TABLE OF CONTENTS

 

PART I				Page
Item 1		Business.		2
Item 1A		Risk Factors.		9
Item 1B		Unresolved Staff Comments.		12
Item 2		Properties.		12
Item 3		Legal Proceedings.		12
Item 4		Submission of Matters to a Vote of Security Holders.		14
		Executive Officers of the Registrant		14
		Directors of the Registrant		15
PART II
Item 5		Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.		15
		Common Stock Performance Graph		16
Item 6		Selected Financial Data.		17
Item 7		Management's Discussion and Analysis of Financial Condition and Results of Operations		19
Item 7A		Quantitative and Qualitative Disclosures About Market Risk.		64
Item 8		Financial Statements and Supplementary Data.		65
Item 9		Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.		123
Item 9A		Controls and Procedures.		123
Item 9B		Other Information.		123
PART III
Item 10		Directors, Executive Officers and Corporate Governance.		123
Item 11		Executive Compensation.		124
Item 12		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.		124
Item 13		Certain Relationships and Related Transactions, and Director Independence.		126
Item 14		Principal Accounting Fees and Services.		126
PART IV
Item 15		Exhibits, Financial Statement Schedules.		126
SIGNATURES				127
EXHIBIT INDEX				E-1

PART I

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

 

ITEM 1 – BUSINESS

BUSINESS OVERVIEW We are one of the largest diversified financial services companies in the United States based on assets, with businesses engaged in retail banking, corporate and institutional banking, asset management and global fund processing services. We provide many of our products and services nationally and others in our primary geographic markets located in Pennsylvania, New Jersey, Washington, DC, Maryland, Virginia, Ohio, Kentucky and Delaware. We also provide certain global fund processing services internationally. At December 31, 2007, our consolidated total assets, deposits and shareholders' equity were $138.9 billion, $82.7 billion and $14.9 billion, respectively.

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

ACQUISITION AND DIVESTITURE ACTIVITY On December 7, 2007, we acquired Albridge Solutions Inc. (“Albridge”), a Lawrenceville, New Jersey-based provider of portfolio accounting and enterprise wealth management services. Albridge provides financial advisors with consolidated client account information from hundreds of data sources, and its enterprise approach to providing a unified client view and performance reporting helps advisors build their client and asset base. Albridge will extend PFPC’s capabilities into the delivery of knowledge-based information services through its relationships with 150 financial institutions and more than 100,000 financial advisors with assets under management that exceed $1 trillion.

Also on December 7, 2007, we acquired Coates Analytics, LP (“Coates Analytics”), a Chadds Ford, Pennsylvania-based provider of web-based analytic tools that help asset managers identify wholesaler territories and financial advisor targets, promote products in the marketplace and strengthen competitive intelligence. Coates Analytics will complement PFPC’s business strategy as it currently serves six of the 10 largest broker/dealers and provides market data to more than 40 of the leading asset management and fund companies.

On November 16, 2007, we entered into a definitive agreement to sell J.J.B. Hilliard, W.L.Lyons, Inc. (“Hilliard Lyons”), a wholly-owned subsidiary of PNC and a full-service brokerage and financial services provider, to Houchens Industries, Inc. Hilliard Lyons is headquartered in Louisville, Kentucky and has 76 branch offices mainly in cities outside of PNC’s retail banking footprint with approximately $29 billion of brokerage account assets and $5 billion of assets under management. As a result of the sale, we expect to report an after-tax gain of approximately $20 million and increase

Tier 1 regulatory capital by approximately $135 million after elimination of goodwill recorded upon the purchase of

Hilliard Lyons in 1998. We expect this transaction to close in the first half of 2008, subject to regulatory and certain other required approvals.

On October 26, 2007, we acquired Hamilton, New Jersey-based Yardville National Bancorp (“Yardville”). Total consideration paid was approximately $399 million in stock and cash. Yardville’s subsidiary bank, The Yardville National Bank (“Yardville National Bank”), is a commercial and consumer bank and at closing had approximately $2.6 billion in assets, $2.0 billion in deposits and 35 branches in central New Jersey and eastern Pennsylvania. We plan to merge Yardville National Bank into PNC Bank, National Association (“PNC Bank, N.A.”) in the first quarter of 2008.

On July 19, 2007, we entered into a definitive agreement with Sterling Financial Corporation (“Sterling”) for PNC to acquire Sterling for approximately 4.5 million shares of PNC common stock and $224 million in cash. Sterling, based in Lancaster, Pennsylvania with approximately $3.2 billion in assets and $2.7 billion in deposits, provides banking and other financial services, including leasing, trust, investment and brokerage, to individuals and businesses through 67 branches in Pennsylvania, Maryland and Delaware. We expect this transaction to close in the second quarter of 2008, subject to customary closing conditions and the approval of Sterling’s shareholders.

On July 2, 2007, we acquired ARCS Commercial Mortgage Co., L.P. (“ARCS”), a Calabasas Hills, California-based lender with 10 origination offices in the United States. ARCS has been a leading originator and servicer of agency multifamily loans for the past decade. It originated more than $2.1 billion of loans in 2006 and services approximately $13 billion of commercial mortgage loans.

On March 2, 2007, we acquired Mercantile Bankshares Corporation (“Mercantile”). Total consideration paid was approximately $5.9 billion in stock and cash. Mercantile has added banking and investment and wealth management services through 235 branches in Maryland, Virginia, the District of Columbia, Delaware and southeastern Pennsylvania. This transaction has significantly expanded our presence in the mid-Atlantic region, particularly within the attractive Maryland, Northern Virginia and Washington, DC markets.

Our acquisition of Mercantile added approximately $21 billion of assets and $12.5 billion of deposits to our Consolidated Balance Sheet. Our Consolidated Income Statement includes the impact of Mercantile subsequent to our March 2, 2007 acquisition.

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

REVIEW OF LINES OF BUSINESS In addition to the following information relating to our lines of business, we incorporate information under the captions Line of Business Highlights,

Product Revenue, Leases and Related Tax Matters, and Business Segments Review in Item 7 of this Report here by reference. Also, we include financial and other information by business in Note 26 Segment Reporting in the Notes To Consolidated Financial Statements in Item 8 of this Report here by reference. We have four major businesses engaged in providing banking, asset management and global fund processing products and services: Retail Banking; Corporate & Institutional Banking; BlackRock; and PFPC. Assets, revenue and earnings attributable to foreign activities were not material in the periods presented.

RETAIL BANKING

Retail Banking provides deposit, lending, brokerage, trust, investment management, and cash management services to approximately 2.9 million consumer and small business customers within our primary geographic markets. Our customers are serviced through over 1,100 offices in our branch network, the call center located in Pittsburgh and the Internet – www.pncbank.com. The branch network is located primarily in Pennsylvania, New Jersey, Washington, DC, Maryland, Virginia, Ohio, Kentucky and Delaware. Brokerage services are provided through PNC Investments, LLC, and Hilliard Lyons. See the Business Overview section of this Item 1 regarding our planned divestiture of Hilliard Lyons in the first half of 2008. Retail Banking also serves as investment manager and trustee for employee benefit plans and charitable and endowment assets and provides nondiscretionary defined contribution plan services. These services are provided to individuals and corporations primarily within our primary geographic markets.

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

CORPORATE & INSTITUTIONAL BANKING

Corporate & Institutional Banking provides lending, treasury management, and capital markets-related products and services to mid-sized corporations, government entities, and selectively to large corporations. Lending products include secured and unsecured loans, letters of credit and equipment leases. Treasury management services include cash and investment management, receivables management, disbursement services, funds transfer services, information reporting, and global trade services. Capital markets-related products and services include foreign exchange, derivatives, loan syndications, mergers and acquisitions advisory and related services to middle-market companies, securities underwriting, and securities sales and trading. We also provide commercial loan servicing, real estate advisory and technology solutions for the commercial real estate finance industry. We provide products and services generally within

our primary geographic markets, with certain products and services provided nationally.

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

BLACKROCK

BlackRock, Inc. (“BlackRock”) is one of the largest publicly traded investment management firms in the United States with $1.357 trillion of assets under management at December 31, 2007. BlackRock manages assets on behalf of institutional and individual investors worldwide through a variety of fixed income, cash management, equity and balanced and alternative investment separate accounts and funds. In addition, BlackRock provides risk management, investment system outsourcing and financial advisory services globally to institutional investors.

At December 31, 2007, our ownership interest in BlackRock was approximately 33.5%. Our investment in BlackRock is a strategic asset of PNC and a key component of our diversified earnings stream. The ability of BlackRock to grow assets under management is the key driver of increases in its revenue, earnings and, ultimately, shareholder value. BlackRock’s strategies for growth in assets under management include a focus on achieving client investment performance objectives in a manner consistent with their risk preferences and delivering excellent client service. The business dedicates significant resources to attracting and retaining talented professionals and to the ongoing enhancement of its investment technology and operating capabilities to deliver on its strategy.

PFPC

PFPC is a leading full service provider of processing, technology and business solutions for the global investment industry. Securities services include custody, securities lending, and accounting and administration for funds registered under the 1940 Act and alternative investments. Investor services include transfer agency, managed accounts, subaccounting, and distribution. We serviced $2.5 trillion in total fund assets and 72 million shareholder accounts as of December 31, 2007 both domestically and internationally.

PFPC’s international and domestic capabilities were expanded during 2007. We received approval for a banking license in Ireland and a branch in Luxembourg, which will allow PFPC to provide depositary services in Europe’s leading domicile for traditional investment funds and the second largest

worldwide domicile after the United States. The opening of a sales office in London supported this initiative. The acquisition of Albridge and Coates Analytics in December 2007 will enhance our business model and product offerings with the delivery of information services to asset managers, financial advisors, and the distribution channel to help them better service their respective target markets.

PFPC focuses technological resources on driving efficiency through streamlining operations and developing flexible systems architecture and client-focused servicing solutions.

SUBSIDIARIES Our corporate legal structure at December 31, 2007 consisted of three subsidiary banks, including their subsidiaries, and approximately 67 active non-bank subsidiaries. PNC Bank, N.A., headquartered in Pittsburgh, Pennsylvania, is our principal bank subsidiary. At December 31, 2007, PNC Bank, N.A. had total consolidated assets representing approximately 90% of our consolidated assets. Our other bank subsidiaries are PNC Bank, Delaware and Yardville National Bank. Our non-bank PFPC subsidiary has obtained a banking license in Ireland and a branch in Luxembourg, which allow PFPC to provide depositary services as part of its business. For additional information on our subsidiaries, you may review Exhibit 21 to this Report.

