PNC Financial Services Group, Inc. — Third Quarter 2012 Form 10-Q
Business context and period. PNC is a diversified U.S. financial services company with retail and corporate banking, asset management, residential mortgage banking and an investment in BlackRock. This unaudited report covers the quarter and nine months ended September 30, 2012; balance-sheet comparisons are primarily with December 31, 2011. Results include RBC Bank (USA) from its March 2, 2012 acquisition.
Financial performance
| Metric | Three months ended Sept. 30, 2012 | Three months ended Sept. 30, 2011 | Nine months ended Sept. 30, 2012 | Nine months ended Sept. 30, 2011 |
|---|---|---|---|---|
| Total revenue | $4.088 billion | $3.544 billion | $11.443 billion | $10.777 billion |
| Net interest income | $2.399 billion | $2.175 billion | $7.216 billion | $6.501 billion |
| Net interest margin | 3.82% | 3.89% | 3.93% | 3.92% |
| Noninterest income | $1.689 billion | $1.369 billion | $4.227 billion | $4.276 billion |
| Noninterest expense | $2.650 billion | $2.140 billion | $7.753 billion | $6.386 billion |
| Provision for credit losses | $228 million | $261 million | $669 million | $962 million |
| Net income | $925 million | $834 million | $2.282 billion | $2.578 billion |
| Diluted EPS | $1.64 | $1.55 | $4.06 | $4.79 |
| Efficiency ratio | 65% | 60% | 68% | 59% |
Third-quarter net income rose 11% year over year, while nine-month net income fell 11%. Revenue growth and lower credit provisions supported earnings, but higher expenses more than offset those benefits year to date. Third-quarter diluted EPS included a $0.17 benefit from the Visa share sale, partly offset by a $0.12 impact from noncash trust-preferred redemption charges and a $0.04 impact from integration costs.
Cash flow (nine months): Operating activities provided $5.626 billion, versus $4.585 billion in 2011; investing activities used $11.633 billion, versus $3.726 billion; and financing activities provided $6.186 billion, versus $174 million used. Cash and due from banks increased $179 million to $4.284 billion. Bank cash flows include substantial lending, securities and deposit movements.
Balance sheet, credit, debt and liquidity
- Total assets were $300.8 billion, up $29.6 billion from year-end 2011. Loans were $181.9 billion, up $22.9 billion; deposits were $206.3 billion, up $18.3 billion. The RBC acquisition contributed approximately $14.5 billion of loans and $18.1 billion of deposits.
- Transaction deposits were $168.4 billion, or 82% of deposits. The loans-to-deposits ratio was 88%, compared with 85% at year-end 2011. Borrowed funds totaled $43.1 billion, up $6.4 billion; commercial paper increased to $10.7 billion.
- PNC reported $58.8 billion of liquid assets, including $6.7 billion of short-term investments and $52.1 billion of available-for-sale securities; $23.1 billion was pledged as collateral. Management described the bank holding company liquidity position as strong.
- Tier 1 common capital was 9.5%, compared with 10.3% at year-end; Tier 1 risk-based capital was 11.7%, total risk-based capital 14.5%, and leverage 10.4%. PNC and PNC Bank were reported as well-capitalized under then-current Basel I requirements. Management’s stated goal was a Basel III Tier 1 common ratio of 8.0%–8.5% by year-end 2013, without phase-in benefits.
- Credit quality improved overall: nonperforming assets were $4.0 billion, down 3% from year-end; nonperforming loans were 1.88% of loans versus 2.24%; and third-quarter annualized net charge-offs were 0.73% versus 0.95% a year earlier. The allowance for loan and lease losses was $4.039 billion, or 2.22% of loans, and 118% of nonperforming loans.
- Residential mortgage repurchase obligations remain a material exposure. The related reserve was $421 million at September 30, up from $83 million at year-end; unresolved asserted claims totaled $512 million. PNC estimated up to approximately $324 million of reasonably possible additional residential mortgage losses above the recorded liability. Home-equity repurchase liabilities were $62 million.
Material changes and unusual items
- The RBC Bank (USA) acquisition materially expanded the branch network and balance sheet. PNC paid $3.6 billion and recorded $950 million of goodwill and $180 million of other intangible assets. Integration costs were $232 million for the first nine months.
- PNC recognized a $137 million pretax gain on the sale of 5 million Visa Class B shares in the third quarter. Approximately 18 million shares remained, with an estimated fair value of about $1 billion; the shares are subject to transfer restrictions and litigation-related conversion adjustments.
- Trust-preferred redemptions totaling approximately $1.8 billion during the first nine months generated $225 million of noncash discount charges, including $95 million in the third quarter. PNC issued approximately $2 billion of preferred stock during the period.
- The residential mortgage repurchase provision was $507 million for the first nine months, including $438 million in the second quarter. Residential Mortgage Banking reported a nine-month loss of $116 million, versus earnings of $150 million in 2011.
- New regulatory guidance led PNC to classify certain bankruptcy-related consumer loans without reaffirmed obligations as troubled debt restructurings. The change added $154.8 million of TDRs, net of charge-offs; $82.9 million of charge-offs were recorded. PNC cautioned that estimates could change as it validates the underlying population.
- After quarter-end, PNC reported Hurricane Sandy damage affecting customers and communities, particularly in New Jersey, but said it could not yet reasonably estimate potential losses. PNC also sold the Smartstreet unit on October 26; the expected gain was immaterial.
Outlook, management commentary and risks
- Management expected fourth-quarter net interest income to be broadly stable with the third quarter, with core growth offset by an expected $30–$35 million decline in purchase-accounting accretion. For 2013, it expected accretion to decline about $400 million from 2012, total revenue to exceed 2012, and net interest margin to remain under pressure if low rates persisted.
- Management expected fourth-quarter credit-loss provision to be similar to recent quarters. Fourth-quarter expense was expected to include $51 million of integration costs and $67 million of noncash charges related to a planned hybrid-capital redemption and remarketing. The 2012 continuous-improvement target was more than $550 million of annualized savings; more than $417 million had been identified or captured as estimated savings by September 30, as described in the filing.
- Key risks include interest-rate and market movements, economic weakness, credit quality, mortgage repurchase claims, acquisition integration and deposit retention, evolving Basel III and other regulation, legal proceedings, fair-value and allowance estimates, and operational or cyber disruptions. Disclosed legal matters had estimated reasonably possible aggregate losses of up to approximately $425 million, excluding matters PNC could not estimate; this is not stated to be a maximum exposure.
- PNC reported effective disclosure controls and no third-quarter change in internal control over financial reporting that materially affected, or was reasonably likely to materially affect, those controls.
Important facts for investors to verify
- How much of loan, deposit and revenue growth reflects RBC acquisition activity versus organic growth, and whether integration savings and anticipated synergies are being realized.
- Whether mortgage repurchase claims, reserve assumptions and the estimated $324 million of possible additional residential losses remain appropriate as claims are resolved.
- Whether reported credit improvement persists, considering rising home-equity nonperforming loans, growing TDR balances and the new bankruptcy-related classification policy.
- How purchase-accounting accretion declines, low interest rates and funding costs affect net interest income, margin and the 2013 revenue outlook.
- Capital and liquidity effects of regulatory changes, planned capital actions, debt issuance and redemption activity; also verify subsequent-event closings and the actual effect of Hurricane Sandy.