Business context and reporting period
PNC Financial Services Group, Inc. is a diversified U.S. financial services company with retail banking, corporate and institutional banking, asset management, residential mortgage banking, and other businesses. This Form 10-K covers the fiscal year ended December 31, 2012; amounts below are annual unless identified as fourth-quarter figures. PNC acquired RBC Bank (USA) on March 2, 2012 for $3.6 billion cash, adding approximately $18.1 billion of deposits and $14.5 billion of loans. The acquisition’s results are included from the closing date.
Financial performance and position
| Metric | 2012 | 2011 |
|---|---|---|
| Total revenue | $15.512 billion | $14.326 billion |
| Net income | $3.001 billion | $3.071 billion |
| Net income attributable to common shareholders | $2.832 billion | $2.998 billion |
| Diluted EPS | $5.30 | $5.64 |
| Net interest income | $9.640 billion | $8.700 billion |
| Net interest margin | 3.94% | 3.92% |
| Provision for credit losses | $987 million | $1.152 billion |
| Noninterest expense | $10.582 billion | $9.105 billion |
- Revenue increased 8%, but net income fell 2% as a 16% increase in noninterest expense more than offset revenue growth and lower credit-loss provision. The efficiency ratio increased to 68% from 64%.
- Net interest income growth reflected the RBC acquisition, organic loan growth, and lower funding costs. The net interest margin was nearly flat as lower liability costs were largely offset by lower yields on earning assets.
- Cash flows: operating activities provided $6.827 billion; investing activities used $17.261 billion; financing activities provided $11.549 billion. Cash and due from banks increased $1.115 billion to $5.220 billion. Bank cash flows reflect financial-institution balance-sheet activity and should not be read like those of a nonfinancial company.
- At year-end, assets were $305.1 billion, loans $185.9 billion, deposits $213.1 billion, borrowed funds $40.9 billion, and shareholders’ equity $39.0 billion. The loans-to-deposits ratio was 87%.
- Tier 1 common capital ratio was 9.6% (10.3% in 2011); Tier 1 risk-based ratio was 11.6% and total risk-based ratio 14.7%. PNC estimated a 7.5% pro forma Basel III Tier 1 common ratio, excluding phase-in benefits.
- Fourth-quarter 2012 net income was $719 million and diluted EPS was $1.24; revenue was $4.069 billion.
Material changes versus the prior comparable period
- Loans grew $26.8 billion, or 17%, and deposits grew $25.2 billion, or 13%, versus year-end 2011, reflecting the RBC acquisition and organic growth. Transaction deposits reached $176.7 billion.
- Credit quality improved overall: nonperforming assets declined 9% to $3.8 billion; net charge-offs fell 21% to $1.289 billion; and the allowance for loan and lease losses decreased to $4.036 billion from $4.347 billion. The allowance equaled 2.17% of loans, versus 2.73%.
- Residential Mortgage Banking reported a $308 million loss, versus $89 million of earnings in 2011. Its $761 million provision for mortgage repurchase obligations was a major driver of the decline.
- Noninterest income rose to $5.872 billion from $5.626 billion, including $267 million of gains on Visa Class B share sales. Noninterest expense rose $1.477 billion, reflecting acquired operations, integration costs, trust-preferred redemption charges, mortgage-related expenses, and a goodwill impairment.
- Available-for-sale securities moved from a $41 million net unrealized loss at year-end 2011 to a $1.6 billion net unrealized gain at year-end 2012. Accumulated other comprehensive income was $834 million, versus a $105 million loss.
Outlook, commentary, risks and unusual items
- Management’s 2013 priorities include positive operating leverage, customer and revenue growth, expense reduction, investment in the business, capital building, and risk management. PNC targeted a Basel III Tier 1 common ratio of 8.0%–8.5% by year-end 2013, without phase-in benefits.
- PNC expected 2013 net interest income to decline from 2012, primarily because purchase-accounting accretion was expected to fall about $400 million; core net interest income was expected to increase. Management anticipated continued margin pressure if low rates persisted.
- Management expected 2013 noninterest income and total revenue to increase, and noninterest expense to decline by a mid-single-digit percentage. Its continuous-improvement savings goal was $700 million, partly offset by business and infrastructure investment. The expected 2013 effective tax rate was 25%–26%. These are forward-looking expectations, not guarantees.
- For first-quarter 2013, management expected net interest income to decline 2%–3% from fourth-quarter 2012 and provision for credit losses of $200–$300 million. It expected noninterest expense to fall at least $300 million from fourth-quarter 2012.
- Residential mortgage repurchase exposure is a key contingency. The year-end liability was $614 million, up from $83 million; management estimated up to approximately $332 million of reasonably possible additional losses above the accrued residential mortgage liability. PNC cited elevated repurchase demands, especially from Fannie Mae and Freddie Mac, and expected claims to increase in 2013.
- PNC agreed in early 2013 to pay approximately $70 million for borrower remediation and provide approximately $111 million of additional foreclosure-prevention or other relief under amended foreclosure consent orders. Other mortgage, consumer-protection, and legal inquiries could result in additional costs. For disclosed legal matters where a loss range could be estimated, PNC estimated aggregate reasonably possible losses of up to approximately $450 million; this excludes matters for which PNC could not estimate a loss and is not a maximum exposure estimate.
- Other notable items included $295 million of noncash charges related to trust-preferred redemptions, $267 million of acquisition integration costs, and a $45 million noncash Residential Mortgage Banking goodwill impairment. Hurricane Sandy-related costs were not significant to the financial statements.
- Key risks include a weak or worsening economy, prolonged low interest rates, credit and real-estate deterioration, mortgage repurchase and servicing claims, regulatory and capital-rule changes, acquisition integration, market and valuation volatility, cybersecurity and operational failures, and litigation. The Federal Reserve’s 2013 capital-plan review could constrain dividends or repurchases.
Most important facts for investors to verify
- How much of loan, deposit, revenue, and earnings growth came from RBC Bank (USA), and whether expected acquisition synergies and Southeast-market growth are being realized.
- Whether mortgage repurchase claims, reserve adequacy, and foreclosure-related remediation costs track management’s estimates, including the possible losses above recorded liabilities.
- Whether expense reductions and revenue growth deliver the stated 2013 operating-leverage objective without weakening customer service or risk controls.
- How purchase-accounting accretion, deposit costs, asset yields, and prevailing rates affect net interest income and margin.
- Capital progression against the 8.0%–8.5% Basel III target, final regulatory requirements, and Federal Reserve decisions on capital distributions.
- Liquidity and funding capacity, including deposit trends, near-term debt maturities, and the availability of contingent borrowing sources.
- The filing reports an unqualified audit opinion and effective internal control over financial reporting as of December 31, 2012.