PNC FINANCIAL SERVICES GROUP, INC. quarterly report, Q1 FY2018

Business context and reporting period

The PNC Financial Services Group, Inc. is a diversified U.S. financial services company with retail banking, corporate and institutional banking, asset management, and an equity-method investment in BlackRock. This unaudited Form 10-Q covers the quarter ended March 31, 2018; income statement and cash flow comparisons are with the first quarter of 2017, while balance sheet comparisons are primarily with December 31, 2017.

Key financial metrics

Efficiency ratio was 61% versus 62%; return on average common shareholders’ equity was 11.04% versus 9.50%, and return on average assets was 1.34% versus 1.19%.

Operating cash flow was $2.922 billion, compared with $1.590 billion in Q1 2017. Investing activities used $1.250 billion versus $5.620 billion; financing activities used $2.272 billion versus providing $4.154 billion. Cash and due from banks fell by $600 million during the quarter to $4.649 billion.

At March 31, 2018, total assets were $379.2 billion, loans $221.6 billion, deposits $264.7 billion, borrowed funds $58.0 billion, and total shareholders’ equity $47.0 billion. Loans to deposits were 84%. Total loans rose 1% from year-end, including 1% growth in commercial lending, while consumer lending declined slightly. Deposits decreased $349 million; borrowed funds declined $1.049 billion.

PNC reported a 9.6% Basel III common equity Tier 1 ratio, 10.8% Tier 1 risk-based ratio, 12.8% total risk-based ratio, 9.4% leverage ratio, and 7.9% supplementary leverage ratio. The CET1 ratio was 9.8% at December 31, 2017 on the same fully phased-in basis. PNC and PNC Bank exceeded the 100% minimum LCR at quarter-end. The allowance for loan and lease losses was $2.604 billion, or 1.18% of loans; nonperforming assets were $2.004 billion.

Material changes versus prior periods

• Earnings growth reflected higher revenue and a lower effective tax rate, partly offset by higher expenses. The statutory federal corporate tax rate fell from 35% to 21% effective January 1, 2018.
• Net interest income and margin benefited from higher rates, loan growth, and wider spreads on deposit funding. Higher deposit and borrowing costs partly offset the benefit.
• Average loans increased 4% year over year, led by commercial lending. At quarter-end, loans rose 1% from December 2017; commercial balances grew while consumer balances declined.
• Noninterest income growth was led by asset management, consumer services, and corporate services. Other noninterest income fell, partly reflecting favorable equity-investment valuation adjustments in Q1 2017; residential mortgage revenue also declined.
• Expenses increased mainly with personnel and equipment costs, including technology, business and employee investments, and costs from the 2017 commercial and vendor finance acquisition.
• Credit indicators were broadly stable: nonperforming assets fell 2% from year-end, delinquencies fell 9%, and net charge-offs were $113 million versus $118 million in Q1 2017. The allowance ratio eased to 1.18% from 1.20% a year earlier.
• After-tax other comprehensive loss was $557 million, driven principally by unrealized securities losses and cash flow hedge losses. The decline in accumulated other comprehensive income contributed to lower equity and CET1 capital.

Outlook, commentary, risks and contingencies

For Q2 2018 versus Q1, management expected modest loan growth; low-single-digit percentage growth in net interest income; mid-single-digit percentage growth in fee income; provision expense of $100 million to $150 million; and low-single-digit percentage growth in noninterest expense. Other noninterest income was expected to run at $225 million to $275 million per quarter, excluding securities gains or losses and Visa activity.

For full-year 2018 versus adjusted 2017, management expected mid-single-digit percentage growth in loans and revenue, low-single-digit percentage growth in noninterest expense, and an effective tax rate of approximately 17%. The adjusted comparison excludes specified 2017 tax-reform and other significant items. PNC’s economic outlook assumed somewhat faster U.S. growth and gradual rate increases; management cited trade restrictions as a downside risk and expected the yield curve to flatten without inverting.

Management said it was on track for $250 million in 2018 cost savings through its continuous improvement program. PNC returned $1.1 billion to shareholders in Q1 through $700 million of repurchases and $400 million of common dividends. Future capital distributions remain subject to regulatory capital review and CCAR.

Key exposures include changing interest rates and deposit pricing, credit deterioration, securities valuation and liquidity, economic conditions, competition, cyber and operational events, and legal or regulatory developments. PNC reported that the interest-rate sensitivity analysis indicated benefit from rising rates and an upward-sloping yield curve, but a modeled 100-basis-point yield-curve flattening reduced forecast net interest income by 0.8% in year one and 3.5% in year two. PNC also noted that the wider three-month versus one-month LIBOR spread had compressed net interest income and margin in Q1.

For disclosed legal matters that could be estimated, PNC assessed reasonably possible aggregate losses of up to approximately $100 million as of March 31, 2018; the estimate excludes matters that could not be estimated and is not a maximum exposure. A False Claims Act foreclosure-cost case had a March 2019 trial date. PNC also reported an agreement in principle to settle a mortgage reinsurance case, with no material expected financial impact. No material changes to previously disclosed risk factors were reported.

PNC expected CECL adoption in 2020 to increase the allowance for credit losses, but said the amount would depend on portfolio characteristics and economic conditions at adoption. The company was still evaluating the impact of the new lease standard, which it planned to adopt in 2019.

Most important facts for investors to verify

• Whether subsequent results deliver the stated loan, revenue, expense, provision, and tax outlook, including the Q2 provision range.
• How net interest income responds to rate increases, deposit repricing, and the LIBOR spread and yield-curve assumptions.
• Whether credit quality and reserve adequacy remain stable as commercial and consumer portfolios evolve, including the effects of CECL implementation.
• How unrealized securities losses affect accumulated other comprehensive income, regulatory capital, and shareholder distributions.
• The status and potential financial consequences of legal and regulatory matters, recognizing that the disclosed $100 million estimate is incomplete for unestimable matters.
• The sustainability of cost savings, expense growth, and returns on capital alongside continued technology, employee, and market investments.