to lower utilization levels and paydowns. Consumer lending increased slightly at March 31, 2009 from December 31, 2008. Increases in education and residential mortgage loans were somewhat offset by a decline in home equity installment loans.
Details Of Loans
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.
Our home equity lines and loans outstanding totaled $37.0 billion at March 31, 2009 and $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 March 31, 2009 and December 31, 2008.
In our $19.7 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 $3.3 billion and comprised approximately 17% of this portfolio at March 31, 2009. The comparable amounts related to the $18.8 billion residential mortgage portfolio as of December 31, 2008 were $2.5 billion and 14%, respectively.
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 $2.8 billion, or 65%, of the total allowance for loan and lease losses at March 31, 2009 to these loans. We allocated $1.5 billion, or 35%, of the remaining allowance at that date to consumer lending outstandings. This allocation also considers other relevant factors such as:
Net unfunded credit commitments are comprised of the following:
Net Unfunded Credit Commitments
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 $8.7 billion at March 31, 2009 and $8.6 billion at December 31, 2008.
Unfunded liquidity facility commitments and standby bond purchase agreements totaled $6.7 billion at March 31, 2009 and $7.0 billion at December 31, 2008 and are included in the preceding table primarily within the Commercial and commercial real estate category.
In addition to credit commitments, our net outstanding standby letters of credit totaled $10.3 billion at March 31, 2009 and December 31, 2008. Standby letters of credit commit us to make payments on behalf of our customers if specified future events occur.
Details Of Investment Securities
Investment securities totaled $46.3 billion at March 31, 2009 and $43.5 billion at December 31, 2008. The increase in securities of $2.8 billion since year-end reflected the purchase of US Treasury and government agency securities, somewhat offset by maturities and prepayments. Securities represented 16% of total assets at March 31, 2009 and 15% of total assets at December 31, 2008.
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.
At March 31, 2009, the investment securities balance included a net unrealized loss of $4.4 billion, which represented the difference between fair value and amortized cost. The comparable amount at December 31, 2008 was a net unrealized loss of $5.4 billion. The fair value of investment securities is impacted by interest rates, credit spreads, and market volatility and illiquidity. The improvement in the unrealized pretax loss from year-end was the result of improving fair values in both agency and nonagency securities. The net unrealized losses at March 31, 2009 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 and US Treasury and government agencies securities collectively represented 56% of the investment securities portfolio at March 31, 2009.
FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments, was issued in April 2009 and amended other-than-temporary impairment (OTTI) guidance for debt securities regarding recognition and disclosure. The major change in the guidance was the requirement to recognize only the credit portion of OTTI charges in current earnings for those debt securities where there is no intent to sell or it is more likely than not the entity would not be required to sell the security prior to expected recovery. The remaining portion of OTTI charges is included in accumulated other comprehensive loss.
As permitted, PNC adopted this guidance effective January 1, 2009. As a result, we recognized total OTTI in the first quarter of 2009 of $686 million, comprised of $537 million in accumulated other comprehensive loss on the Consolidated Balance Sheet at March 31, 2009, and $149 million recognized as a reduction of noninterest income in our Consolidated Income Statement. Note 7 Investment Securities in the Notes To Consolidated Financial Statements of this Report provides further information regarding the credit portion of OTTI recognized in the first quarter of 2009.
As required under the new FASB guidance, we also recorded a cumulative effect adjustment of $110 million to retained earnings at January 1, 2009 to reclassify the noncredit component of OTTI recognized in 2008 from retained earnings to accumulated other comprehensive loss.
We also early adopted FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, during the first quarter of 2009. The Fair Value Measurements and Fair Value Option section of this Financial Review has additional information related to FSP FAS 157-4.
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, and Balance Sheet Risk Management. The senior management team considers the results of the assessments, as well as other factors, in determining whether the impairment is other-than-temporary. The Fair Value Measurements And Fair Value Option section of this Financial Review provides further detail on the composition of our securities portfolio, including vintage, credit rating, and FICO score, where applicable. Note 7 Investment Securities in the Notes To Consolidated Financial Statements of this Report includes a further discussion of our process for assessing OTTI and the results of the most recent assessment.
