PNC Financial Services Group, Inc. — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011. Unless otherwise indicated, income-statement and cash-flow comparisons are with Q1 2010; balance-sheet comparisons are with December 31, 2010. Amounts are in U.S. dollars.
Business context and financial results
PNC is a diversified financial services company with retail and corporate banking, asset management, residential mortgage banking and other activities. Q1 results improved chiefly because credit-loss provisions were lower, despite weaker net interest income and total revenue.
| Metric | Q1 2011 | Q1 2010 |
|---|---|---|
| Total revenue | $3.631 billion | $3.763 billion |
| Net interest income | $2.176 billion | $2.379 billion |
| Noninterest income | $1.455 billion | $1.384 billion |
| Provision for credit losses | $421 million | $751 million |
| Noninterest expense | $2.070 billion | $2.113 billion |
| Income from continuing operations before tax and noncontrolling interests | $1.140 billion | $899 million |
| Net income | $832 million | $671 million |
| Diluted EPS, continuing operations | $1.57 | $0.61 |
| Net interest margin | 3.94% | 4.24% |
| Efficiency ratio | 57% | 56% |
Net interest income and margin fell as lower purchase-accounting accretion, soft loan demand and low rates outweighed lower funding costs. Noninterest income rose on residential mortgage revenue, securities gains and lower repurchase reserves, partly offset by reduced deposit service charges and corporate service revenue. The provision decline reflected improving credit quality and reduced exposure. The effective tax rate was 27.0%, versus 27.9%.
Balance sheet, credit, liquidity and capital
- Balance sheet: Total assets were $259.4 billion, down from $264.3 billion at year-end. Loans were $149.4 billion, down 1%; commercial loan growth was offset by declines in commercial real estate, residential mortgage and home equity loans. Deposits were $182.0 billion, down 1%, while borrowed funds fell to $35.0 billion from $39.5 billion.
- Funding and liquidity: Loans equaled 82% of deposits. PNC reported $60.4 billion of liquid assets, of which $24.6 billion was pledged. It also reported unused secured borrowing capacity of $15.2 billion with the FHLB and $25.0 billion with the Federal Reserve Bank.
- Cash flow: Operating activities provided $727 million, compared with $2.272 billion in Q1 2010; investing activities provided $5.113 billion and financing activities used $5.748 billion. Cash and due from banks increased $92 million during the quarter to $3.389 billion. Investing and financing flows included substantial securities activity and funding maturities.
- Credit: Net charge-offs were $533 million, down from $691 million; the annualized ratio was 1.44%, versus 1.77%. Nonperforming assets were $5.258 billion, down $43 million from year-end, and nonperforming loans were $4.393 billion. The allowance was $4.759 billion, or 3.19% of loans and 108% of nonperforming loans. Troubled debt restructurings rose to $1.835 billion from $1.658 billion; $882 million were nonperforming.
- Capital: Tier 1 common ratio increased to 10.3% from 9.8% at year-end; Tier 1 risk-based capital was 12.6%, total risk-based capital 16.2%, and leverage 10.6%. Shareholders’ equity was $31.1 billion.
Material changes and segment performance
Compared with Q1 2010, lower credit provisions supported higher continuing-operations pretax income and net income, while revenue contracted. PNC sold PNC Global Investment Servicing in July 2010; its Q1 2010 results are shown as discontinued operations. Q1 2010 common earnings were also reduced by a one-time, noncash $250 million TARP preferred-stock discount accretion charge; PNC had redeemed that preferred stock in February 2010.
- Corporate & Institutional Banking earnings increased to $432 million from $368 million, mainly on lower credit costs.
- Retail Banking reported an $18 million loss, versus $24 million earnings, amid lower overdraft-related fees and a low-rate environment.
- Asset Management Group earned $43 million, versus $39 million; assets under administration were $219 billion.
- Residential Mortgage Banking earned $71 million, versus $78 million. Higher loan-sale revenue and mortgage-servicing-rights hedge gains were offset by lower servicing fees and net interest income, higher credit provision and expenses.
- Distressed Assets Portfolio earnings declined to $25 million from $73 million, while its average loan balance contracted.
- “Other” earnings were $193 million, versus an $11 million loss, reflecting, among other items, a reversal of $38 million of Visa indemnification liability and higher securities gains; 2010 also included integration costs.
Outlook, risks and unusual items
- Management expected full-year 2011 purchase-accounting accretion to decline by as much as $700 million versus 2010. Excluding that effect, it expected net interest income to increase by $100 million or more, while net interest margin was expected to decline.
- Management expected full-year provision for credit losses to be at least $800 million below 2010, assuming budgeted loan growth. It expected noninterest expense below 2010, subject to investment levels and legal or regulatory contingencies.
- Excluding an estimated approximately $400 million incremental 2011 impact from Regulation E and proposed debit interchange limits, management expected noninterest income to grow in the low-to-mid single digits. The estimate depended on final interchange rules and did not include all possible regulatory effects.
- In April 2011, the board raised the quarterly common dividend from $0.10 to $0.35 per share and authorized plans to repurchase up to $500 million of common stock during the remainder of 2011 under the existing 25-million-share program. The Federal Reserve had accepted PNC’s capital plan without objection. These actions occurred after quarter-end.
- PNC and PNC Bank entered into April 2011 regulatory consent orders concerning foreclosure and mortgage-servicing controls. The orders require enhanced programs, an independent review of certain foreclosure actions and remedial measures; additional investigations, penalties or remedies remain possible.
- For disclosed legal matters where PNC could estimate possible losses, it reported an aggregate reasonably possible exposure of up to approximately $375 million, while stating that the estimate excludes some matters and is not a maximum exposure.
- Other significant risks include housing and economic conditions, continued credit deterioration, interest-rate and securities-market changes, mortgage repurchase claims, Dodd-Frank implementation, evolving capital rules and regulatory costs. PNC reported $252 million of residential mortgage and home-equity repurchase liabilities and $56 million of commercial mortgage recourse reserves at quarter-end.
Important facts for investors to verify
- Whether credit improvement continues, particularly in home equity, commercial real estate, troubled restructurings and foreclosed properties.
- Whether purchase-accounting accretion, loan demand, funding costs and the projected net-interest-income outlook develop as management expected.
- The realized revenue effects of Regulation E, debit interchange rules and other Dodd-Frank requirements.
- The adequacy of mortgage repurchase and indemnification reserves, and the effects of foreclosure consent orders and related legal proceedings.
- Execution and regulatory conditions for the planned BankAtlantic branch acquisition, dividend increase and contemplated share repurchases.
- The quality and valuation sensitivity of securities with unrealized losses, including non-agency mortgage-backed securities and Level 3 assets.