PNC Financial Services Group, Inc. — Q2 2021 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2021. Comparisons are generally with the corresponding 2020 periods; balance-sheet comparisons are with December 31, 2020. PNC is a diversified U.S. financial institution with Retail Banking, Corporate & Institutional Banking, and Asset Management businesses.
Business context and material changes
PNC acquired BBVA USA Bancshares on June 1, 2021, for $11.5 billion in cash. Second-quarter results include one month of BBVA operations; the June 30 balance sheet includes $95.7 billion of acquired assets, $82.2 billion of deposits, and $60.5 billion of loans. PNC expected to merge BBVA USA into PNC Bank in October 2021. The acquisition materially affects period-over-period balance-sheet comparisons and adds acquisition, integration, and purchase-accounting effects to results.
The 2020 comparison also includes BlackRock as discontinued operations: PNC sold its 22.4% investment in May 2020, recognizing a $4.3 billion after-tax gain. Consequently, reported total net income comparisons are not directly comparable; continuing-operations results provide a more relevant operating comparison.
Financial performance
| Metric | Q2 2021 | Q2 2020 | Six months 2021 | Six months 2020 |
|---|---|---|---|---|
| Total revenue | $4.667 billion | $4.076 billion | $8.887 billion | $8.412 billion |
| Net interest income | $2.581 billion | $2.527 billion | $4.929 billion | $5.038 billion |
| Noninterest income | $2.086 billion | $1.549 billion | $3.958 billion | $3.374 billion |
| Provision for (recapture of) credit losses | $302 million | $2.463 billion | $(249) million | $3.377 billion |
| Noninterest expense | $3.050 billion | $2.515 billion | $5.624 billion | $5.058 billion |
| Net income from continuing operations | $1.103 billion | $(744) million | $2.929 billion | $15 million |
| Diluted EPS from continuing operations | $2.43 | $(1.90) | $6.53 | $(0.29) |
Q2 revenue rose 14% year over year, while continuing-operations net income improved primarily because credit-loss provisions were substantially lower. Q2 net interest income included $236 million from BBVA; the 2% increase reflected acquired balances and lower deposit costs, partly offset by lower legacy loan balances and securities yields. Net interest margin declined 23 basis points to 2.29%, primarily reflecting higher balances held at the Federal Reserve. Noninterest income increased 35%, supported by consumer and corporate services and other income; residential mortgage income fell. Expense increased 21%, including $179 million of BBVA operating expense, $101 million of integration expense, higher business and marketing activity, and additions to legal reserves. The Q2 provision included a $1.0 billion initial BBVA provision, more than offsetting a $704 million recapture.
For the first half, net interest income declined 2% and margin fell 39 basis points to 2.28%; higher deposit costs were lower than in 2020, but loan and securities yields declined and balances held at the Federal Reserve increased. First-half credit-loss provision was a net recapture, reflecting improved credit quality and economic forecasts, partly offset by BBVA-related provisions. Efficiency ratio was 65% in Q2 versus 62% in Q2 2020, and 63% for the first half versus 60% in 2020. The continuing-operations effective tax rate was 16.1% in Q2 and 16.6% for the first half.
Balance sheet, credit, cash flow, and capital
- Balance sheet: At June 30, assets were $554.2 billion, loans $294.7 billion, deposits $452.9 billion, borrowed funds $34.8 billion, and shareholders’ equity $54.6 billion. Versus year-end 2020, assets rose 19%, loans 22%, and deposits 24%, largely due to BBVA. Investment securities increased 43% to $126.5 billion. Loans-to-deposits were 65%, compared with 66% at year-end.
- Credit: Loan and lease allowance was $5.73 billion; total loan-related allowance, including unfunded commitments, was $6.38 billion, or 2.16% of loans, versus 2.46% at year-end. Q2 net charge-offs were $306 million, or 0.48% annualized, including $248 million associated with BBVA purchase accounting. Nonperforming assets were $2.82 billion, up 21% from year-end, including $880 million from BBVA; nonperforming loans were 0.94% of loans. Accruing loans past due totaled $1.29 billion, down 5% from year-end.