If the current issues affecting the US housing market were to continue for the foreseeable future or worsen, 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 and we could incur additional OTTI charges that would impact our Consolidated Income Statement.
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 5 months at March 31, 2009 and 3 years and 1 month at December 31, 2008.
We estimate that at March 31, 2009 the effective duration of investment securities was 2.3 years for an immediate 50 basis points parallel increase in interest rates and 1.9 years for an immediate 50 basis points parallel decrease in interest rates. Comparable amounts at December 31, 2008 were 3.7 years and 3.1 years, respectively.
LOANS HELD FOR SALE
Under SFAS 159, we account for certain commercial and residential mortgage loans held for sale at fair value.
We stopped originating certain commercial mortgage loans held for sale at fair value during the first quarter of 2008 and intend to continue pursuing opportunities to reduce these positions at appropriate prices. We sold $.1 billion of commercial mortgage loans held for sale carried at fair value in the first quarter of 2009 and recognized losses of $1 million on these loans, net of hedges. Losses of $166 million on commercial mortgage loans held for sale carried at fair value, net of hedges, were recognized in the first quarter of 2008.
Strong origination volumes partially offset sales to government agencies of $1.6 billion of commercial mortgages held for sale at lower of cost or market during the first quarter of 2009.
Residential mortgage loans held for sale increased during the first quarter of 2009 due to strong refinancing volumes. Loan origination volume was $6.9 billion. Substantially all such loans were originated to agency standards. We sold $6.3 billion of this production, recognizing revenue of $175 million, during the first quarter of 2009. Net interest income on residential mortgage loans held for sale was $87 million for the first quarter of 2009.
FUNDING AND CAPITAL SOURCES
Details Of Funding Sources
Total funding sources decreased $2.0 billion at March 31, 2009 compared with the balance at December 31, 2008 as an increase in total deposits was more than offset by a decline in total borrowed funds.
Total deposits increased $1.8 billion at March 31, 2009 compared with December 31, 2008 as growth in money market deposits was partially offset by the decline of higher rate non-relationship certificates of deposit. Interest-bearing deposits represented 79% of total deposits at March 31, 2009 compared with 81% of total deposits at December 31, 2008.
Borrowed funds totaled $48.5 billion at March 31, 2009 compared with $52.2 billion at December 31, 2008. The $3.7 billion decline primarily resulted from repayments of Federal Home Loan Bank and other borrowings. PNC issued $1.0 billion of senior notes guaranteed by the FDIC under the Temporary Liquidity Guarantee Program in the first quarter of 2009. The Liquidity Risk Management section of this Financial Review contains further details regarding actions we have taken which impacted our borrowed funds balances in 2009.
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. The reduction in our quarterly common stock dividend beginning in April 2009 is expected to add $1 billion annually to PNCs common equity and cash positions, resulting in annual improvement in capital ratios of approximately 40 basis points.
Total shareholders equity increased $1.1 billion, to $26.5 billion, at March 31, 2009 compared with December 31, 2008 primarily due to a $.7 billion decline in accumulated other comprehensive loss and an increase of $.3 billion in retained earnings. The Investment Securities section has further information regarding the accumulated other comprehensive loss.
Common shares outstanding were 445 million at March 31, 2009 and 443 million at December 31, 2008.
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 the first quarter of 2009 under this program and, as described below, are restricted from doing so under the TARP Capital Purchase Program.
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, under the TARP Capital Purchase Program agreements, the US Treasurys consent will be required for any increase in common dividends per share above $.66 per share quarterly 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 Treasurys 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. Any increase in our dividends while we remain subject to these restrictions would depend on the status of our efforts to put ourselves into position to redeem the US Treasurys investment in PNC.
Capital levels were strengthened during the first quarter of 2009. Higher capital levels were net of dividend payments, including $47 million paid to the US Department of the Treasury during the first quarter of 2009 on $7.6 billion of preferred stock. We plan to redeem the Treasury Departments investment as soon as appropriate, subject to approval by our primary banking regulators.