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

 

Form 10-K page
Average Consolidated Balance Sheet And Net Interest Analysis		119
Analysis Of Year-To-Year Changes In Net Interest Income		118
Book Values Of Securities		26 and 84-86
Maturities And Weighted-Average Yield Of Securities		86
Loan Types		25, 87 and 120
Selected Loan Maturities And Interest Sensitivity		122
Nonaccrual, Past Due And Restructured Loans And Other Nonperforming Assets		47-48, 74, 89 and 120
Potential Problem Loans And Loans Held For Sale		27 and 47-48
Summary Of Loan Loss Experience		48-49 and 121
Assignment Of Allowance For Loan And Lease Losses		48-49 and 121
Average Amount And Average Rate Paid On Deposits		119
Time Deposits Of $100,000 Or More		91 and 122
Selected Consolidated Financial Data		17-18

SUPERVISION AND REGULATION

OVERVIEW

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

We are subject to numerous governmental regulations, some of which are highlighted below. You should also read Note 22 Regulatory Matters in the Notes To Consolidated Financial Statements in Item 8 of this Report, included here by reference,

for additional information regarding our regulatory issues. Applicable laws and regulations restrict permissible activities and investments and require compliance with protections for loan, deposit, brokerage, fiduciary, mutual fund and other customers, among other things. They also restrict our ability to repurchase stock or to receive dividends from bank subsidiaries and impose capital adequacy requirements. The consequences of noncompliance can include substantial monetary and nonmonetary sanctions.

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

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

Over the last several years, there has been an increasing regulatory focus on compliance with anti-money laundering laws and regulations, resulting in, among other things, several significant publicly announced enforcement actions. There has also been a heightened focus recently on the protection of confidential customer information.

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

 

BANK REGULATION

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

Notwithstanding PNC’s reduced ownership interest in BlackRock and the deconsolidation resulting from the BlackRock/MLIM transaction (described in Note 2 Acquisitions and Divestitures in the Notes To Consolidated Financial Statements in Item 8 of this Report), BlackRock continues to be subject to the supervision and regulation of the Federal Reserve to the same extent as it was prior to the transaction.

Parent Company Liquidity and Dividends.  The principal source of our liquidity at the parent company level is dividends from PNC Bank, N.A. Our subsidiary banks are subject to various federal and state restrictions on their ability to pay dividends to PNC Bancorp, Inc., the direct parent of the subsidiary banks, which in turn may affect the ability of PNC Bancorp, Inc. to pay dividends to PNC at the parent company level. As noted below, we expect to merge Yardville National Bank into PNC Bank, N.A., in the first quarter of 2008. Our subsidiary banks are also subject to federal laws limiting extensions of credit to their parent holding company and non-bank affiliates as discussed in Note 22 Regulatory Matters included in the Notes To Consolidated Financial Statements in Item 8 of this Report, which is incorporated herein by reference. Further information on bank level liquidity and parent company liquidity and on certain contractual restrictions is also available in the Liquidity Risk Management section and in the “Perpetual Trust Securities” and “Acquired Entity Trust Preferred Securities” sections of the Off-Balance Sheet Arrangements and VIEs section of Item 7 of this Report.

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

Additional Powers Under the GLB Act.  The GLB Act permits a qualifying bank holding company to become a “financial holding company” and thereby to affiliate with financial

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

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

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

To continue to qualify for financial holding company status, our domestic subsidiary banks must maintain “well capitalized” capital ratios, examination ratings of “1” or “2” (on a scale of 1 to 5), and certain other criteria that are incorporated into the definition of “well managed” under the BHC Act and Federal Reserve rules. If we were to no longer qualify for this status, we could not continue to enjoy the after-the-fact notice process for new non-banking activities and non-banking acquisitions, and would be required promptly to enter into an agreement with the Federal Reserve providing a plan for our subsidiary banks to meet the “well capitalized” and “well managed” criteria. The Federal Reserve would have broad authority to limit our activities. Failure to satisfy the criteria within a six-month period could result in a requirement that we conform existing non-banking activities to activities that were permissible prior to the enactment of the GLB Act. If a subsidiary bank failed to maintain a “satisfactory” or better rating under the Community Reinvestment Act of 1977, as amended (“CRA”), we could not commence new activities or make new investments in reliance on the GLB Act.

In addition, the GLB Act permits a national bank, such as PNC Bank, N.A., to engage in expanded activities through the formation of a “financial subsidiary.” In order to qualify to

establish or acquire a financial subsidiary, PNC Bank, N.A. and each of its depository institution affiliates must be “well capitalized” and “well managed” and may not have a less than “satisfactory” CRA rating. A national bank that is one of the largest 50 insured banks in the United States, such as PNC Bank, N.A., must also have issued debt (which, for this purpose, may include the uninsured portion of PNC Bank, N.A.’s long-term certificates of deposit) with certain minimum ratings. PNC Bank, N.A. has filed a financial subsidiary certification with the OCC and currently engages in insurance agency activities through a financial subsidiary. PNC Bank, N.A. may also generally engage through a financial subsidiary in any activity that is financial in nature or incidental to a financial activity. Certain activities, however, are impermissible for a financial subsidiary of a national bank, including insurance underwriting, insurance investments, real estate investment or development, and merchant banking.

If one of our domestic subsidiary banks were to fail to meet the “well capitalized” or “well managed” and related criteria, PNC Bank, N.A. would be required to enter into an agreement with the OCC to correct the condition. The OCC would have the authority to limit the activities of the bank. If the condition were not corrected within six months or within any additional time granted by the OCC, PNC Bank, N.A. could be required to conform the activities of any of its financial subsidiaries to activities in which a national bank could engage directly. In addition, if the bank or any insured depository institution affiliate receives a less than satisfactory CRA examination rating, PNC Bank, N.A. would not be permitted to engage in any new activities or to make new investments in reliance on the financial subsidiary authority.

Other Federal Reserve and OCC Regulation.  The federal banking agencies possess broad powers to take corrective action as deemed appropriate for an insured depository institution and its holding company. The extent of these powers depends upon whether the institution in question is considered “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Generally, the smaller an institution’s capital base in relation to its risk-weighted assets, the greater the scope and severity of the agencies’ powers, ultimately permitting the agencies to appoint a receiver for the institution. Business activities may also be influenced by an institution’s capital classification. For instance, only a “well capitalized” depository institution may accept brokered deposits without prior regulatory approval and an “adequately capitalized” depository institution may accept brokered deposits only with prior regulatory approval. At December 31, 2007, each of our domestic subsidiary banks exceeded the required ratios for classification as “well capitalized.” For additional discussion of capital adequacy requirements, we refer you to “Funding and Capital Sources” in the Consolidated Balance Sheet Review section of Item 7 of this Report and to Note 22 Regulatory Matters included in the Notes To Consolidated Financial Statements in Item 8 of this Report.

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

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

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

At December 31, 2007, PNC Bank, N.A. and PNC Bank, Delaware, were rated “outstanding” and Yardville National Bank was rated “satisfactory” with respect to CRA.

FDIC Insurance.  All three of our domestic subsidiary banks are insured by the FDIC and subject to premium assessments. Regulatory matters could increase the cost of FDIC deposit insurance premiums to an insured bank. Since 1996, the FDIC had not assessed banks in the most favorable capital and assessment risk classification categories for insurance premiums for most deposits, due to the favorable ratio of the assets in the FDIC’s deposit insurance funds to the aggregate level of insured deposits outstanding. This resulted in significant cost savings to all insured banks. Deposit insurance premiums are assessed as a percentage of the deposits of the insured institution.

Beginning January 1, 2007, the FDIC reinstituted the assessment premiums for all deposits, which could impose a significant cost to all insured banks, including our subsidiary banks, reducing the net spread between deposit and other bank funding costs and the earnings from assets and services of the bank, and thus the net income of the bank. Because of a one-time assessment credit based on deposit premiums that the subsidiary banks of PNC had paid prior to 1996, the deposit insurance assessment for PNC’s subsidiary banks should be substantially offset through 2008.

FDIC deposit insurance premiums are “risk based”; therefore, higher fee percentages would be charged to banks that have lower capital ratios or higher risk profiles. These risk profiles take into account weaknesses that are found by the primary banking regulator through its examination and supervision of

the bank. A negative evaluation by the FDIC or a bank’s primary federal banking regulator could increase the costs to a bank and result in an aggregate cost of deposit funds higher than that of competing banks in a lower risk category. Our subsidiary banks are subject to “cross-guarantee” provisions under federal law that provide that if one of these banks fails or requires FDIC assistance, the FDIC may assess a “commonly-controlled” bank for the estimated losses suffered by the FDIC. Such liability could have a material adverse effect on our financial condition or that of the assessed bank. While the FDIC's claim is junior to the claims of depositors, holders of secured liabilities, general creditors and subordinated creditors, it is superior to the claims of the bank’s shareholders and affiliates, including PNC and intermediate bank holding companies.

SECURITIES AND RELATED REGULATION

The SEC, together with either the OCC or the Federal Reserve, regulates our registered broker-dealer subsidiaries. These subsidiaries are also subject to rules and regulations promulgated by the Financial Industry Regulatory Authority (“FINRA”), among others. Hilliard Lyons is also a member of the New York Stock Exchange and various regional and national exchanges whose members are subject to regulation and supervision.

Several of our subsidiaries are registered with the SEC as investment advisers and, therefore, are subject to the requirements of the Investment Advisers Act of 1940, as amended, and the SEC's regulations thereunder. The principal purpose of the regulations applicable to investment advisers is the protection of clients and the securities markets, rather than the protection of creditors and shareholders of investment advisors. The regulations applicable to investment advisers cover all aspects of the investment advisory business, including limitations on the ability of investment advisers to charge performance-based or non-refundable fees to clients; record-keeping; operational, marketing and reporting requirements; disclosure requirements; limitations on principal transactions between an adviser or its affiliates and advisory clients; as well as general anti-fraud prohibitions. These investment advisory subsidiaries also may be subject to state securities laws and regulations. In addition, our investment advisory subsidiaries that are investment advisors to registered investment companies and other managed accounts are subject to the requirements of the Investment Company Act of 1940, as amended, and the SEC’s regulations thereunder. PFPC is subject to regulation by the SEC as a service provider to registered investment companies.

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

governing taxation, antitrust regulation and electronic commerce.

Over the past several years, the SEC and other governmental agencies have been investigating the mutual fund industry, including PFPC and other service providers. The SEC has adopted and proposed various rules, and legislation has been introduced in Congress, intended to reform the regulation of this industry. The effect of regulatory reform has, and is likely to continue to, increase the extent of regulation of the mutual fund industry and impose additional compliance obligations and costs on our subsidiaries involved with that industry.

