PNC Financial Services Group, Inc. — First-Quarter 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; comparisons are with first-quarter 2016 unless otherwise stated. Balance-sheet comparisons are generally with December 31, 2016. PNC is a diversified financial services company with retail banking, corporate and institutional banking, asset management, and an equity interest in BlackRock.
Financial performance
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Total revenue | $3.884 billion | $3.665 billion | +6% |
| Net interest income (GAAP) | $2.160 billion | $2.098 billion | +3% |
| Noninterest income | $1.724 billion | $1.567 billion | +10% |
| Provision for credit losses | $88 million | $152 million | Down $64 million |
| Noninterest expense | $2.402 billion | $2.281 billion | +5% |
| Net income | $1.074 billion | $943 million | +14% |
| Diluted earnings per share | $1.96 | $1.68 | +17% |
Net interest margin was 2.77%, compared with 2.75% a year earlier, on a taxable-equivalent basis. The efficiency ratio was 62% in both periods. Return on average common shareholders’ equity was 9.50% (8.44% in Q1 2016), and return on average assets was 1.19% (1.07%). The effective tax rate was 23.0%, versus 23.5%.
Revenue growth reflected higher fee income and net interest income. Asset management income rose 18%, corporate services rose 21%, and residential mortgage income rose 13%; consumer services declined 1%. Higher loan yields and growth in average loans and securities supported net interest income, partly offset by higher deposit and borrowing costs. Lower credit provision primarily reflected a smaller provision for energy-related loans than in Q1 2016. Expense growth reflected higher activity, personnel costs, and equipment costs.
Balance sheet, capital and liquidity
- At March 31, 2017, total assets were $370.9 billion, loans were $212.8 billion, and deposits were $260.7 billion. Versus year-end 2016, assets increased $4.6 billion, loans $2.0 billion, and deposits $3.5 billion.
- Commercial lending increased $2.7 billion during the quarter; consumer lending decreased $0.7 billion. Loans-to-deposits were 82%.
- Borrowed funds totaled $55.1 billion, up $2.4 billion from year-end. Senior and subordinated debt together were $30.6 billion, down from $31.0 billion at year-end. Total shareholders’ equity was $45.8 billion; total equity was $45.9 billion, down $1.0 billion, primarily reflecting redemption of $1.0 billion in perpetual trust securities.
- Transitional Basel III common equity Tier 1 was 10.5%; estimated fully phased-in standardized CET1 was 10.0%. PNC and PNC Bank were considered well capitalized. The company reported an 8.4% supplementary leverage ratio.
- PNC’s and PNC Bank’s liquidity coverage ratios exceeded the 100% fully phased-in minimum. Liquid assets totaled $91.7 billion, including $32.4 billion of short-term investments and $59.3 billion of available-for-sale securities. Parent-company available liquidity was $4.5 billion.
- PNC returned approximately $0.9 billion to common shareholders in Q1 through $0.6 billion of repurchases and $0.3 billion of dividends. It announced an increase in its repurchase authorization, bringing planned repurchases to up to $2.3 billion for the four-quarter period ending June 30, 2017.
Cash flows and asset quality
For Q1 2017, operating activities provided $1.609 billion, investing activities used $5.639 billion, and financing activities provided $4.154 billion. Cash and due from banks increased $124 million to $5.003 billion. The investing outflow included a $2.359 billion net increase in loans and a $2.166 billion net increase in interest-earning deposits with banks. Cash flows can be affected by balance-sheet movements and are not equivalent to net income.
Credit indicators improved from year-end: nonperforming assets fell $162 million to $2.212 billion; nonperforming loans were 0.94% of loans, down from 1.02%; and accruing loans past due declined $192 million to $1.384 billion. The allowance for loan and lease losses was $2.561 billion, or 1.20% of loans, compared with $2.589 billion, or 1.23%, at year-end. Q1 net charge-offs were $118 million, versus $149 million a year earlier, and the annualized net charge-off ratio was 0.23%.
Business developments, outlook and risks
- PNC realigned its reporting segments in Q1, combining residential mortgage banking into Retail Banking and eliminating the Non-Strategic Assets Portfolio segment. It also revised its internal funds-transfer-pricing methodology; prior periods were recast, but segment comparisons may still reflect allocation methodology.
- Corporate & Institutional Banking earnings increased 22% to $484 million, aided by stronger revenue and lower credit provision. Retail Banking earnings fell 12% to $213 million, and Asset Management Group earnings fell 4% to $47 million. BlackRock-related segment earnings were $145 million, compared with $114 million.
- Management’s 2017 assumptions included moderate U.S. economic and labor-market growth, gradually rising rates, and two 25-basis-point Federal Reserve rate increases—in June and December. Full-year expectations versus 2016: loans up mid-single digits; revenue growth at the upper end of the mid-single-digit range; noninterest expense up low single digits; and an effective tax rate of about 25%, absent tax reform. Other noninterest income was expected to be $225–$275 million per quarter for the remaining quarters.
- For Q2 2017 versus Q1, management expected modest loan growth, low-single-digit growth in net interest income, mid-single-digit growth in fee income, provision of $75–$125 million (potentially toward the high end due to an initial provision for acquired loans), and low-single-digit expense growth. Management said it was on track for $350 million of 2017 cost savings through its continuous-improvement program.
- Interest-rate sensitivity modeling showed first-year net interest income sensitivity of +2.5% to a gradual 100-basis-point increase and -4.5% to a 100-basis-point decrease; a yield-curve-flattening scenario showed -2.3% in year one and -6.5% in year two. These are modeled outcomes, not forecasts.
- Unusual items included a $47 million positive valuation adjustment on private-equity investments associated with a five-year extension to conform certain Volcker Rule investments. Q1 2016 included $44 million of Visa Class B share-sale gains. PNC also changed the accounting treatment of variation margin on certain centrally cleared derivatives; the change reduced gross derivative assets and liabilities but had no net fair-value impact.
- For disclosed legal matters where PNC could estimate possible losses, it estimated aggregate reasonably possible losses of up to approximately $425 million. This excludes matters for which losses could not be estimated and is not a maximum exposure; actual losses could be higher. In one CBNV mortgage case, arbitration awarded the plaintiff class $24 million, the amount PNC had proposed.
- Key risks include economic and market changes, interest-rate and credit-spread movements, credit quality and commodity-price volatility, regulatory and legal developments, capital-planning constraints, competition, cyber and operational events, and risks associated with BlackRock and fair-value estimates. PNC said there were no material changes to the risk factors disclosed in its 2016 Form 10-K.
Important facts for investors to verify
- Whether loan and revenue growth, net interest margin, and the full-year outlook are tracking management’s stated ranges.
- Whether fee growth and the $350 million cost-savings goal are achieved without undermining planned technology and business investment.
- How credit performance evolves, particularly commercial energy exposure, consumer delinquencies, nonperforming assets, charge-offs, and allowance adequacy.
- Whether deposit pricing and funding costs rise faster than asset yields, and how actual results compare with interest-rate sensitivity scenarios.
- Capital and liquidity levels, regulatory approval for planned capital returns, and progress toward the repurchase authorization.
- Potential legal losses beyond the estimable $425 million aggregate, and valuation sensitivity in mortgage servicing rights, securities, private equity, and other Level 3 assets.
- The effects of segment realignment and funds-transfer-pricing changes when interpreting business-level comparisons.