As described in the Executive Summary section of this Financial Review, as a result of the Supervisory Capital Assessment Program, we will be required to increase our Tier 1 common capital by $600 million by November 9, 2009. We intend to do so through a combination of growth in retained earnings and other capital raising alternatives. We do not contemplate exchanging any of the shares of preferred stock issued to the US Treasury under the TARP Capital Purchase Program for shares of mandatorily convertible preferred stock.
PNCs Tier 1 risk-based capital ratio increased by 30 basis points to 10.0% at March 31, 2009 from 9.7% at December 31, 2008. The increase in the ratio was due to higher risk-based capital primarily from retained earnings coupled with a decline in risk-weighted assets. Our Tier 1 common capital ratio was 4.9% at March 31, 2009.
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 PNCs adjusted average total assets.
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 March 31, 2009 and December 31, 2008, each of our domestic bank subsidiaries was considered well capitalized based on US regulatory capital ratio requirements, which are indicated on page 2 of this Report. We believe our bank subsidiaries will continue to meet these requirements during the remainder of 2009.
OFF-BALANCE SHEET ARRANGEMENTS AND VARIABLE INTEREST ENTITIES
We engage in a variety of activities that involve unconsolidated entities or that are otherwise not reflected in our Consolidated Balance Sheet that are generally referred to as off-balance sheet arrangements. The following sections of this Report provide further information on these types of activities:
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 March 31, 2009 and December 31, 2008.
Consolidated VIEs PNC Is Primary Beneficiary
Non-Consolidated VIEs Significant Variable Interests
Market Street Funding LLC (Market Street) is a multi-seller asset-backed commercial paper conduit that is owned by an independent third party. Market Streets 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 & Poors and Moodys, 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 2008 and the first quarter of 2009, Market Street met all of its funding needs through the issuance of commercial paper.
Market Street commercial paper outstanding was $4.1 billion at March 31, 2009 and $4.4 billion at December 31, 2008. The
weighted average maturity of the commercial paper was 27 days at March 31, 2009 compared with 24 days at December 31, 2008.
Effective October 28, 2008, Market Street was approved to participate in the Federal Reserves 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 March 31, 2009, Market Street did not have any outstandings in the CPFF.
During the first quarter of 2009, PNC Capital Markets, acting as a placement agent for Market Street, held a maximum daily position in Market Street commercial paper of $8 million with an average of $5 million. This compares with a maximum daily position of $75 million with an average of $12 million for the year ended December 31, 2008. PNC Capital Markets owned $8 million of Market Street commercial paper at March 31, 2009 and none at December 31, 2008. PNC Bank, N.A. made no purchases of Market Street commercial paper during the first quarter of 2009.
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. Program administrator fees and commitment fees related to PNCs portion of the liquidity facilities for the first quarters of 2009 and 2008 were insignificant.
The commercial paper obligations at March 31, 2009 and December 31, 2008 were effectively collateralized by Market Streets assets. While PNC may be obligated to fund under the $6.1 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 18 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.
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 $8.0 million as of March 31, 2009. 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.
Assets of Market Street Funding LLC (a)
Market Street Commitments by Credit Rating (a)
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 March 31, 2009, this loss would not be material. In addition, the consolidation of Market Street would have minimal to no impact on our risk-weighted assets, risk-based capital ratios or debt covenants.
Credit Risk Transfer Transaction
PNCs subsidiary, 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 and currently holds the right to put certain tranches of the mezzanine notes to the independent third-party at par. NCB holds the senior notes and will be responsible for credit losses in excess of the mezzanine securities.
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 certain of the asset-backed securities. Accordingly, this SPE was consolidated and all of the entitys assets, liabilities, and equity associated with the note tranches held by NCB 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 $661 million at March 31, 2009.
At March 31, 2009, the carrying value of the mezzanine notes held by NCB was $153 million. During the first quarter of 2009, cumulative credit losses in the mortgage loan pool
surpassed the principal balance of subordinated equity notes, giving NCB the right to put the first mezzanine note to the third party in accordance with the credit risk transfer agreement. As a result, NCB exercised its put option and received $16 million for this mezzanine note. In April 2009, NCB entered into negotiations with the third party to terminate a portion of each partys rights and obligations under the credit risk transfer agreement. In exchange for a $105 million payment received from the third party, NCB agreed to terminate its contractual right to put the two senior mezzanine note tranches to the third party. A pretax gain of $8 million was recognized in connection with this transaction.