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

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

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

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

In making loans, our subsidiary banks compete with traditional banking institutions as well as consumer finance companies, leasing companies and other non-bank lenders, and institutional investors including CLO managers, hedge funds, mutual fund complexes and private equity firms. Loan pricing, structure and credit standards are under competitive pressure as lenders seek to deploy capital and a broad range of borrowers have access to capital markets. Traditional deposit activities are subject to pricing pressures and customer migration as a result of intense competition for consumer investment dollars.

 

Our subsidiary banks compete for deposits with the following:

•

Other commercial banks,

•

Savings banks,

•

Savings and loan associations,

•

Credit unions,

•

Treasury management service companies,

•

Insurance companies, and

•

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

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

•

Commercial banks,

•

Investment banking firms,

•

Merchant banks,

•

Insurance companies,

•

Private equity firms, and

•

Other investment vehicles.

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

•

Investment management firms,

•

Large banks and other financial institutions,

•

Brokerage firms,

•

Mutual fund complexes, and

•

Insurance companies.

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

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

EMPLOYEES Period-end employees totaled 28,320 at December 31, 2007 (comprised of 25,480 full-time and 2,840 part-time employees).

SEC REPORTS AND CORPORATE GOVERNANCE INFORMATION

We are subject to the informational requirements of the Securities Exchange Act of 1934, as amended (“Exchange Act”), and, in accordance with the Exchange Act, we file annual, quarterly and current reports, proxy statements, and other information with the SEC. Our SEC File Number is 001-09718. You may read and copy this information at the SEC’s Public Reference Room located at 100 F Street NE, Room 1580, Washington, D.C. 20549. You can obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.

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

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

We also make our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished to the SEC pursuant to Section 13(a) or 15(d) of the Exchange Act available free of charge on or through our internet website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. PNC’s corporate internet address is www.pnc.com and you can find this information at www.pnc.com/secfilings. Shareholders and bondholders may also obtain copies of these filings without charge by contacting Shareholder Services at 800-982-7652 or via e-mail at web.queries@computershare.com for copies without exhibits, or by contacting Shareholder Relations at (800) 843-2206 or via e-mail at investor.relations@pnc.com for copies of exhibits. We filed the certifications of our Chairman and Chief Executive Officer and our Chief Financial Officer required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 with respect to our Annual Report on Form 10-K for 2006 and both amendments thereto with the SEC as exhibits to that report and have filed the CEO and CFO certifications required by Section 302 of that Act with respect to this Form 10-K as exhibits to this Report.

Information about our Board and its committees and corporate governance at PNC is available on PNC’s corporate website at www.pnc.com/corporategovernance. Shareholders who would like to request printed copies of the PNC Code of Business Conduct and Ethics or our Corporate Governance Guidelines or the charters of our Board’s Audit, Nominating and Governance, or Personnel and Compensation Committees (all of which are posted on the PNC corporate website) may do so by sending their requests to George P. Long, III, Corporate Secretary, at corporate headquarters at One PNC Plaza, 249 Fifth Avenue, Pittsburgh, Pennsylvania 15222-2707. Copies will be provided without charge to shareholders.

Our common stock is listed on the New York Stock Exchange (“NYSE”) under the symbol “PNC.” Our Chairman and Chief Executive Officer submitted the required annual CEO’s Certification regarding the NYSE’s corporate governance listing standards (a Section 12(a) CEO Certification) to the NYSE within 30 days after our 2007 annual shareholders meeting.

ITEM 1A – RISK FACTORS

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

 

There are risks that are known to exist at the outset of a transaction. For example, every loan transaction presents credit risk (the risk that the borrower may not perform in accordance with contractual terms) and interest rate risk (a potential loss in earnings or economic value due to adverse movement in market interest rates or credit spreads), with the nature and extent of these risks principally depending on the identity of the borrower and overall economic conditions. These risks are inherent in every loan transaction; if we wish to make loans, we must manage these risks through the terms and structure of the loans and through management of our deposits and other funding sources. The success of our business is dependent on our ability to identify, understand and manage the risks presented by our business activities so that we can balance appropriately revenue generation and profitability with these inherent risks. We discuss our principal risk management processes and, in appropriate places, related historical performance in the Risk Management section included in Item 7 of this Report.

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

A sustained weakness or weakening in business and economic conditions generally or specifically in the principal markets in which we do business could adversely affect our business and operating results.

PNC’s business could be adversely affected to the extent that weaknesses in business and economic conditions have direct or indirect impacts on us or on our customers and counterparties. These conditions could lead, for example, to one or more of the following:

 

•

A decrease in the demand for loans and other products and services offered by us;

•

A decrease in the value of our loans held for sale;

•

A decrease in the usage of unfunded commitments;

•

A decrease in customer savings generally and in the demand for savings and investment products offered by us; and

•

An increase in the number of customers and counterparties who become delinquent, file for protection under bankruptcy laws, or default on their loans or other obligations to us. An increase in the number of delinquencies, bankruptcies or defaults could result in a higher level of nonperforming assets, net charge-offs, provision for credit losses, and valuation adjustments on loans held for sale.

Although many of our businesses are national and some are international in scope, our retail banking business is concentrated within our retail branch network footprint (Delaware, Indiana, Kentucky, New Jersey, Ohio, Pennsylvania, Washington, D.C., Maryland and Virginia), and thus that business is particularly vulnerable to adverse changes in economic conditions in these regions.

Changes in interest rates, in the shape of the yield curve, in valuations in the debt or equity markets, or disruptions in the liquidity or other functioning of financial markets could directly impact our assets and liabilities and our performance.

Given our business mix, our traditional banking activities of gathering deposits and extending loans, and the fact that most of our assets and liabilities are financial in nature, we tend to be particularly sensitive to market interest rate movement and the performance of the financial markets. Starting in the middle of 2007, there has been significant turmoil and volatility in worldwide financial markets which is, at present, ongoing. These conditions have resulted in increased liquidity risk. In addition to the impact on the economy generally, with some of the potential effects outlined above, changes in interest rates, in the shape of the yield curve, or in valuations in the debt or equity markets or disruptions in the liquidity or other functioning of financial markets, all of which have been seen recently, could directly impact us in one or more of the following ways:

 

•

Such situations could affect the difference between the interest that we earn on assets and the interest that we pay on liabilities, as well as the value of some or all of our on-balance sheet and off-balance sheet financial instruments or the value of equity investments that we hold or of our equity funding obligations;

•

Such situations could affect the ability of borrowers to repay their loans or other counterparties to meet their obligations, and thus could directly or indirectly increase the credit risk associated with some of our financial transactions;

•

Such situations could adversely affect the operation of our businesses, including by impacting the nature, profitability or risk profile of the financial transactions in which we engage;

•

To the extent to which we access capital markets to raise funds to support our business and overall liquidity position, such situations could affect the cost of such funds or our ability to raise such funds; and

•

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

Among the situations that could have one or more of the preceding impacts are (1) ongoing volatility in the markets for real estate and other assets commonly securing financial products, as well as in the markets for such financial products, and (2) changes in the availability of insurance providing

credit enhancement with respect to financial products or in the ratings of the companies providing such insurance.

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

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

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

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

A failure to address adequately the competitive pressures we face could make it harder for us to attract and retain customers across our businesses. On the other hand, meeting these competitive pressures could require us to incur significant additional expenses or to accept risk beyond what we would otherwise view as desirable under the circumstances. In addition, in our interest sensitive businesses, pressures to increase rates on deposits or decrease rates on loans could

reduce our net interest margin with a resulting negative impact on our net interest income. Any of these results would likely have an adverse effect on our overall financial performance.

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

Acquisitions of other financial services companies in general present risks to PNC in addition to those presented by the nature of the business acquired. In particular, acquisitions may be substantially more expensive to complete (including as a result of costs incurred in connection with the integration of the acquired company) and the anticipated benefits (including anticipated cost savings and strategic gains) may be significantly harder or take longer to achieve than expected. In some cases, acquisitions involve our entry into new businesses or new geographic or other markets, and these situations also present risks resulting from our inexperience in these new areas. As a regulated financial institution, our pursuit of attractive acquisition opportunities could be negatively impacted due to regulatory delays or other regulatory issues. Regulatory and/or legal issues relating to the pre-acquisition operations of an acquired business may cause reputational harm to PNC following the acquisition and integration of the acquired business into ours and may result in additional future costs arising as a result of those issues.

Our pending acquisition of Sterling presents many of the risks and uncertainties related to acquisition transactions themselves and to the integration of the acquired businesses into PNC after closing described above. Sterling presents regulatory and litigation risk as a result of financial irregularities at Sterling’s commercial finance subsidiary.

The performance of our asset management businesses may be adversely affected by the relative performance of our products compared with alternative investments.

Asset management revenue is primarily based on a percentage of the value of assets under management and, in some cases, performance fees, in most cases expressed as a percentage of the returns realized on assets under management, and thus is impacted by general changes in capital markets valuations and customer preferences. In addition, investment performance is an important factor influencing the level of assets under management. Poor investment performance could impair revenue and growth as existing clients might withdraw funds in favor of better performing products. Also, performance fees could be lower or nonexistent. Additionally, the ability to attract funds from existing and new clients might diminish.

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

 

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

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

PNC is a bank and financial holding company and is subject to numerous governmental regulations involving both its business and organization. Our businesses are subject to regulation by multiple bank regulatory bodies as well as multiple securities industry regulators. Applicable laws and regulations restrict our ability to repurchase stock or to receive dividends from bank subsidiaries and impose capital adequacy requirements. They also restrict permissible activities and investments and require compliance with protections for loan, deposit, brokerage, fiduciary, mutual fund and other customers, and for the protection of customer information, among other things. The consequences of noncompliance can include substantial monetary and nonmonetary sanctions as well as damage to our reputation and business.

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

We discuss these and other regulatory issues applicable to PNC in the Supervision and Regulation section included in Item 1 of this Report and in Note 22 Regulatory Matters in the Notes To Consolidated Financial Statements in Item 8 of this Report and here by reference.

Over the last several years, there has been an increasing regulatory focus on compliance with anti-money laundering

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

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

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

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

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

Our ability to mitigate the adverse consequences of such occurrences is in part dependent on the quality of our resiliency planning, including our ability to anticipate the nature of any such event that occurs. The adverse impact of natural disasters or terrorist activities or international hostilities also could be

increased to the extent that there is a lack of preparedness on the part of national or regional emergency responders or on the part of other organizations and businesses that we deal with, particularly those that we depend upon.

ITEM 1B – UNRESOLVED STAFF COMMENTS

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

ITEM 2 – PROPERTIES

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

We own or lease numerous other premises for use in conducting business activities. We consider the facilities owned or occupied under lease by our subsidiaries to be adequate. We include here by reference the additional information regarding our properties in Note 9 Premises, Equipment and Leasehold Improvements in the Notes To Consolidated Financial Statements in Item 8 of this Report.

