PNC Financial Services Group, Inc. — Second Quarter 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014; comparisons are with the corresponding 2013 periods unless noted. PNC is a diversified U.S. financial services company spanning retail and corporate banking, asset management, residential mortgage banking and related businesses. The filing is unaudited.
Financial results and position
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenue | $3.810 billion | $4.064 billion | $7.587 billion | $8.019 billion |
| Net interest income | $2.129 billion | $2.258 billion | $4.324 billion | $4.647 billion |
| Noninterest income | $1.681 billion | $1.806 billion | $3.263 billion | $3.372 billion |
| Provision for credit losses | $72 million | $157 million | $166 million | $393 million |
| Noninterest expense | $2.328 billion | $2.405 billion | $4.592 billion | $4.773 billion |
| Net income | $1.052 billion | $1.115 billion | $2.112 billion | $2.110 billion |
| Diluted EPS | $1.85 | $1.98 | $3.67 | $3.72 |
| Net interest margin | 3.12% | 3.58% | 3.19% | 3.69% |
- Q2 net income fell 6% as lower revenue more than offset reduced expenses and credit provision. First-half net income was nearly flat, with expense and provision reductions offsetting weaker revenue.
- Q2 efficiency ratio was 61%, versus 59%; return on average common equity was 10.12%, versus 11.71%, and return on average assets was 1.31%, versus 1.48%.
- Six-month cash flows: operating activities provided $3.470 billion, investing activities used $6.282 billion, and financing activities provided $3.661 billion. Cash and due from banks increased $849 million to $4.892 billion. For a bank, these cash-flow movements should be considered alongside balance-sheet and liquidity trends.
- At June 30, total assets were $327.1 billion; loans were $201.0 billion, deposits $222.6 billion, borrowed funds $49.1 billion, and shareholders’ equity $44.2 billion. Loans-to-deposits was 90%.
- PNC reported $65.1 billion in liquid assets, including $20.6 billion in short-term investments and $44.5 billion in available-for-sale securities; $16.5 billion of liquid assets was pledged. Interest-earning deposits with banks rose to $16.9 billion, primarily reflecting balances at the Federal Reserve.
- Transitional Basel III common equity Tier 1 ratio was 11.0%; estimated pro forma fully phased-in standardized-approach ratio was 10.0%, up from 9.4% at year-end 2013. PNC and PNC Bank were described as well capitalized under applicable requirements.
Material changes and operating trends
- Revenue declined 6% in Q2 and 5% in the first half. Net interest income fell primarily because of lower loan yields and purchase-accounting accretion, with loan growth partly offsetting the pressure. Higher balances held at the Federal Reserve to strengthen liquidity also weighed on asset yields.
- Noninterest income fell 7% in Q2 and 3% year to date. Fee growth was offset by lower asset-valuation and asset-sale revenue, weaker residential mortgage loan-sale activity, and lower customer-derivative credit valuation revenue. First-half other income included a $116 million gain on sales of Visa Class B shares.
- Loan balances grew $5.4 billion from year-end, led by $6.9 billion of commercial lending growth; consumer lending declined $1.6 billion. Deposits increased $1.6 billion. Borrowed funds rose $3.0 billion, including higher FHLB borrowings and debt issuances, partly in support of liquidity.
- Credit quality improved: nonperforming assets declined to $3.17 billion from $3.46 billion at year-end; the nonperforming-assets-to-total-assets ratio fell to 0.97% from 1.08%. First-half net charge-offs were $331 million, versus $664 million; the prior-year comparison included charge-offs following alignment with interagency guidance. The allowance was $3.45 billion, or 1.72% of loans and 123% of nonperforming loans.
- Segment results were mixed for the first half: Retail Banking earnings rose to $383 million from $278 million; Corporate & Institutional Banking fell to $993 million from $1.153 billion; Asset Management rose to $90 million from $79 million; Residential Mortgage Banking fell to $32 million from $65 million; BlackRock earnings attributable to PNC rose to $253 million from $220 million; and the Non-Strategic Assets Portfolio rose to $209 million from $139 million.
Outlook, risks and unusual items
- Management expected Q3 net interest income to be modestly lower, fee-based noninterest income to remain stable, provision for credit losses of $75 million to $125 million, and noninterest expense to rise by low single digits from Q2. For full-year 2014, PNC expected revenue to remain under pressure and potentially decline from 2013, while noninterest expense was expected to decline.
- Management expected purchase-accounting accretion to decrease approximately $300 million in 2014 versus 2013 and approximately $225 million in 2015 versus 2014. PNC said it had completed actions representing more than two-thirds of its $500 million 2014 continuous-improvement savings goal and expected to achieve the full-year goal.
- PNC increased its quarterly common dividend from $0.44 to $0.48 per share. Its Federal Reserve-accepted 2014 capital plan authorized up to $1.5 billion of repurchases over four quarters beginning Q2; Q2 repurchases totaled $223 million.
- Accounting changes included early adoption of ASU 2014-01 for qualifying low-income-housing tax-credit investments, including a $74 million cumulative reduction to retained earnings at January 1, 2014 and revised presentation of related amortization and tax credits. PNC also reclassified $31 million of commercial facility fees from net interest income to noninterest income in Q2; prior periods were not adjusted because the impact was described as not significant.
- Residential mortgage repurchase reserve was $101 million, down from $131 million at year-end; PNC estimated reasonably possible additional residential mortgage losses of up to approximately $87 million above that reserve. The combined residential mortgage and home-equity indemnification/repurchase liability was $126 million.
- For disclosed legal matters, PNC estimated reasonably possible aggregate losses of up to approximately $725 million. The filing cautions that this estimate excludes some matters and is not a maximum-loss estimate; outcomes remain uncertain. Regulatory and governmental inquiries, mortgage-related claims, litigation, and potential fines or changes to business practices remain risks.
- Key external and business risks include prolonged low rates and spread compression, economic or market deterioration, credit and asset-valuation changes, evolving capital, liquidity and consumer regulations, litigation and investigations, competition, cyber and operational risks, and execution of growth and expense initiatives.
Important facts for investors to verify
- Whether loan growth, deposit mix and pricing can offset continued margin compression and declining purchase-accounting accretion.
- Whether the stated revenue, expense, credit-provision and $500 million savings outlook is achieved, and how much of earnings depends on gains or valuation-sensitive income.
- Credit trends and reserve adequacy, including commercial portfolio growth, home-equity exposure, purchased-impaired-loan cash-flow assumptions, and the effect of prior-period charge-off comparability.
- Liquidity and funding composition, including increased borrowed funds, pledged liquid assets, contingent borrowing capacity and regulatory liquidity requirements.
- Capital-ratio assumptions under Basel III, the timing and amount of planned dividends and repurchases, and continuing Federal Reserve or regulatory approval requirements.
- Developments in the estimated legal-loss exposure, mortgage repurchase claims and other contingencies; the filing’s legal-loss estimate is not a ceiling on potential exposure.