Management assessed what impact the reconsideration events above would have on determining whether NCB would remain the primary beneficiary of the SPE. Management concluded that NCB 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.
Our 2008 Form 10-K includes additional information regarding the Trust I and Trust II Securities, including descriptions of replacement capital covenants.
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 PNCs capital stock for any other class or series of PNCs 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 Es 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 as described more fully in our 2008 Form 10-K.
Acquired Entity Trust Preferred Securities
As a result of the National City acquisition, we assumed obligations with respect to $2.4 billion in principal amount of junior subordinated debentures issued by the acquired entity. Under the terms of these debentures and $158 million in principal amount of similar debentures assumed as a result of prior acquisitions, 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 PNCs guarantee of such payment obligations, PNC would be subject during the period of such default or deferral to restrictions on dividends and other provisions protecting the status of the debenture holders similar to or in some ways more restrictive than those potentially imposed under the Exchange Agreements with Trust II and Trust III, as described above.
As more fully described in our 2008 Form 10-K, we are subject to replacement capital covenants with respect to four tranches of junior subordinated debentures inherited from National City as well as a replacement capital covenant with respect to our Series L Preferred Stock.
FAIR VALUE MEASUREMENTS AND FAIR VALUE OPTION
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. See Note 8 Fair Value in the Notes To Consolidated Financial Statements under Part 1, Item 1 of this Report for further information. FSP FAS 157-4 was issued in April 2009 and provides additional guidance for estimating fair values when the volume and level of activity for the asset or liability have significantly decreased. It also provides guidance on identifying circumstances that indicate a transaction is not orderly. As permitted, PNC adopted this guidance effective January 1, 2009.
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 acquired from National City on December 31, 2008 are excluded from our SFAS 157 and SFAS 159 disclosures as of that date, but are included as of and for the three months ended March 31, 2009.
At March 31, 2009, assets recorded at fair value represented 20% of total assets and fair value liabilities represented 2% of total liabilities compared with 13% of total assets and 2% of total liabilities as of December 31, 2008.
Fair Value Measurements Summary
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 Part I, Item 1 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 and are based on current information. Inactive markets are typically
characterized by low transaction volumes, price quotations which vary substantially among market participants or are not based on current information, wide bid/ask spreads, a significant increase in implied liquidity risk premiums, yields, or performance indicators for observed transactions or quoted prices compared to historical periods, a significant decline or absence of a market for new issuance, or any combination of the above factors. We also consider nonperformance risks including credit risk as part of our valuation methodology for all assets and liabilities measured at fair value. Any models used to determine fair values or to validate dealer quotes based on the descriptions below are subject to review and independent testing as part of our model validation and internal control testing processes. Our Model Validation Committee tests significant models on at least an annual basis. In addition, we have teams, independent of the traders, verify marks and assumptions used for valuations at each period end.
Securities 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 60% of our positions are valued using prices obtained from pricing services provided by the Barclays Capital Index, formerly known as the Lehman Index, and Interactive Data Corp. (IDC) and for approximately 30% more of our positions, we use prices obtained from the pricing services as an input into the valuation process. Barclays Capital 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 pricing models considering adjustments for ratings, spreads, matrix pricing and prepayments for the instruments we value using this service, such as non-agency residential mortgage-backed securities, agency adjustable rate mortgage securities, agency CMOs and municipal bonds. 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. In circumstances where relevant market prices are limited or unavailable, valuations may require significant management judgments or adjustments to determine fair value. In these cases, the securities are classified as Level 3.