ITEM 3 – LEGAL PROCEEDINGS

Adelphia

Some of our subsidiaries are defendants (or have potential contractual contribution obligations to other defendants) in several pending lawsuits brought during late 2002 and 2003 arising out of the bankruptcy of Adelphia Communications Corporation and its subsidiaries.

One of the lawsuits was brought on Adelphia’s behalf by the unsecured creditors’ committee and equity committee in Adelphia’s consolidated bankruptcy proceeding and was removed to the United States District Court for the Southern District of New York by order dated February 9, 2006. Pursuant to Adelphia’s plan of reorganization, this lawsuit will be prosecuted by a contingent value vehicle, known as the Adelphia Recovery Trust. In October 2007, the Adelphia Recovery Trust filed an amended complaint in this lawsuit, adding defendants and making additional allegations. The other lawsuits, one of which is a putative consolidated class action, were brought by holders of debt and equity securities of Adelphia and have been consolidated for pretrial purposes in the above district court. The bank defendants, including the PNC defendants, have entered into a settlement of the consolidated class action. This settlement was approved by the district court in November 2006. In December 2006, a group of class members appealed orders related to the settlement to the United States Court of Appeals for the Second Circuit. The amount for which we would be responsible under this settlement is insignificant.

The non-settled lawsuits arise out of lending and investment banking activities engaged in by PNC subsidiaries together with other financial services companies. In the aggregate, hundreds of other financial services companies and numerous

other companies and individuals have been named as defendants in one or more of these lawsuits. Collectively, with respect to some or all of the defendants, the lawsuits allege federal law claims (including violations of federal securities and banking laws), violations of common law duties, aiding and abetting such violations, voidable preference payments, and fraudulent transfers, among other matters. The lawsuits seek monetary damages (including in some cases punitive or treble damages), interest, attorneys’ fees and other expenses, and a return of the alleged voidable preference and fraudulent transfer payments, among other remedies.

We believe that we have defenses to the claims against us in these lawsuits, as well as potential claims against third parties, and intend to defend the remaining lawsuits vigorously. These lawsuits involve complex issues of law and fact, presenting complicated relationships among the many financial and other participants in the events giving rise to these lawsuits, and have not progressed to the point where we can predict the outcome of the non-settled lawsuits. It is not possible to determine what the likely aggregate recoveries on the part of the plaintiffs in these remaining matters might be or the portion of any such recoveries for which we would ultimately be responsible, but the final consequences to PNC could be material.

Data Treasury

In March 2006, a first amended complaint was filed in the United States District Court for the Eastern District of Texas by Data Treasury Corporation against PNC and PNC Bank, N.A., as well as more than 50 other financial institutions, vendors, and other companies, claiming that the defendants are infringing, and inducing or contributing to the infringement of, the plaintiff’s patents, which allegedly involve check imaging, storage and transfer. The plaintiff seeks unspecified damages and interest and trebling of both, attorneys’ fees and other expenses, and injunctive relief against the alleged infringement. We believe that we have defenses to the claims against us in this lawsuit and intend to defend it vigorously. In January 2007, the district court entered an order staying the claims asserted against PNC under two of the four patents allegedly infringed by PNC, pending reexamination of these patents by the United States Patent and Trademark Office. The Patent Office has since indicated that all of the claims are allowable. In September 2007, the parties agreed to stay the other two patents-in-suit pending reexamination of those patents. The entire case is presently stayed. Data Treasury has moved to lift the stay.

CBNV Mortgage Litigation

Between 2001 and 2003, on behalf of either individual plaintiffs or a putative class of plaintiffs, several separate actions were filed in state and federal court against Community Bank of Northern Virginia (“CBNV”) and other defendants challenging the validity of second mortgage loans the defendants made to the plaintiffs. CBNV was merged into one of Mercantile’s banks. These cases were either filed in, or removed to, the United States District Court for the Western District of Pennsylvania.

 

In July 2003, the court conditionally certified a class for settlement purposes and preliminarily approved a settlement of the various actions. Thereafter, certain plaintiffs who had initially opted out of the proposed settlement and other objectors challenged the validity of the settlement in the district court. The district court approved the settlement, and these “opt out” plaintiffs and other objectors appealed to the United States Court of Appeals for the Third Circuit. In August 2005, the court of appeals reversed the district court’s approval of the settlement and remanded the case to the district court with instructions to consider and address certain specific issues when re-evaluating the settlement. In August 2006, the settling parties submitted a modified settlement agreement to the district court for its approval. In January 2008, the district court conditionally certified a class for settlement purposes, preliminarily approved the proposed modified settlement agreement, and directed that the settlement agreement be submitted to the class members for their consideration. This settlement remains subject to final court approval. Some of the objecting plaintiffs are seeking permission to appeal the district court’s decision certifying the class for settlement purposes and preliminarily approving the settlement. These same plaintiffs also filed a motion to stay the district court proceedings pending a decision on their appeal request. The district court denied the stay request, and there is a similar stay motion pending in the appeals court.

In January 2008, the district court also issued an order sending back to state court in North Carolina the claims of certain plaintiffs seeking to represent a class of North Carolina borrowers.

In addition to these lawsuits, several individuals have filed actions on behalf of themselves or a putative class of plaintiffs alleging claims involving CBNV’s second mortgage loans. These actions also were filed in, or transferred for coordinated or consolidated pre-trial proceedings to, the United States District Court for the Western District of Pennsylvania.

The plaintiffs in these lawsuits seek unquantified monetary damages, interest, attorneys’ fees and other expenses, and a refund of all origination fees and fees paid for title services.

BAE Derivative Litigation

In September 2007, a derivative lawsuit was filed on behalf of BAE Systems plc by a holder of its American Depositary Receipts against current and former directors and officers of BAE, Prince Bandar bin Sultan, PNC (as successor to Riggs National Corporation and Riggs Bank, N.A.), Joseph L. Allbritton, Robert L. Allbritton, and Barbara Allbritton. The complaint alleges that BAE directors and officers breached their fiduciary duties by making or permitting to be made improper or illegal bribes, kickbacks and other payments with respect to a military contract obtained in the mid-1980s from the Saudi Arabian Ministry of Defense, and that Prince Bandar was the primary recipient or beneficiary of these payments. The complaint also alleges that Riggs, together with the Allbrittons (as former directors, officers and controlling

persons of Riggs), acted as the primary intermediaries through which the payments were laundered and actively concealed, and aided and abetted the BAE defendants’ breaches of fiduciary duties. As it relates to PNC, plaintiff is seeking unquantified monetary damages (including punitive damages), an accounting, interest, attorneys’ fees and other expenses. We believe that we have defenses to the claims against us in this lawsuit and intend to defend it vigorously. We have filed a motion seeking dismissal of the claims against us. As a result of our acquisition of Riggs, PNC may be responsible for indemnifying the Allbrittons in connection with this lawsuit.

Regulatory and Governmental Inquiries

In connection with an audit of the services provided by Mercantile Safe Deposit & Trust Company (now PNC Bank) as trustee of the AFL-CIO Building Investment Trust, a collective trust fund that invests pension plan assets in commercial real estate assets, the United States Department of Labor has identified the possibility that Mercantile collected unauthorized fees in violation of ERISA. If it is ultimately determined that these fees were collected in violation of the law, we could be subject to requirements to return the fees to the Building Investment Trust, with interest, and could also be subject to penalties and taxes.

As a result of the regulated nature of our business and that of a number of our subsidiaries, particularly in the banking and securities areas, we and our subsidiaries are the subject of investigations and other forms of regulatory inquiry, often as part of industry-wide regulatory reviews of specified activities. One of these situations is in connection with investigations of practices in the mutual fund industry, where several of our subsidiaries have received requests for information and other inquiries from governmental and regulatory authorities.

Our practice is to cooperate fully with regulatory and governmental investigations, audits and other inquiries, including those described above. Such investigations, audits and other inquiries may lead to remedies such as fines, restitution or alterations in our business practices.

Other

In addition to the proceedings or other matters described above, PNC and persons to whom we may have indemnification obligations, in the normal course of business, are subject to various other pending and threatened legal proceedings in which claims for monetary damages and other relief are asserted. See Note 24 Commitments and Guarantees in the Notes To Consolidated Financial Statements in Item 8 of this Report for additional information regarding the Visa indemnification and our obligation to provide indemnification to current and former officers, directors, employees and agents of PNC and companies we have acquired. We do not anticipate, at the present time, that the ultimate aggregate liability, if any, arising out of such other legal proceedings will have a material adverse effect on our financial position. However, we cannot now determine whether or not any claims asserted against us or others to whom we may have

indemnification obligations, whether in the proceedings or other matters specifically described above or otherwise, will have a material adverse effect on our results of operations in any future reporting period.

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

None during the fourth quarter of 2007.

EXECUTIVE OFFICERS OF THE REGISTRANT Information regarding each of our executive officers as of February 15, 2008 is set forth below. Executive officers do not have a stated term of office. Each executive officer has held the position or positions indicated or another executive position with the same entity or one of its affiliates for the past five years unless otherwise indicated below.

 

Name		Age		Position with PNC		Year Employed (1)
James E. Rohr		59		Chairman and Chief Executive Officer (2)		1972
Joseph C. Guyaux		57		President		1972
William S. Demchak		45		Vice Chairman		2002
William C. Mutterperl		61		Vice Chairman		2002
Timothy G. Shack		57		Executive Vice President and Chief Information Officer		1976
Thomas K. Whitford		51		Executive Vice President and Chief Administrative Officer		1983
Michael J. Hannon		51		Senior Vice President and Chief Credit Officer		1982
Richard J. Johnson		51		Senior Vice President and Chief Financial Officer		2002
Samuel R. Patterson		49		Senior Vice President and Controller		1986
Helen P. Pudlin		58		Senior Vice President and General Counsel		1989
John J. Wixted, Jr.		56		Senior Vice President and Chief Risk Officer		2002

(1)	Where applicable, refers to year employed by predecessor company.

(2)	Also serves as a director of PNC.

William S. Demchak joined PNC as Vice Chairman and Chief Financial Officer in September 2002. In August 2005, he took on additional oversight responsibilities for the Corporation’s Corporate & Institutional Banking business and continued to oversee PNC’s asset and liability management and equity management activities while transitioning the responsibilities of Chief Financial Officer to Richard J. Johnson.

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

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

John J. Wixted, Jr. joined PNC as Senior Vice President and Chief Regulatory Officer in August 2002. He served in this role until May 2007, when he was appointed Chief Risk Officer.

