PNC Financial Services Group, Inc. — Second Quarter 2015 Form 10-Q
Business context and period. PNC is a diversified U.S. financial services company with retail banking, corporate and institutional banking, asset management, residential mortgage banking, a BlackRock investment, and a non-strategic assets portfolio. This unaudited report covers the quarter and six months ended June 30, 2015; balance-sheet comparisons are primarily with December 31, 2014.
Financial performance and condition
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Total revenue | $3.866 billion | $3.810 billion | $7.597 billion | $7.587 billion |
| Net interest income | $2.052 billion | $2.129 billion | $4.124 billion | $4.324 billion |
| Noninterest income | $1.814 billion | $1.681 billion | $3.473 billion | $3.263 billion |
| Provision for credit losses | $46 million | $72 million | $100 million | $166 million |
| Noninterest expense | $2.366 billion | $2.328 billion | $4.715 billion | $4.592 billion |
| Net income | $1.044 billion | $1.052 billion | $2.048 billion | $2.112 billion |
| Diluted earnings per common share | $1.88 | $1.85 | $3.63 | $3.67 |
- Margins and returns: Net interest margin was 2.73% in Q2 versus 3.12% a year earlier, and 2.78% for the half-year versus 3.19%. The efficiency ratio was 61% for Q2 and 62% year to date. Q2 return on average assets was 1.19%; return on average common equity was 9.75%.
- Cash flow: For the first six months, operating cash flow was $1.629 billion (versus $3.470 billion in 2014), investing cash flow was negative $8.483 billion (versus negative $6.282 billion), and financing cash flow was positive $6.906 billion (versus positive $3.661 billion). Cash and due from banks ended June at $4.412 billion. The filing does not provide a separate Q2-only cash-flow total in the presented data.
- Balance sheet and funding: At June 30, assets were $353.945 billion, loans $205.153 billion, deposits $239.704 billion, borrowed funds $58.276 billion, and shareholders’ equity $44.515 billion. Since year-end, assets grew 3%, deposits 3%, and borrowed funds 3%; securities rose 10% to $61.362 billion. The loans-to-deposits ratio was 86%.
- Capital and liquidity: Transitional Basel III common equity Tier 1 was 10.6%, down from 10.9% at year-end; estimated fully phased-in standardized CET1 was 10.0%. PNC and PNC Bank each reported an LCR above 100%, against the 2015 phased-in minimum of 80%. Management described liquidity and capital as strong; both PNC and PNC Bank were considered well capitalized.
- Credit quality: Nonperforming assets declined to $2.578 billion from $2.880 billion at year-end; nonperforming assets were 0.73% of total assets. Q2 net charge-offs were $67 million, or 0.13% of average loans annualized, versus $145 million and 0.29% a year earlier. The allowance for loan and lease losses was $3.272 billion, equal to 1.59% of loans and 145% of nonperforming loans.
Material changes and notable items
- Q2 net income fell $8 million year over year: higher fee income and lower credit provision were more than offset by lower net interest income and higher expenses. For the first half, net income declined 3%.
- Management attributed weaker net interest income and margin principally to the low-rate environment, lower loan yields, increased liquidity balances, and lower purchase-accounting accretion. Commercial and commercial real estate lending growth and higher securities balances partly offset these pressures.
- Noninterest income growth reflected stronger client fees and asset-sale gains, including a $79 million gain on Visa Class B share sales in Q2. PNC held approximately 6 million Visa Class B shares with reported fair value of about $649 million at quarter-end.
- Loans were nearly flat versus year-end: commercial lending increased $2.354 billion, while consumer lending declined $2.018 billion, including runoff in home equity, auto, and education loans.
- PNC repurchased 5.9 million shares for about $0.6 billion in Q2 and declared a quarterly common dividend of $0.51 per share. It redeemed $500 million of Series K preferred stock in May. The Federal Reserve accepted the 2015 capital plan without objection; the plan authorized repurchases of up to $2.875 billion over five quarters beginning Q2 2015.
- On June 17, 2015, the OCC terminated PNC Bank’s 2011 and amended 2013 residential mortgage servicing consent orders. A related Federal Reserve consent order remained open.
Outlook, risks, and contingencies
- Management expected Q3 net interest income to remain stable versus Q2; fee categories to remain stable; credit-loss provision of $50 million to $100 million; and noninterest expense to remain stable. It expected full-year 2015 expenses to be about 1% below 2014 and the effective tax rate to be about 26%.
- Expected 2015 purchase-accounting accretion was revised to be approximately $200 million below 2014, compared with a prior estimate of $225 million below; stronger-than-expected cash recoveries in the first half informed the revision.
- Management’s stated economic assumptions included U.S. growth near 3.2% in the second half of 2015 and a gradual rise in short-term rates and bond yields. These are forward-looking assumptions, not guaranteed outcomes. Key risks include interest-rate and market movements, economic weakness, credit quality, regulatory and compliance costs, litigation, technology and cybersecurity, and execution of strategic and expense initiatives.
- For disclosed legal matters where losses could be estimated, PNC reported aggregate reasonably possible losses of up to approximately $725 million. The estimate excludes some matters and is not a maximum exposure; actual losses could be higher. Separately, possible residential mortgage repurchase losses above the recorded liability were estimated at up to approximately $81 million. The recorded liability for residential mortgage and home-equity repurchase claims was $125 million.
- PNC reported $138.242 billion of commitments to extend credit and $9.509 billion of net standby letters of credit. These are contingent commitments, not amounts necessarily expected to be funded. Management also identified potential sensitivity in securities valuations, mortgage servicing rights, and purchased impaired loan cash-flow estimates.
Important facts for investors to verify
- Whether fee growth and asset-sale gains can offset continued pressure on net interest income and margin, including the effect of interest rates and purchase-accounting accretion.
- Whether the Q3 and full-year expense, provision, tax, and accretion outlooks are achieved, and how much earnings depend on one-time or market-sensitive items.
- Credit trends beneath headline improvement, including consumer and home-equity exposures, troubled debt restructurings, and purchased impaired loans, which are excluded from reported nonperforming-loan measures.
- Capital and liquidity headroom under applicable regulatory rules, and the effect of planned share repurchases, dividends, and balance-sheet growth.
- The eventual outcome of legal and regulatory matters and mortgage repurchase claims, noting that disclosed loss estimates exclude certain matters and may not cap exposure.