The valuation techniques used for securities classified as Level 3 include identifying a proxy security, market transaction or index along with, in certain instances, using a discounted cash flow approach. 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 securities, single dealer quotes, and/or other observable and unobservable inputs. For certain security types, primarily non-agency residential and commercial mortgage-backed securities, the fair value methodology incorporates values obtained from a discounted cash flow model. The modeling process incorporates assumptions management believes willing market participants would use to value the security under current market conditions. The assumptions used include prepayment projections, credit loss assumptions, and discount rates, which include a risk premium due to liquidity and uncertainty, that are based on both observable and unobservable inputs. We use the discounted cash flow analysis, in conjunction with other relevant pricing information obtained from either pricing services or broker quotes to establish the fair value that management believes is representative under current market conditions. Management has applied this approach to an increasing number of positions over the past several quarters as the level of market activity for these assets has significantly decreased. For purposes of determining fair value at March 31, 2009, the relevant pricing information was the predominant input.
The following table provides additional information on fair values and net unrealized losses for certain of our available for sale securities. Note 7 Investment Securities in the Notes To Consolidated Financial Statements of this Report includes further discussion of our process for assessing OTTI and the results of the most recent assessment.
Residential Mortgage-Backed Securities
At March 31, 2009, our residential mortgage-backed securities portfolio was comprised of $23.6 billion fair value of US government agency-backed securities compared with $12.7 billion fair value at December 31, 2008 and $9.3 billion fair value of private-issuer securities compared with $7.4 billion fair value at December 31, 2008. 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 non-conforming (i.e., original balances in excess of the amount qualifying for agency securities) and predominately have interest rates that are fixed for a period of time, after which the rate adjusts to a floating rate based upon
a contractual spread that is indexed to a market rate (i.e., a hybrid ARM), or interest rates that are fixed for the term of the loan.
Substantially all of the 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 March 31, 2009, $2.4 billion, or 26%, of private-issuer securities were rated below BBB by at least one national rating agency or not rated. 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 39 non-agency residential mortgage-backed securities, we recorded OTTI charges of $118 million in the first quarter of 2009. Seven of these securities, with remaining fair value of $117 million, were rated investment grade (three AAA, three AA, and one BBB). Of the remaining securities for which we recorded OTTI, two were rated BB-equivalent (remaining fair value of $19 million), seven were rated B-equivalent (remaining fair value of $101 million), and 23 were rated lower than B-equivalent (remaining fair value $417 million). Prior to the first quarter of 2009, we recorded OTTI charges for eight securities. At March 31, 2009, one of these securities was rated B-equivalent (remaining fair value of $35 million) and seven of these securities were rated lower than B-equivalent (remaining fair value $155 million).
For the sub-investment grade securities for which we have not recorded an OTTI through March 31, 2009, the remaining fair value was $1.7 billion. The results of our security-level assessments indicate that we will recover the entire cost basis of these securities. Refer to Note 7 Investment Securities in the Notes To Consolidated Financial Statements of this Report for a further discussion of our process for assessing OTTI and the results of the most recent assessment.
Commercial Mortgage-Backed Securities
The commercial mortgage-backed securities portfolio was $3.4 billion fair value at March 31, 2009 and December 31, 2008 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 March 31, 2009 $15 million, or 1%, of the commercial mortgage-backed securities were not rated. At December 31, 2008, $18 million, or 1%, of the commercial mortgage-backed securities were not rated.
For three commercial mortgage-backed securities, we recorded OTTI charges of $5 million in the first quarter of 2009. All of these securities were rated B-equivalent or lower. The remaining fair value of these securities approximates zero. We recorded no OTTI charges prior to the first quarter of 2009 for commercial mortgage-backed securities.
Other Asset-Backed Securities
The asset-backed securities portfolio was $1.5 billion fair value at March 31, 2009 and December 31, 2008, and consisted of fixed-rate and floating-rate, private-issuer securities collateralized primarily by various consumer credit products, including second-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 March 31, 2009, $698 million, or 47%, of the asset-backed securities were rated below BBB by at least one national rating agency or not rated. 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 four asset-backed securities collateralized by residential mortgage loans, we recorded OTTI charges of $18 million in the first quarter of 2009. Three of these securities, with a remaining fair value of $69 million, were rated lower than B-equivalent and one, with a remaining fair value of $22 million, was rated A-equivalent. Prior to the first quarter of 2009, we recorded OTTI charges for seven securities. The remaining fair value of these securities, substantially all of which are currently rated lower than B-equivalent, totaled $106 million.