DIRECTORS OF THE REGISTRANT The name, age and principal occupation of each of our directors as of February 15, 2008, and the year he or she first became a director is set forth below:

 

•

Richard O. Berndt, 65, Managing Partner of Gallagher, Evelius & Jones LLP (law firm), (2007),

 

•

Charles E. Bunch, 58, Chairman and Chief Executive Officer of PPG Industries, Inc. (coatings, sealants and glass products), (2007),

 

•

Paul W. Chellgren, 65, Operating Partner, SPG Partners, LLC, (private equity), (1995),

 

•

Robert N. Clay, 61, President and Chief Executive Officer of Clay Holding Company (investments), (1987),

 

•

George A. Davidson, Jr., 69, Retired Chairman of Dominion Resources, Inc. (public utility holding company), (1988),

 

•

Kay Coles James, 58, President and Founder of The Gloucester Institute (non-profit), (2006),

 

•

Richard B. Kelson, 61, Operating Advisor, Pegasus Capital Advisors, L.P., (private equity), (2002),

 

•

Bruce C. Lindsay, 66, Chairman and Managing Member of 2117 Associates, LLC (advisory company), (1995),

 

•

Anthony A. Massaro, 63, Retired Chairman and Chief Executive Officer of Lincoln Electric Holdings, Inc. (full-line manufacturer of welding and cutting products), (2002),

 

•

Jane G. Pepper, 62, President of Pennsylvania Horticultural Society (non-profit membership organization), (1997),

 

•

James E. Rohr, 59, Chairman and Chief Executive Officer of PNC, (1990),

 

•

Donald J. Shepard, 61, Chairman of the Executive Board and Chief Executive Officer, AEGON N.V. (insurance), (2007),

 

•

Lorene K. Steffes, 62, Independent Business Advisor, (2000),

 

•

Dennis F. Strigl, 61, President and Chief Operating Officer of Verizon Communications Inc. (telecommunications), (2001),

 

•

Stephen G. Thieke, 61, Retired Chairman, Risk Management Committee of JP Morgan Incorporated (financial and investment banking services), (2002),

 

•

Thomas J. Usher, 65, Retired Chairman of United States Steel Corporation (integrated steelmaker) and Chairman of Marathon Oil Corporation (oil and gas industry), (1992),

 

•

George H. Walls, Jr., 65, former Chief Deputy Auditor of the State of North Carolina, (2006),

 

•

Helge H. Wehmeier, 65, Retired President and Chief Executive Officer of Bayer Corporation (healthcare, crop protection, and chemicals), (1992).

PART II

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

(a) Our common stock is listed on the New York Stock Exchange and is traded under the symbol “PNC.” At the close of business on February 15, 2008, there were 49,566 common shareholders of record.

Holders of PNC common stock are entitled to receive dividends when declared by the Board of Directors out of funds legally available for this purpose. Our Board of Directors may not pay or set apart dividends on the common stock until dividends for all past dividend periods on any series of outstanding preferred stock have been paid or declared and set apart for payment. The Board presently intends to continue the policy of paying quarterly cash dividends. However, the amount of any future dividends will depend on earnings, our financial condition and other factors, including contractual restrictions and applicable government regulations and policies (such as those relating to the ability of bank and non-bank subsidiaries to pay dividends to the parent company).

The Federal Reserve has the power to prohibit us from paying dividends without its approval. For further information concerning dividend restrictions and restrictions on loans, dividends or advances from bank subsidiaries to the parent company, you may review “Supervision and Regulation” in Item 1 of this Report, “Liquidity Risk Management” in the Risk Management section and “Perpetual Trust Securities”, “PNC Capital Trust E Trust Preferred Securities” and “Acquired Entity Trust Preferred Securities” in the Off-Balance Sheet Arrangements and VIEs section of Item 7 of this Report, and Note 22 Regulatory Matters in the Notes To Consolidated Financial Statements in Item 8 of this Report, which we include here by reference.

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

We include here by reference the information regarding our compensation plans under which PNC equity securities are authorized for issuance as of December 31, 2007 in the table (with introductory paragraph and notes) that appears under Item 12 of this Report.

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

Computershare Investor Services, LLC

250 Royall Street

Canton, MA 02021

800-982-7652

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

 

(b)	Not applicable.

(c) Details of our repurchases of PNC common stock during the fourth quarter of 2007 are included in the following table:

In thousands, except per share data

 

2007 period		Total shares purchased (a)		Average price paid per share			Total shares purchased as part of publicly announced programs (b)		Maximum number of shares that may yet be purchased under the programs (b)
October 1 – October 31		318		$	70.86		145		24,855
November 1 – November 30		433		$	70.48		145		24,710
December 1 – December 31		169		$	69.39				24,710
Total		920		$	70.41		290

(a)	Includes PNC common stock purchased under the program referred to in note (b) to this table and PNC common stock purchased in connection with our various employee benefit plans.

(b)

Our current stock repurchase program, allows us to purchase up to 25 million shares on the open market or in privately negotiated transactions. This program was authorized on October 4, 2007 and replaced the prior program, which was authorized in February 2005. This program will remain in effect until fully utilized or until modified, superseded or terminated.

Common Stock Performance Graph

This graph shows the cumulative total shareholder return (i.e., price change plus reinvestment of dividends) on our common stock during the five-year period ended December 31, 2007, as compared with: (1) a selected peer group of our competitors, called the “Peer Group;” (2) an overall stock market index, the S&P 500 Index; and (3) a published industry index, the S&P 500 Banks. The yearly points marked on the horizontal axis of the graph correspond to December 31 of that year. The stock performance graph assumes that $100 was invested on January 1, 2003 for the five-year period and that any dividends were reinvested. The table below the graph shows the resultant compound annual growth rate for the performance period.

 

 

		Base Period		Assumes $100 investment at Close of Market on December 31, 2002 Total Return = Price change plus reinvestment of dividends										5-Year Com-pound Growth Rate
		Dec02		Dec03		Dec04		Dec05		Dec06		Dec07
PNC		$100		136.06		148.25		165.41		204.29		187.41		13.39	%
S&P 500 Index		$100		128.67		142.65		149.65		173.26		182.78		12.82	%
S&P 500 Banks		$100		126.65		144.92		142.86		165.89		116.49		3.10	%
Peer Group		$100		129.36		146.85		147.23		167.31		123.96		4.39	%

The Peer Group for the preceding chart and table consists of the following companies: BB&T Corporation; Comerica Inc.; Fifth Third Bancorp; KeyCorp; National City Corporation; The PNC Financial Services Group, Inc.; SunTrust Banks, Inc.; U.S. Bancorp.; Wachovia Corporation; Regions Financial Corporation; and Wells Fargo & Co. The Peer Group shown is the Peer Group approved by the Board’s Personnel and Compensation Committee for 2007.

Each yearly point for the Peer Group is determined by calculating the cumulative total shareholder return for each company in the Peer Group from December 31, 2002 to December 31 of that year (End of Month Dividend Reinvestment Assumed) and then using the median of these returns as the yearly plot point.

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

ITEM 7 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

EXECUTIVE SUMMARY

THE PNC FINANCIAL SERVICES GROUP, INC.

PNC is one of the largest diversified financial services companies in the United States based on assets, with businesses engaged in retail banking, corporate and institutional banking, asset management, and global fund processing services. We provide many of our products and services nationally and others in our primary geographic markets located in Pennsylvania, New Jersey, Washington, DC, Maryland, Virginia, Ohio, Kentucky and Delaware. We also provide certain global fund processing services internationally.

KEY STRATEGIC GOALS

Our strategy to enhance shareholder value centers on driving positive operating leverage by achieving growth in revenue from our diverse business mix that exceeds growth in expenses as a result of disciplined cost management. In each of our business segments, the primary drivers of revenue growth are the acquisition, expansion and retention of customer relationships. We strive to expand our customer base by providing convenient banking options and leading technology systems, providing a broad range of fee-based 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 have maintained a moderate risk profile characterized by strong credit quality 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 strong balance sheet, ample liquidity and investment flexibility to adjust, where appropriate, to changing interest rates and market conditions. We continue to be disciplined in investing capital in our businesses while returning a portion to shareholders through dividends and share repurchases when appropriate.

ACQUISITION AND DIVESTITURE ACTIVITY

A summary of pending and recently completed acquisitions and divestitures is included under Item 1 and in Note 2 Acquisitions and Divestitures in the Notes To Consolidated Financial Statements in Item 8 of this Report.

KEY FACTORS AFFECTING FINANCIAL PERFORMANCE

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

•

General economic conditions,

•

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

•

Customer demand for other products and services,

•

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

•

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

•

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

•

The impact of credit spreads on valuations of commercial mortgage loans held for sale and the market for securitization and sale of these assets.

Starting in the middle of 2007, and continuing at present, there has been significant turmoil and volatility in worldwide financial markets, accompanied by uncertain prospects for the overall economy. Our performance in 2008 will be impacted by developments in these areas. In addition, our success in 2008 will depend, among other things, upon:

•

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

•

The successful integration of Yardville and progress toward closing and integrating the Sterling acquisition,

•

Completing the divestiture of Hilliard Lyons,

•

Continued development of the Mercantile franchise, including full deployment of our product offerings,

•

Revenue growth,

•

A sustained focus on expense management and creating positive operating leverage,

•

Maintaining strong overall asset quality,

•

Prudent risk and capital management, and

•

Actions we take within the capital and other financial markets.

SUMMARY FINANCIAL RESULTS

 

		Year ended December 31
In billions, except for per share data		2007			2006
Net income		$1.467			$2.595
Diluted earnings per share		$4.35			$8.73
Return on
Average common shareholders’ equity		10.53	%		27.97	%
Average assets		1.19	%		2.73	%

We refer you to the Consolidated Income Statement Review portion of the 2006 Versus 2005 section of this Item 7 for significant items which collectively increased net income for 2006 by $1.1 billion, or $3.67 per diluted share.

Our performance in 2007 included the following accomplishments:

•

Our total assets at December 31, 2007 reached a record level of $139 billion, as further detailed in the Consolidated Balance Sheet Review section of this Item 7. We achieved growth by expanding our footprint, growing and deepening customer relationships, and enhancing product capabilities.

•

We differentiated ourselves with a diverse revenue mix of both interest and noninterest

 

income. Noninterest income represented 57% of total revenue for 2007.

•

Overall asset quality remained strong, reflecting our commitment to maintain a moderate risk profile. While nonperforming assets increased in 2007 compared with 2006, the coverage ratio of the allowance for loan and lease losses to nonperforming loans was 190% and the allowance for loan and lease losses to total loans increased to 1.21% at December 31, 2007.

•

PNC continued to be well capitalized and maintained a strong liquidity position.

