PNC Financial Services Group, Inc. — Third-Quarter 2013 Form 10-Q
Business context and reporting period
PNC is a diversified U.S. financial services company with retail banking, corporate and institutional banking, asset management, residential mortgage banking and other businesses. This unaudited filing covers the quarter and nine months ended September 30, 2013; comparisons are with the corresponding 2012 periods unless otherwise noted.
Key financial metrics
| Metric | Q3 2013 | Nine months 2013 |
|---|---|---|
| Total revenue | $3.920 billion | $11.939 billion |
| Net interest income | $2.234 billion | $6.881 billion |
| Noninterest income | $1.686 billion | $5.058 billion |
| Noninterest expense | $2.424 billion | $7.254 billion |
| Provision for credit losses | $137 million | $530 million |
| Net income | $1.039 billion | $3.166 billion |
| Net income attributable to common shareholders | $966 million | $2.973 billion |
| Diluted earnings per common share | $1.79 | $5.55 |
| Net interest margin | 3.47% | 3.62% |
Q3 efficiency ratio was 62%, compared with 65% a year earlier; nine-month efficiency was 61%, compared with 68%. The nine-month effective tax rate was 23.8%, versus 24.5% in 2012.
For the nine months, operating cash flow was $5.896 billion, investing cash flow was $(7.829) billion and financing cash flow was $1.621 billion. Cash and due from banks ended at $4.908 billion.
At September 30, 2013, total assets were $308.6 billion; loans were $192.9 billion, net of a $3.7 billion loan-loss allowance; deposits were $216.1 billion; borrowed funds were $40.3 billion; and shareholders’ equity was $41.1 billion. Loans-to-deposits were 89%. Total liquid assets were $56.3 billion, including $10.5 billion of short-term investments and $45.8 billion of available-for-sale securities; $22.3 billion of liquid assets were pledged as collateral.
Capital ratios under Basel I were 10.3% Tier 1 common, 12.3% Tier 1 risk-based, 15.6% total risk-based and 11.1% leverage. The estimated fully phased-in Basel III Tier 1 common ratio was 8.7%; PNC cautioned that this estimate depends on evolving models and regulatory interpretation.
Material changes versus comparable periods
- Q3 revenue declined 4% year over year, while net income increased 12%. Lower net interest income drove the revenue decline; lower expenses and credit provision supported earnings.
- Q3 net interest income fell 7% and net interest margin declined from 3.82% to 3.47%, primarily reflecting lower asset yields and purchase-accounting accretion.
- Q3 noninterest income was broadly unchanged. Client fee growth was offset by lower residential mortgage revenue and lower gains on asset sales and valuations.
- For the first nine months, revenue rose 4% and net income rose from $2.282 billion to $3.166 billion. Noninterest income increased 20%, including improved residential mortgage repurchase provisions, client fee growth and higher valuation gains.
- Nine-month noninterest expense decreased 6%, reflecting lower integration, trust-preferred-redemption and foreclosure-related costs.
- Loans increased $7.0 billion and deposits $2.9 billion from December 31, 2012. Nonperforming assets declined to $3.6 billion from $3.8 billion at year-end; the nonperforming-asset ratio was 1.17%, versus 1.24%.
- Nine-month net charge-offs were $888 million, down from $979 million; the annualized charge-off ratio was 0.63%, versus 0.75%. The allowance-to-loans ratio declined to 1.91% from 2.17% at year-end.
Outlook, commentary, risks and unusual items
- Management expected Q4 net interest income to be down modestly, with purchase-accounting accretion projected at about $175 million, versus $199 million in Q3. It expected full-year 2013 accretion to decline about $300 million from 2012 and a further decline of about $300 million in 2014.
- Management expected Q4 credit-loss provision of $150 million to $225 million, Q4 noninterest expense to be stable with Q3, and full-year 2013 noninterest expense to be more than 5% below 2012. It expected full-year 2013 noninterest income and total revenue to exceed 2012.
- PNC said it had already met its $700 million continuous-improvement savings goal by September 30 and expected to exceed it. It did not expect common-stock repurchases in 2013; the quarterly common dividend had increased to $0.44 per share.
- In October 2013, PNC reached an agreement in principle with FNMA to resolve repurchase demands on loans sold from 2000 through 2008. The agreement remained subject to documentation and approvals, and the settlement amount had been fully accrued at September 30. The residential mortgage repurchase liability was $471 million; PNC estimated reasonably possible additional losses above that accrual of up to approximately $203 million.
- For disclosed legal matters where PNC could estimate possible losses, it reported a reasonably possible aggregate loss of up to approximately $425 million. This estimate excluded some matters and is not a maximum exposure estimate; actual losses could be higher.
- Regulatory and market risks include Basel III capital implementation, proposed liquidity rules, interest-rate and credit-spread movements, potential effects of U.S. fiscal and debt-limit uncertainty, and the appeal concerning debit-card interchange rules. PNC warned that an adverse interchange-rule outcome could materially affect debit revenue; 2012 debit-card interchange revenue was approximately $305 million.
- PNC initiated the wind-down of the Market Street commercial-paper conduit, expected to be completed by year-end 2013. The company said it expected no material financial impact; PNC Bank could have been required to fund Market Street under liquidity facilities until completion.
- Q3 included a $1.9 billion transfer of securities from available for sale to held to maturity to reduce volatility in accumulated other comprehensive income and certain capital measures. The nine-month comparison also reflected a $168 million gain from Visa share sales and tax benefits, including a one-time benefit related to permanently reinvested foreign earnings.
Important facts for investors to verify
- Whether the FNMA settlement is finalized, its terms and subsequent effects on repurchase reserves and cash flows.
- Trends in net interest margin and purchase-accounting accretion against management’s Q4 2013 and 2014 expectations.
- Credit quality and reserve adequacy, including the effect of 2013 consumer-loan classification changes and purchased-impaired-loan cash-flow estimates.
- Progress on Basel III implementation, capital estimates, liquidity requirements and the Federal Reserve’s review of capital distributions.
- Resolution of material legal and regulatory matters, including the disclosed possible-loss estimate and interchange-rule appeal.
- Whether expense, revenue and credit-provision outlooks were achieved, and whether liquidity remains available after pledged collateral and contingent commitments are considered.