For the sub-investment grade securities for which we have not recorded an OTTI charge through March 31, 2009, the remaining fair value was $523 million. The results of our security-level assessments indicate that we will recover the entire cost basis of these securities. Refer to Note 7 Investment Securities in the Notes To Consolidated Financial Statements of this Report for a further discussion of our process for assessing OTTI and the results of the most recent assessment.
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 new loan pricing and considers externally available bond spreads, in conjunction with internal historical recovery observations. The credit risk adjustment is not currently material to the overall derivatives valuation.
Commercial Mortgage Loans Held for Sale
We account for certain commercial mortgage loans held for sale at fair value under SFAS 159. 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. At origination, these loans were intended for securitization. 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. Due to inactivity in the CMBS securitization market in 2008 and 2009, we now determine the fair value of commercial mortgage loans held for sale under SFAS 159 by using a whole loan methodology. Fair value is determined using assumptions that management believes a market participant would use in pricing the loans. When available, valuation assumptions included observable inputs based on whole loan sales in the quarter. Adjustments are made to these assumptions to account when uncertainties exist, including market conditions, and liquidity. Based on the significance of unobservable inputs, we classified this portfolio as Level 3.
Customer Resale Agreements
We 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.
BlackRock Series C Preferred Stock
Effective February 27, 2009, we elected to account for the approximately 2.9 million shares of the BlackRock Series C Preferred Stock received in a stock exchange with BlackRock at fair value. The Series C Preferred Stock will economically hedge the BlackRock LTIP liability that is accounted for as a derivative. The fair value of the Series C Preferred Stock is determined using a third-party modeling approach, which includes both observable and unobservable inputs. This approach considers expectations of a default/liquidation event and the use of liquidity discounts based on our inability to sell the security at a fair, open market price in a timely manner. Due to the significance of unobservable inputs, this security is classified as Level 3.
Residential Mortgage Loans Held for Sale
We account for residential mortgage loans originated for sale at fair value on a recurring basis under SFAS 159. Residential mortgage loans are valued based on quoted market prices, where available, prices for other traded mortgage loans with similar characteristics, and purchase commitments and bid information received from market participants. These loans are regularly traded in active markets and observable pricing
information is available from market participants. The prices are adjusted as necessary to include the embedded servicing value in the loans and to take into consideration the specific characteristics of certain loans that are priced based on the pricing of similar loans. These adjustments represent unobservable inputs to the valuation but are not considered significant to the fair value of the loans. Accordingly, residential mortgage loans held for sale are classified as Level 2.
The valuation of direct and indirect private equity investments requires significant management judgment due to the absence of quoted market prices, inherent lack of liquidity and the long-term nature of such investments. The carrying values of direct and affiliated partnership interests reflect the expected exit price and are based on various techniques including 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.
Residential mortgage servicing rights
Residential mortgage servicing rights (MSRs) are carried at fair value on a recurring basis. These residential MSRs do not trade in an active open market with readily observable prices. Although sales of servicing assets do occur, the precise terms and conditions typically would not be available. Accordingly, management determines the fair value of its residential MSRs using a discounted cash flow model incorporating assumptions about loan prepayment rates, discount rates, servicing costs, and other economic factors. Management compares its fair value estimates to third-party valuations on a quarterly basis to assess the reasonableness of the fair values calculated by its internal valuation models. Due to the nature of the valuation inputs, residential MSRs are classified as Level 3.
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 March 31, 2009, Level 3 fair value assets of $18.5 billion represented 32% of total assets at fair value and 6% of total assets. At December 31, 2008, Level 3 fair value assets of $7.0 billion represented 19% of total assets at fair value and 2% of total assets. Level 3 fair value liabilities of $101 million at March 31, 2009 represented 2% of total liabilities at fair value and less than 1% of total liabilities at that date. 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 the first quarter of 2009, securities transferred into Level 3 from Level 2 exceeded securities transferred out by $8.2 billion. These primarily related to non-agency residential and commercial mortgaged-backed securities where management determined that the volume and level of activity for these assets had significantly decreased. The lack of relevant market activity for these securities resulted in management modifying its valuation methodology for the instruments transferred in the first quarter of 2009. Other Level 3 assets include commercial mortgage loans held for sale, certain equity securities, private equity investments, residential mortgage servicing rights and other assets. Unrealized gains and losses on available for sale securities do not impact liquidity or risk-based capital. However, reductions in the credit ratings of these securities would have an impact on the determination of risk-weighted assets which could reduce our regulatory capital ratios. In addition, the amount representing the credit-related portion of other-than-temporary impairments on available for sale securities would reduce our regulatory capital ratios.