•

At December 31, 2007, our investment in BlackRock was $4.1 billion and, based upon the closing price of BlackRock’s common stock on that date, we had an additional $5.3 billion of pretax value that was not recognized.

BALANCE SHEET HIGHLIGHTS

Total assets were $138.9 billion at December 31, 2007 compared with $101.8 billion at December 31, 2006. The increase compared with December 31, 2006 was primarily due to the addition of approximately $21 billion of assets related to the Mercantile acquisition, growth in loans and higher securities available for sale.

Total average assets were $123.4 billion for 2007 compared with $95.0 billion for 2006. This increase reflected a $20.3 billion increase in average interest-earning assets and an increase in average other noninterest-earning assets. An increase of $12.9 billion in loans and a $5.2 billion increase in securities available for sale were the primary factors for the increase in average interest-earning assets.

The increase in average other noninterest-earning assets for 2007 reflected our equity investment in BlackRock, which averaged $3.8 billion for 2007 and which had been consolidated for the first nine months of 2006, and an increase in average goodwill of $3.6 billion primarily related to the Mercantile and Yardville acquisitions.

Average total loans were $62.5 billion for 2007 and $49.6 billion for 2006. The increase in average total loans included the effect of the Mercantile acquisition for 10 months of 2007 and higher commercial loans. The increase in average total loans included growth in commercial loans of $5.3 billion and growth in commercial real estate loans of $4.5 billion. Loans represented 64% of average interest-earning assets for both 2007 and 2006.

Average securities available for sale totaled $26.5 billion for 2007 and $21.3 billion for 2006. The 10-month impact of Mercantile contributed to the increase in average securities for the 2007 period, along with overall balance sheet growth. Securities available for sale comprised 27% of average interest-earning assets for both 2007 and 2006.

Average total deposits were $76.8 billion for 2007, an increase of $13.5 billion over 2006. Average deposits grew from the

prior year primarily as a result of an increase in money market, noninterest-bearing demand deposits and retail certificates of deposit. These increases reflected the 10-month impact of the Mercantile acquisition and growth in deposits in Corporate & Institutional Banking.

Average total deposits represented 62% of average total assets for 2007 and 67% for 2006. Average transaction deposits were $50.7 billion for 2007 compared with $42.3 billion for 2006.

Average borrowed funds were $23.0 billion for 2007 and $15.0 billion for 2006. Increases of $3.2 billion in bank notes and senior debt, $2.5 billion in federal funds purchased and $1.5 billion in Federal Home Loan bank borrowings drove the increase in average borrowed funds compared with 2006.

Shareholders’ equity totaled $14.9 billion at December 31, 2007, compared with $10.8 billion at December 31, 2006. The increase resulted primarily from the Mercantile and Yardville acquisitions. See the Consolidated Balance Sheet Review section of this Item 7 for additional information.

LINE OF BUSINESS HIGHLIGHTS

We refer you to Item 1 of this Report under the captions Business Overview and Review of Lines of Business for an overview of our business segments and to the Business Segments Review section of this Item 7 for a Results Of Businesses – Summary table and further analysis of business segment results for 2007 and 2006, including presentation differences from Note 26. Total business segment earnings were $1.7 billion for 2007 and $1.5 billion for 2006.

We provide a reconciliation of total business segment earnings to total PNC consolidated net income as reported on a GAAP basis in Note 26 Segment Reporting in the Notes To Consolidated Financial Statements in Item 8 of this Report.

Retail Banking

Retail Banking’s 2007 earnings increased $128 million, to $893 million, up 17% compared with 2006. The increase in earnings over the prior year was driven by acquisitions and strong fee income and customer growth, partially offset by increases in the provision for credit losses and continued investments in the business.

Corporate & Institutional Banking

Corporate & Institutional Banking earned $432 million in 2007 compared with $454 million in 2006. While total revenue increased more than noninterest expense, earnings declined due to an increase in the provision for credit losses. Market-related declines in commercial mortgage- backed securities (“CMBS”) securitization activities and non-customer-related trading revenue resulted in a year-over-year reduction in noninterest income.

BlackRock

Our BlackRock business segment earned $253 million in 2007 and $187 million in 2006. Subsequent to the September 29, 2006 deconsolidation of BlackRock, these business segment earnings are determined primarily by taking our proportionate share of BlackRock’s earnings. Also, for this business segment presentation, after-tax BlackRock/MLIM transaction integration costs totaling $3 million and $65 million in 2007 and 2006, respectively, have been reclassified from BlackRock to “Other.”

PFPC

PFPC earned $128 million for 2007 compared with $124 million in 2006. Results for 2006 benefited from the impact of a $14 million reversal of deferred taxes related to earnings from foreign subsidiaries following management’s determination that the earnings would be indefinitely reinvested outside of the United States. Apart from the impact of this item, the earnings increase of $18 million in 2007 reflected the successful conversion of net new business, organic growth and market appreciation.

 

Other

“Other” incurred a loss of $239 million in 2007 compared with earnings for 2006 of $1.1 billion. “Other” for 2007 included the after-tax impact of the following:

•

Integration costs totaling $99 million after taxes,

•

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

•

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

“Other” earnings for 2006 included the $1.3 billion after-tax gain on the BlackRock/MLIM transaction recorded in the third quarter of 2006, partially offset by the after-tax impact of charges related to our third quarter 2006 balance sheet repositioning activities and BlackRock/MLIM integration costs. Further information regarding the BlackRock/MLIM transaction is included in Note 2 Acquisitions and Divestitures included in the Notes To Consolidated Financial Statements in Item 8 of this Report.

CONSOLIDATED INCOME STATEMENT REVIEW

NET INTEREST INCOME - OVERVIEW

Changes in net interest income and margin result from the interaction of the volume and composition of interest-earning assets and related yields, interest-bearing liabilities and related rates paid, and noninterest-bearing sources of funding.

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

NET INTEREST INCOME - GAAP RECONCILIATION

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

A reconciliation of net interest income as reported in the Consolidated Income Statement (GAAP basis) to net interest income on a taxable-equivalent basis follows (in millions):

 

		For the year ended December 31,
			2007			2006			2005
Net interest income, GAAP basis		$	2,915		$	2,245		$	2,154
Taxable-equivalent adjustment			27			25			33
Net interest income, taxable- equivalent basis		$	2,942		$	2,270		$	2,187

Taxable-equivalent net interest income increased $672 million, or 30%, in 2007 compared with 2006. This increase was consistent with the $20.3 billion, or 26%, increase in average interest-earning assets during 2007 compared with 2006. The reasons driving the higher interest-earning assets in 2007 are further discussed in the Balance Sheet Highlights portion of the Executive Summary section of this Item 7.

We expect net interest income to be higher in 2008 compared with 2007, assuming our current expectations for interest rates and economic conditions. Our forward-looking statements are based on our current expectations that interest rates will remain low through most of 2008 and that economic conditions, although showing slower growth than in recent years, will avoid a recession.

 

NET INTEREST MARGIN

The net interest margin was 3.00% for 2007 and 2.92% for 2006. The following factors impacted the comparison:

•

The Mercantile acquisition.

•

The yield on interest-earning assets increased 35 basis points. The yield on loans, the single largest component, increased 31 basis points.

•

These factors were partially offset by an increase in the rate paid on interest-bearing liabilities of 25 basis points. The rate paid on interest-bearing deposits, the single largest component, increased 22 basis points.

•

The impact of noninterest-bearing sources of funding decreased 2 basis points in 2007 compared with the prior year.

Comparing yields and rates paid to the broader market, the average federal funds rate was 5.03% during 2007 compared with 4.96% for 2006.

We believe that net interest margins for our industry will continue to be impacted by competition for high quality loans and deposits and customer migration from lower to higher rate deposit or other products. We expect our net interest margin to improve slightly in 2008 compared with 2007, assuming our current expectations for interest rates and economic conditions.

PROVISION FOR CREDIT LOSSES

The provision for credit losses totaled $315 million for 2007 and $124 million for 2006. Of the total 2007 provision, $188 million was recorded in the fourth quarter, including approximately $45 million related to our Yardville acquisition. The higher provision in 2007 was also impacted by an increase in our real estate portfolio, including residential real estate development exposure, and growth in total credit exposure. Total residential real estate development outstandings were approximately $2.1 billion at December 31, 2007.

We do not expect to sustain asset quality at its current level. Given our projections for loan growth and continued credit deterioration, we expect nonperforming assets and the provision for credit losses will be higher in 2008 compared with 2007. Also, we expect that the level of provision for credit losses in the first quarter of 2008 will be modestly lower than the amount reported for the fourth quarter of 2007.

The Credit Risk Management portion of the Risk Management section of this Item 7 includes additional information regarding factors impacting the provision for credit losses.

NONINTEREST INCOME

Summary

Noninterest income was $3.790 billion for 2007 and $6.327 billion for 2006. Noninterest income for 2007 included the impact of $83 million gain recognized in connection with our transfer of BlackRock shares to satisfy a portion of PNC’s LTIP obligation and a $210 million net loss representing the mark-to-market adjustment on our LTIP obligation.

Noninterest income for 2006 included the impact of the following items:

•

The gain on the BlackRock/MLIM transaction, which totaled $2.078 billion,

•

The effects of our third quarter 2006 balance sheet repositioning activities that resulted in charges totaling $244 million, and

•

PNC consolidated BlackRock in its results for the first nine months of 2006 but accounted for BlackRock on the equity method for the fourth quarter of 2006 and all of 2007. Had our BlackRock investment been on the equity method for all of 2006, BlackRock’s noninterest income reported by us would have been lower by $943 million for that year.

Apart from the impact of these items, noninterest income increased $367 million, or 10%, in 2007 compared with 2006 largely as a result of the Mercantile acquisition and growth in several fee income categories.

We expect that net interest income and noninterest income will increase in 2008 compared with 2007. We also believe that PNC will create positive operating leverage in 2008 with a percentage growth in total revenue relative to 2007 that will exceed the percentage growth in noninterest expense from 2007.

Additional analysis

Asset management fees totaled $784 million for 2007 and $1.420 billion for 2006. Our equity income from BlackRock has been included in asset management fees beginning with the fourth quarter of 2006. Asset management fees were higher in 2006 as the first nine months of 2006 reflected the impact of BlackRock’s revenue on a consolidated basis.

Assets managed at December 31, 2007 totaled $73 billion compared with $54 billion at December 31, 2006. This increase resulted primarily from the Mercantile acquisition. We refer you to the Retail Banking section of the Business Segments Review section of this Item 7 for further discussion of assets under management.

