PNC Financial Services Group, Inc. — Second Quarter 2017 Form 10-Q
Business context and reporting period
PNC is a diversified U.S. financial services company operating in retail banking, corporate and institutional banking, asset management, and an equity interest in BlackRock. This unaudited filing covers the quarter and six months ended June 30, 2017; comparisons are primarily with the corresponding 2016 periods, or December 31, 2016 for balance-sheet measures.
Financial results and position
| Metric | Q2 2017 | Q2 2016 | Change |
|---|---|---|---|
| Total revenue | $4.060 billion | $3.794 billion | Up 7% |
| Net interest income (GAAP) | $2.258 billion | $2.068 billion | Up 9% |
| Noninterest income | $1.802 billion | $1.726 billion | Up 4% |
| Provision for credit losses | $98 million | $127 million | Down $29 million |
| Noninterest expense | $2.479 billion | $2.360 billion | Up 5% |
| Net income | $1.097 billion | $989 million | Up 11% |
| Diluted EPS | $2.10 | $1.82 | Up 15% |
| Net interest margin | 2.84% | 2.70% | Up 14 basis points |
| Efficiency ratio | 61% | 62% | Improved 1 percentage point |
For the first six months, revenue was $7.944 billion, net income was $2.171 billion, and diluted EPS was $4.05, up 7%, 12%, and 16%, respectively, year over year. The six-month effective tax rate was 24.5%, versus 23.9%.
- Balance sheet at June 30: Assets were $372.2 billion, loans $218.0 billion, deposits $259.2 billion, borrowed funds $56.4 billion, and shareholders’ equity $46.1 billion. Versus year-end 2016, loans rose 3%, deposits 1%, and borrowed funds 7%. Loans-to-deposits were 84%.
- Loan mix: Commercial lending grew 6% to $145.8 billion, while consumer lending declined 1% to $72.3 billion. The company attributed commercial growth partly to a commercial and vendor finance acquisition.
- Credit quality: Nonperforming assets fell 9% from year-end to $2.153 billion; nonperforming loans were 0.90% of loans, versus 1.02%. Second-quarter net charge-offs were $110 million, down 18% year over year; the six-month annualized net charge-off rate was 0.21%, versus 0.27%.
- Allowance: The allowance for loan and lease losses was $2.561 billion, or 1.17% of loans, compared with $2.589 billion, or 1.23%, at year-end. Coverage of nonperforming loans was 131%.
- Cash flows, six months: Operating activities provided $2.284 billion; investing activities used $4.833 billion; financing activities provided $2.709 billion. Cash and due from banks increased $160 million to $5.039 billion. Investing cash use included $7.080 billion of net loan growth and $1.323 billion paid for an acquisition.
- Capital and liquidity: Transitional Basel III CET1 was 10.3% and estimated fully phased-in standardized CET1 was 9.8%, compared with 10.6% and 10.0% at year-end, respectively. PNC said both it and PNC Bank exceeded the 100% minimum LCR requirement. Liquid assets totaled $86.1 billion, and parent-company available liquidity was $5.7 billion.
Material changes and management commentary
Revenue and earnings growth reflected higher loan yields and balances, higher interest rates, increased securities balances, stronger asset-management and corporate-services fees, and lower credit-loss provisions. Higher borrowing and deposit costs partly offset net interest income growth. Other income benefited from private-equity valuation adjustments and customer-derivative credit valuations; residential mortgage revenue declined due to lower loan-sale revenue and a smaller mortgage-servicing-rights valuation benefit.
Expense growth reflected business activity and continued technology and infrastructure investment. PNC said it was on track for $350 million in 2017 continuous-improvement cost savings. Segment results were affected by a 2017 realignment and changes to internal funds-transfer pricing; prior periods were recast for comparability. Retail Banking six-month earnings declined 22% to $443 million, while Corporate & Institutional Banking earnings rose 17% to $1.002 billion.
Outlook, risks, and unusual items
- 2017 outlook versus 2016: PNC maintained expectations for mid-single-digit loan growth, revenue growth at the upper end of the mid-single-digit range, low-single-digit expense growth, and a 25%–26% effective tax rate absent tax reform. Other noninterest income was expected at $250–$300 million in each remaining quarter.
- Q3 outlook versus Q2: Modest loan growth; low-single-digit net interest income growth; stable fee income and expenses; and provision for credit losses of $75–$125 million. Management’s assumptions included moderate U.S. growth and a 25-basis-point Federal Reserve rate increase in December 2017; actual conditions may differ.
- Capital returns: PNC returned $1.0 billion to shareholders in Q2 through $0.7 billion of repurchases and $0.3 billion of common dividends. It announced repurchases of up to $2.7 billion for the four quarters beginning Q3 2017. In July, the board raised the quarterly dividend from $0.55 to $0.75 per share, subject to regulatory and capital considerations.
- Legal exposure: For certain disclosed matters where loss estimates were possible, PNC estimated aggregate possible losses of up to approximately $425 million at June 30. This estimate excludes some matters and is not a maximum exposure; actual losses could be higher. The filing also describes ongoing regulatory and governmental inquiries.
- Regulatory and accounting: A CFPB arbitration-agreement rule issued in July 2017 was expected to apply to covered agreements entered into on or after March 19, 2018. PNC was assessing required changes. The company expected the forthcoming expected-credit-loss standard to increase its allowance, but said the adoption-date impact was not yet quantifiable.
- Subsequent debt issuance: On July 28, PNC Bank issued $750 million of five-year fixed-rate senior notes and $500 million of floating-rate senior notes.
- Market and operating risks: Risks include changes in rates and markets, economic weakness, credit deterioration, regulatory or legal outcomes, competition, cyberattacks and system failures. PNC’s rate sensitivity analysis indicated potential benefit from rising rates, but a flatter yield curve could reduce projected net interest income.
Most important facts for investors to verify
- Whether loan, revenue and net interest income growth meet the stated full-year and Q3 outlook, and how deposit and funding costs affect margins.
- Whether expense growth is contained and the $350 million cost-savings target is achieved while technology and business investments continue.
- Credit trends, particularly commercial exposures, consumer delinquencies, criticized loans, TDR performance, and allowance adequacy as the portfolio grows.
- Capital ratios and regulatory approval conditions for the announced repurchase program and higher dividend.
- The eventual financial impact of legal proceedings and regulatory inquiries; the stated $425 million estimate is incomplete and not a maximum loss estimate.
- Acquisition integration and performance, and the effects of changing interest rates and securities valuations on earnings, liquidity, and capital.