Total securities measured at fair value at March 31, 2009 and 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 the first quarter of 2009, we made changes to our business organization structure and management reporting in conjunction with the acquisition of National City. As a result, we now have seven reportable business segments which include:
Business segment results for the first quarter of 2008 have been reclassified to present prior periods on the same basis.
Business segment results, including inter-segment revenues, and a description of each business are included in Note 19 Segment Reporting included in the Notes To Consolidated Financial Statements under Part I, Item 1 of this Report. Certain revenue and expense amounts included in this Financial Review differ from the amounts shown in Note 19 primarily due to the presentation in this Financial Review of business net interest revenue on a taxable-equivalent basis and income statement classification differences related to Global Investment Servicing.
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 shareholders 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.
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 for the first quarter of 2008, integration costs, asset and liability management activities including net securities gains or losses and certain trading activities, equity management activities, alternative investments, intercompany eliminations, most corporate overhead, and differences between business segment performance reporting and financial statement reporting (GAAP), including the presentation of net income attributable to noncontrolling interests.
Employee data as reported by each business segment in the table above reflects staff directly employed by the respective businesses and excludes operations, technology and staff services employees reported in the Other segment. Global Investment Servicing employees are stated on a legal entity basis.
Results Of Businesses Summary
Retail Bankings earnings were $56 million for the first quarter of 2009 compared with $137 million for the same period in 2008. The first quarter of 2009 includes revenues and expenses associated with business acquired with National City. These results were challenged in this environment by ongoing credit deterioration, a lower value assigned to our deposits, reduced consumer spending and increased FDIC insurance costs. Retail Banking continues to maintain its focus on customer growth, employee and customer satisfaction, investing in the business for future growth, as well as disciplined expense management during this period of market and economic uncertainty.
Highlights of Retail Bankings performance during the first quarter of 2009 include the following:
Total revenue for the first quarter of 2009 was $1.445 billion compared with $741 million for the same quarter in 2008. Net interest income of $928 million increased $523 million compared with 2008. The increase in net interest income was driven by the National City acquisition and partially offset by declines in legacy net interest income as a result of the negative impact of a lower value assigned to deposits in this low rate environment.
Noninterest income for the first quarter of 2009 was $517 million, an increase of $181 million over the prior year first quarter. The National City acquisition was the major factor for the increase, partially offset in the comparison by a $95 million gain from the redemption of Visa common shares in
the first quarter of 2008. In addition, core growth in consumer related fees has been negatively impacted by current economic conditions and a decline in consumer spending.
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 the first three months of 2009 was $303 million compared with $94 million in the first three months of 2008. Net charge-offs were $207 million for the first quarter of 2009 and $65 million in the same period of 2008. The increases in provision and net charge-offs were primarily a result of a loan portfolio that has increased 128%, including a significantly larger credit card portfolio, and the continued credit deterioration in both the commercial and consumer loan portfolios.
Given the current environment and the acquisition of National City, we believe the provision and nonperforming assets in 2009 will continue to exceed comparable 2008 levels.
Noninterest expense for the first quarter of 2009 totaled $1.063 billion, an increase of $641 million over the same period in 2008. Increases were attributable to the impact of acquisitions, continued investments in the business, and increased FDIC insurance costs.
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. In the first quarter of 2009, average total deposits increased $84.3 billion compared with the same period in 2008.
Currently, we are predominately 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.
In the first three months of 2009, average total loans were $57.3 billion, an increase of $32.2 billion over the same period in 2008.
CORPORATE & INSTITUTIONAL BANKING