Fund servicing fees declined $58 million in 2007, to $835 million, compared with $893 million in the prior year. Amounts for 2006 included $117 million of distribution fee revenue at PFPC. Effective January 1, 2007, we refined our accounting and reporting of PFPC’s distribution fee revenue and related expense amounts and present these amounts net on a prospective basis. Prior to 2007, the distribution amounts were shown on a gross basis within fund servicing fees and within other noninterest expense and offset each other entirely with no impact on earnings.

Apart from the impact of the distribution fee revenue included in the 2006 amounts, fund servicing fees increased $59 million in 2007 compared with the prior year. Higher revenue from offshore operations, transfer agency, managed accounts and alternative investments contributed to the increase in

2007, reflecting net new business and growth from existing clients. The PFPC section of the Business Segments Review section of this Item 7 includes information on net fund assets and custody fund assets serviced.

Service charges on deposits increased $35 million, or 11%, to $348 million for 2007 compared with 2006. The increase was primarily due to the impact of Mercantile.

Brokerage fees increased $32 million, or 13%, to $278 million for 2007 compared with the prior year. The increase was primarily due to higher mutual fund-related revenues, continued growth in our fee-based fund advisory business and higher annuity income.

Consumer services fees increased $49 million, or 13%, to $414 million in 2007 compared with 2006. The increase reflected the impact of Mercantile, higher debit card revenues resulting from higher transaction volumes, and fees from the credit card business that began in the latter part of 2006.

Corporate services revenue was $713 million for 2007, an increase of $87 million, or 14%, over 2006. Higher revenue from commercial mortgage servicing including the impact of the ARCS acquisition, treasury management, third party consumer loan servicing activities and the Mercantile acquisition contributed to the increase in 2007 over the prior year.

Equity management (private equity) net gains on portfolio investments totaled $102 million in 2007 and $107 million in 2006. Based on the nature of private equity activities, net gains or losses may fluctuate from period to period.

Net securities losses totaled $5 million in 2007 and $207 million in 2006. We took actions during the third quarter of 2006 that resulted in the sale of approximately $6 billion of securities available for sale at an aggregate pretax loss of $196 million during that quarter.

Noninterest revenue from trading activities totaled $104 million in 2007 compared with $183 million in 2006. While customer trading income increased in comparison, total trading revenue declined in 2007 largely due to the lower economic hedging gains associated with commercial mortgage loan activity and economic hedging losses associated with structured resale agreements. We provide additional information on our trading activities under Market Risk Management – Trading Risk in the Risk Management section of this Item 7.

Net losses related to our BlackRock investment amounted to $127 million in 2007, representing the net of the mark-to-market adjustment on our LTIP obligation and gain recognized in connection with our transfer of shares to satisfy a portion of our LTIP obligation, compared with a net gain of $2.066 billion in 2006. The 2006 amount included the $2.078 billion gain on the BlackRock/MLIM transaction. See the BlackRock portion of the Business Segments Review section of Item 7 of this Report for further information.

Other noninterest income increased $29 million, to $344 million, in 2007 compared with 2006. Other noninterest income for 2007 included the negative impact in the fourth quarter of a $26 million valuation adjustment for commercial mortgage loans held for sale. In early 2008, spreads have been widening and there has been limited activity in the CMBS securitization market. We value our commercial mortgage loans held for sale based on securitization prices. Therefore, if these conditions continue, additional losses will be incurred that will be significantly higher than the losses incurred during the fourth quarter of 2007. However, we do not expect the impact to be significant to our capital position. Currently, these valuation losses are unrealized (non-cash) and all of the loans in this portfolio are performing.

Other noninterest income for 2006 included a $48 million loss incurred in the third quarter in connection with the rebalancing of our residential mortgage portfolio.

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

PRODUCT REVENUE

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

Treasury management revenue, which includes fees as well as net interest income from customer deposit balances, increased 14% to $476 million for 2007 compared with $418 million for 2006. The higher revenue reflected continued expansion and client utilization of commercial payment card services, strong revenue growth in investment products and in various electronic payment and information services.

Revenue from capital markets-related products and services totaled $290 million for 2007 compared with $283 million in 2006. This increase was driven primarily by merger and acquisition advisory and related services.

Midland Loan Services offers servicing, real estate advisory and technology solutions for the commercial real estate finance industry. Midland’s revenue, which includes servicing fees and net interest income from servicing portfolio deposit balances, totaled $220 million for 2007 and $184 million for 2006, an increase of 20%. The revenue growth was primarily driven by growth in the commercial mortgage servicing portfolio and related services.

As a component of our advisory services to clients, we provide a select set of insurance products to fulfill specific customer financial needs. Primary insurance offerings include annuities, life, credit life, health, and disability. Revenue from these products increased 4% to $74 million for 2007 compared with $71 million for 2006.

 

PNC, through subsidiary company Alpine Indemnity Limited, participates as a direct writer for its general liability, automobile liability, workers’ compensation, property and terrorism insurance programs. In the normal course of business, Alpine Indemnity Limited maintains insurance reserves for reported claims and for claims incurred but not reported based on actuarial assessments. We believe these reserves were adequate at December 31, 2007.

NONINTEREST EXPENSE

Total noninterest expense was $4.296 billion for 2007, a decrease of $147 million compared with $4.443 billion for 2006.

Item 6 of this Report includes our efficiency ratios for 2007 and 2006, along with information regarding certain significant items impacting noninterest income and expense in 2006.

Noninterest expense for 2007 included the following:

•

Acquisition integration costs of $102 million, and

•

A charge of $82 million for an indemnification obligation related to certain Visa litigation.

Noninterest expense for 2006 included the following:

•

The first nine months of 2006 included $765 million of expenses related to BlackRock, which was still consolidated during that time, and

•

BlackRock/MLIM transaction integration costs totaling $91 million.

Apart from the impact of these items, noninterest expense increased $525 million, or 15%, in 2007 compared with 2006. These increases were largely a result of the acquisition of Mercantile. Investments in growth initiatives were mitigated by disciplined expense management.

We expect to incur pretax integration costs of approximately $70 million in 2008 primarily related to our planned acquisition of Sterling and additional costs related to the Yardville and Albridge acquisitions.

EFFECTIVE TAX RATE

Our effective tax rate was 29.9% for 2007 and 34% for 2006. The lower effective tax rate in 2007 compared with the prior year reflected the impact of the following matters:

•

An increase in income taxes related to the gain from, and a $57 million cumulative adjustment to increase deferred income taxes in connection with, the BlackRock/MLIM transaction in 2006, and

•

Lower pretax income for the fourth quarter of 2007 had the impact of reducing the effective tax rate for the full year.

Our effective tax rate is sensitive to levels of pretax income as certain income tax credits and items not subject to income tax remain relatively constant. Based upon current projections, we believe that the effective tax rate will be approximately 31% in 2008, before considering the impact of the pending sale of Hilliard Lyons.

CONSOLIDATED BALANCE SHEET REVIEW

SUMMARIZED BALANCE SHEET DATA

 

December 31 - in millions		2007		2006
Assets
Loans, net of unearned income		$68,319		$50,105
Securities available for sale		30,225		23,191
Loans held for sale		3,927		2,366
Equity investments		6,045		5,330
Goodwill and other intangible assets		9,551		4,043
Other		20,853		16,785
Total assets		$138,920		$101,820
Liabilities
Funding sources		$113,627		$81,329
Other		8,785		8,818
Total liabilities		122,412		90,147
Minority and noncontrolling interests in consolidated entities		1,654		885
Total shareholders' equity		14,854		10,788
Total liabilities, minority and noncontrolling interests, and shareholders' equity		$138,920		$101,820

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

Our Consolidated Balance Sheet at December 31, 2007 reflects the addition of approximately $21 billion of assets resulting from our Mercantile acquisition and approximately $3 billion of assets related to our Yardville acquisition.

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

An analysis of changes in selected balance sheet categories follows.

LOANS, NET OF UNEARNED INCOME

Loans increased $18.2 billion, or 36%, as of December 31, 2007 compared with December 31, 2006. Our Mercantile acquisition added $12.4 billion of loans including $4.9 billion of commercial, $4.8 billion of commercial real estate, $1.6 billion of consumer and $1.1 billion of residential mortgage loans. Our Yardville acquisition added $1.9 billion of loans.

 

Details Of Loans

 

December 31 - in millions		2007			2006
Commercial
Retail/wholesale		$6,653			$5,301
Manufacturing		4,563			4,189
Other service providers		3,014			2,186
Real estate related (a)		5,730			2,825
Financial services		1,226			1,324
Health care		1,260			707
Other		6,161			4,052
Total commercial		28,607			20,584
Commercial real estate
Real estate projects		6,114			2,716
Mortgage		2,792			816
Total commercial real estate		8,906			3,532
Lease financing		3,500			3,556
Total commercial lending		41,013			27,672
Consumer
Home equity		14,447			13,749
Automobile		1,513			1,135
Other		2,366			1,631
Total consumer		18,326			16,515
Residential mortgage		9,557			6,337
Other		413			376
Unearned income		(990	)		(795	)
Total, net of unearned income		$68,319			$50,105

(a)	Includes loans related to customers in the real estate, rental, leasing and construction industries.

Our loan portfolio continued to be diversified among numerous industries and types of businesses. The loans that we hold are also concentrated in, and diversified across, our principal geographic markets. See Note 5 Loans, Commitments To Extend Credit and Concentrations of Credit Risk in the Notes To Consolidated Financial Statements in Item 8 of this Report for additional information.

Commercial lending outstandings in the table above 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 $713 million, or 86%, of the total allowance for loan and lease losses at December 31, 2007 to these loans. We allocated $68 million, or 8%, of the remaining allowance at that date to consumer loans and $49 million, or 6%, to all other loans. This allocation also considers other relevant factors such as:

•

Actual versus estimated losses,

•

Regional and national economic conditions,

•

Business segment and portfolio concentrations,

•

Industry conditions,

•

The impact of government regulations, and

•

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

Net Unfunded Credit Commitments

 

December 31 - in millions		2007			2006
Commercial		$	39,171		$	32,265
Consumer			10,875			9,239
Commercial real estate			2,734			2,752
Other			567			579
Total		$	53,347		$	44,835

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 $8.9 billion at December 31, 2007 and $8.3 billion at December 31, 2006. Consumer home equity lines of credit accounted for 80% of consumer unfunded credit commitments.

Unfunded liquidity facility commitments and standby bond purchase agreements totaled $9.4 billion at December 31, 2007 and $6.0 billion at December 31, 2006 and are included in the preceding table primarily within the “Commercial” and “Consumer” categories.