- Cash flow: For the first six months, operating activities provided $2.20 billion, investing activities provided $2.95 billion, and financing activities used $3.44 billion. Investing cash flow included $10.51 billion net cash paid for BBVA after acquired cash. The 2020 cash-flow comparison includes $14.23 billion of BlackRock sale proceeds.
- Liquidity and debt: Liquid assets included $83.8 billion of cash and short-term investments and $125.1 billion of available-for-sale securities; $24.0 billion of securities were pledged. Unused secured borrowing capacity at the FHLB and Federal Reserve was $96.4 billion. PNC and PNC Bank’s liquidity coverage ratios exceeded the 100% regulatory minimum. Consolidated senior and subordinated debt was $31.5 billion; total borrowed funds were $34.8 billion.
- Capital and shareholder returns: CET1 was 10.1% at June 30, down from 12.2% at year-end, primarily due to the acquisition; fully implemented CET1 was 9.9%. PNC said it remained well capitalized. It paid $0.5 billion of common dividends in Q2 and did not repurchase shares during the quarter due to the transaction. It announced up to $2.9 billion of repurchases over the four quarters beginning Q3 2021. The board subsequently raised the quarterly common dividend to $1.25 per share, effective with the August 2021 payment.
Outlook, risks, and unusual items
For Q3 2021 versus Q2, management expected period-end loans to increase modestly; net interest income to rise in the mid-teens percentage range; fee income to rise mid-single digits; other noninterest income of $325 million–$375 million; noninterest expense excluding integration costs to rise high-single digits; and net loan charge-offs of $150 million–$200 million. For full-year 2021, management expected revenue growth of approximately 12%–14%, noninterest expense excluding integration costs growth of approximately 13%–15%, an effective tax rate of 17%, and period-end loans modestly above June 30 levels. PNC expected $900 million of net BBVA expense savings in 2022 and approximately $980 million of total nonrecurring merger and integration costs, with most expected in 2021.
Management described the U.S. economy as recovering, expected strong growth through 2021 and into 2022, anticipated inflation to slow in the second half of 2021, and expected the federal funds rate to remain at 0.00%–0.25% until mid-2023. These expectations and guidance are subject to economic, interest-rate, credit, market, legal, and regulatory uncertainty. PNC identified continuing stress risk in COVID-affected commercial sectors and uncertainty about consumer payment behavior as stimulus wanes. Its severe-adverse credit scenario would increase the legacy PNC allowance by a hypothetical $2.2 billion, excluding qualitative adjustments; management emphasized this was not its expected scenario.
Other material risks include successful integration and realization of BBVA synergies, acquisition-related valuation estimates, potential deterioration in credit quality, interest-rate and securities valuation changes, legal and regulatory matters, and the transition away from LIBOR. PNC reported that disclosed legal matters with estimable losses could result in aggregate losses less than $100 million above related accruals; this estimate excludes some matters and is not a maximum exposure. The filing discusses USAA patent litigation, including a new July 2021 lawsuit. Management stated disclosure controls were effective, but excluded BBVA from its internal-control-over-financial-reporting assessment under the permitted acquisition transition period.
Important facts for investors to verify
- Whether BBVA integration proceeds as planned, including the anticipated system and bank merger timing, $900 million savings target, and $980 million integration-cost estimate.
- How much of the improvement in earnings and credit provisions is sustainable apart from acquisition accounting, reserve releases, and the prior-year BlackRock gain.
- Loan growth, credit deterioration, charge-offs, and allowance adequacy—especially in COVID-affected commercial sectors and acquired BBVA portfolios.
- Delivery of Q3 and full-year guidance, including revenue, expense, net interest income, and charge-off expectations.
- Post-acquisition capital and liquidity levels, and whether announced repurchases and the higher dividend remain consistent with regulatory and stress-capital requirements.
- Developments in the USAA litigation and other legal or regulatory matters, and execution of the LIBOR transition.