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PNC Financial's

(PNC) - Get PNC Financial Services Group, Inc. Report

yearlong effort to get problem loans off its books ran into trouble Tuesday when the

Federal Reserve

said some of its accounting procedures were improper.

The Pittsburgh regional bank said complying with the Fed's edict will result in a $155 million reduction in its 2001 earnings. Potentially more damaging is the timing of the disclosure: Investors nervous about any mention of accounting issues in the wake of the


scandal knocked more than 9% off PNC's share price, sending it down $5.79 to $56.08.

"After Enron everyone is very nervous and skittish about financial structures that are difficult to explain," said Stephens analyst James Schutz. "But I think the Fed will recognize that there is no risk to PNC over time."

The Entities

At issue are financial entities set up by PNC with an unnamed insurer to buy the loans and dispose of them over time. PNC transferred the loans from its "held for sale" portfolio to the companies and classified preferred stock it received in return as securities available for sale on its balance sheet.

But the Fed said PNC should've consolidated the vehicles' results with its own, effectively requiring it to reclassify the preferred shares as the original loans and requiring their value be retroactively adjusted over several quarters, leading to the earnings revision.

The central bank's opinion differed from that of PNC's independent financial adviser Ernst & Young, although the company plans to comply.

"They've been hiving off problem loans so management didn't have to deal with them, and they set up a separate bank to do it," said Schutz.


The accounting change will cut PNC's 2001 net income by 53 cents a share and its liabilities by more than $100 million, PNC said. It is not expected to alter 2002 operating results, and PNC reaffirmed analyst predictions that it will earn $4.60 a share this year.

Schutz noted that there may be some risk to 2002 numbers but said he does not believe the company's accounting practices were "shady," despite an investigation by the

Securities and Exchange Commission

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and the Fed.

"This reminds me of



good bank/bad bank entity," he said. "That worked extremely well. It retained an interest but was not forced to consolidate."

Mellon created Grant Street in 1988 to isolate problem loans and run them out. More recently,



put $1.3 billion of loans into a separate entity and sold them.

In the meantime, Schutz said, the ramifications of this are likely to be widely felt. "I'm not sure of the extent that banks are doing it, but it is going on."


Several banks were hit hard Tuesday, with Mellon and FleetBoston both down 6%, to $37.43 and $32.86, respectively.


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fell 5% to $46.71,

J.P. Morgan Chase

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lost 6% to $32.05, and

Bank of America

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shed almost 7% to $59.20.

PNC noted that there isn't any "off-balance-sheet debt related to the subsidiaries," and described them as fully funded by equity capital with "significant liquid assets."

The bank will revise fourth-quarter results and restate the second and third quarters to reflect the consolidation. As a result, net income for 2001 is estimated to be $412 million, or $1.38 a share. The company previously reported 2001 earnings of $567 million, or $1.91 a diluted share, including a $615 million charge for costs to restructure its banking and venture-capital businesses.