In addition to credit commitments, our net outstanding standby letters of credit totaled $4.8 billion at December 31, 2007 and $4.4 billion at December 31, 2006. Standby letters of credit commit us to make payments on behalf of our customers if specified future events occur. At December 31, 2007, the largest industry concentration was for general medical and surgical hospitals, which accounted for approximately 5% of the total letters of credit and bankers’ acceptances.

Leases and Related Tax Matters

The lease portfolio totaled $3.5 billion at December 31, 2007. Aggregate residual value at risk on the lease portfolio at December 31, 2007 was $1.1 billion. We have taken steps to mitigate $.6 billion of this residual risk, including residual value insurance coverage with third parties, third party guarantees, and other actions. The portfolio included approximately $1.7 billion of cross-border leases at December 31, 2007. Cross-border leases are leveraged leases of equipment located in foreign countries, primarily in western Europe and Australia. We have not entered into cross-border lease transactions since 2003.

We have reached a settlement with the Internal Revenue Service (IRS) regarding our tax liability related to cross- border lease transactions, principally arising from adjustments to the timing of income tax deductions in connection with IRS examinations of our 1998-2003 consolidated Federal income tax returns. The impact of the final settlement was included in results of operations for 2007 and was not material. See Note 1 Accounting Policies in the Notes To Consolidated Financial Statements in Item 8 of this Report regarding our adoption of FSP FAS 13-2, “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Income Taxes Generated by a Leveraged Lease Transaction.”

 

SECURITIES

Details of Securities

 

In millions		Amortized Cost			Fair Value
December 31, 2007
SECURITIES AVAILABLE FOR SALE
Debt securities
Residential mortgage-backed		$	21,147		$	20,952
Commercial mortgage-backed			5,227			5,264
Asset-backed			2,878			2,770
U.S. Treasury and government agencies			151			155
State and municipal			340			336
Other debt			85			84
Corporate stocks and other			662			664
Total securities available for sale		$	30,490		$	30,225
December 31, 2006
SECURITIES AVAILABLE FOR SALE
Debt securities
Residential mortgage-backed		$	17,325		$	17,208
Commercial mortgage-backed			3,231			3,219
Asset-backed			1,615			1,609
U.S. Treasury and government agencies			611			608
State and municipal			140			139
Other debt			90			87
Corporate stocks and other			321			321
Total securities available for sale		$	23,333		$	23,191

Securities represented 22% of total assets at December 31, 2007 and 23% of total assets at December 31, 2006. Our acquisition of Mercantile included approximately $2 billion of securities classified as available for sale. The increase in total securities compared with December 31, 2006 was primarily due to higher balances in residential mortgage-backed, commercial mortgage-backed and asset-backed securities.

We evaluate our portfolio of securities available for sale in light of changing market conditions and other factors and, where appropriate, take steps intended to improve our overall positioning.

At December 31, 2007, the securities available for sale balance included a net unrealized loss of $265 million, which represented the difference between fair value and amortized cost. The comparable amount at December 31, 2006 was a net unrealized loss of $142 million. 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 securities available for sale generally decreases when interest rates increase and vice versa.

The expected weighted-average life of securities available for sale (excluding corporate stocks and other) was 3 years and 6 months at December 31, 2007 and 3 years and 8 months at December 31, 2006.

We estimate that at December 31, 2007 the effective duration of securities available for sale was 2.8 years for an immediate 50 basis points parallel increase in interest rates and 2.5 years for an immediate 50 basis points parallel decrease in interest rates. Comparable amounts at December 31, 2006 were 2.6 years and 2.2 years, respectively.

LOANS HELD FOR SALE

Loans held for sale totaled $3.9 billion at December 31, 2007 compared with $2.4 billion a year ago.

Loans held for sale included commercial mortgage loans intended for securitization totaling $2.1 billion at December 31, 2007 and $.9 billion at December 31, 2006. The balance at December 31, 2007 increased as market conditions were not conducive to completing securitization transactions during the fourth quarter of 2007. We also reduced our origination activity in early 2008. During the fourth quarter of 2007, a lower of cost or fair value adjustment was recorded of $26 million. This loss was reflected in the other noninterest income line item in our Consolidated Income Statement and in the results of the Corporate & Institutional Banking business segment. In early 2008, spreads have been widening and there has been limited activity in the CMBS securitization market. We value our commercial mortgage loans held for sale based on securitization prices. Therefore, if these conditions continue, additional losses will be incurred that will be significantly higher than the losses incurred during the fourth quarter of 2007. However, we do not expect the impact to be significant to our capital position. Currently, these valuation losses are unrealized (non-cash) and all of the loans in this portfolio are performing.

Loans held for sale also included education loans held for sale of $1.5 billion at December 31, 2007 and $1.3 billion at December 31, 2006. Historically, we classified substantially all of our education loans as loans held for sale. Gains on sales of education loans totaled $24 million in 2007, $33 million for 2006 and $19 million for 2005. These gains are reflected in the other noninterest income line item in our Consolidated Income Statement and in the results of the Retail Banking business segment.

In the past, we have sold education loans to issuers of asset-backed paper when the loans are placed into repayment status. Recently, the secondary markets for education loans have been impacted by liquidity issues similar to other asset classes. As a result, we believe the ability to sell education loans and generate related gains will be limited in 2008. Given this outlook and the economic and customer relationship value inherent in this product, in February 2008, we transferred the loans at lower of cost or market value from held for sale to the loan portfolio.

 

GOODWILL AND OTHER INTANGIBLE ASSETS

The sum of goodwill and other intangible assets increased $5.5 billion at December 31, 2007 compared with the prior year end, to $9.6 billion. We added $4.7 billion of goodwill and other intangible assets in connection with the Mercantile acquisition. In addition, our acquisitions of ARCS, Yardville and Albridge collectively added $.9 billion of goodwill and other intangible assets during 2007. Additional information is included in Note 7 Goodwill And Other Intangible Assets in the Notes To Consolidated Financial Statements under Item 8 of this Report.

OTHER ASSETS

The increase of $4.1 billion in “Assets-Other” in the preceding “Summarized Balance Sheet Data” table included the impact of a $1.0 billion increase in Federal funds sold and resale agreements and a $1.0 billion increase in other short-term investments, including trading securities.

FUNDING AND CAPITAL SOURCES

Details Of Funding Sources

 

December 31 - in millions		2007		2006
Deposits
Money market		$32,785		$28,580
Demand		20,861		16,833
Retail certificates of deposit		16,939		14,725
Savings		2,648		1,864
Other time		2,088		1,326
Time deposits in foreign offices		7,375		2,973
Total deposits		82,696		66,301
Borrowed funds
Federal funds purchased		7,037		2,711
Repurchase agreements		2,737		2,051
Federal Home Loan Bank borrowing		7,065		42
Bank notes and senior debt		6,821		3,633
Subordinated debt		4,506		3,962
Other		2,765		2,629
Total borrowed funds		30,931		15,028
Total		$113,627		$81,329

Total funding sources increased $32.3 billion at December 31, 2007 compared with the balance at December 31, 2006, as total deposits increased $16.4 billion and total borrowed funds increased $15.9 billion. Our acquisition of Mercantile added $12.5 billion of deposits and $2.1 billion of borrowed funds. The Yardville acquisition resulted in $2.0 billion of deposits.

During the first quarter of 2007 we issued borrowings to fund the $2.1 billion cash portion of the Mercantile acquisition. The remaining increase in borrowed funds was the result of growth in loans and securities and the need to fund other net changes in our balance sheet. During the second half of 2007 we substantially increased Federal Home Loan Bank borrowings, which provided us with additional liquidity at relatively attractive rates. The Liquidity Risk Management section of this Item 7 contains further details regarding actions we have taken which impacted our borrowed funds balances during 2007 and early 2008.

 

Capital

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

Total shareholders’ equity increased $4.1 billion, to $14.9 billion, at December 31, 2007 compared with December 31, 2006. In addition to the net impact of earnings and dividends in 2007, this increase reflected a $2.5 billion reduction in treasury stock and a $1.0 billion increase in capital surplus, largely due to the issuance of PNC common shares for the Mercantile and Yardville acquisitions.

Common shares outstanding were 341 million at December 31, 2007 and 293 million at December 31, 2006. The increase in shares during 2007 reflected the issuance of approximately 53 million shares in connection with the Mercantile acquisition and approximately 3 million shares in connection with the Yardville acquisition.

In October 2007, our Board of Directors terminated the prior program and approved a new stock repurchase program to purchase up to 25 million shares of PNC common stock on the open market or in privately negotiated transactions. This new program will remain in effect until fully utilized or until modified, superseded or terminated. During 2007, we purchased 11 million common shares under our new and prior common stock repurchase programs at a total cost of approximately $800 million.

The extent and timing of additional share repurchases under the new 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 limitations resulting from merger activity, and the potential impact on our credit rating. We do not expect to actively engage in share repurchase activity for the foreseeable future.

Risk-Based Capital

 

December 31 - dollars in millions		2007			2006
Capital components
Shareholders’ equity
Common		$14,847			$10,781
Preferred		7			7
Trust preferred capital securities		572			965
Minority interest		985			494
Goodwill and other intangibles		(8,853	)		(3,566	)
Eligible deferred income taxes on intangible assets		119			26
Pension, other postretirement and postemployment benefit plan adjustments		177			148
Net unrealized securities losses, after tax		167			91
Net unrealized losses (gains) on cash flow hedge derivatives, after tax		(175	)		13
Equity investments in nonfinancial companies		(31	)		(30	)
Other, net					(5	)
Tier 1 risk-based capital		7,815			8,924
Subordinated debt		3,024			1,954
Eligible allowance for credit losses		964			681
Total risk-based capital		$11,803			$11,559
Assets
Risk-weighted assets, including off-balance sheet instruments and market risk equivalent assets		$115,132			$85,539
Adjusted average total assets		126,139			95,590
Capital ratios
Tier 1 risk-based		6.8	%		10.4	%
Total risk-based		10.3			13.5
Leverage		6.2			9.3
Tangible capital
Common shareholders’ equity		$14,847			$10,781
Goodwill and other intangibles		(8,853	)		(3,566	)
Eligible deferred income taxes on intangible assets		119			26
Tangible capital		$6,113			$7,241
Total assets excluding goodwill and other intangible assets, net of eligible deferred income taxes		$130,185			$98,280
Tangible common equity		4.7	%		7.4	%

The declines in capital ratios from December 31, 2006 were primarily due to the impact of acquisitions, which increased risk-weighted assets and goodwill, common share repurchases and organic balance sheet growth.

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

At December 31, 2007 and December 31, 2006, each of our domestic bank subsidiaries was considered “well capitalized” based on US regulatory capital ratio requirements. See the Supervision And Regulation section of Item 1 of this Report and Note 22 Regulatory Matters in the Notes To Consolidated