PNC Financial Services Group, Inc. — Third Quarter 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. PNC is a diversified financial services company with retail banking, corporate and institutional banking, asset management, residential mortgage banking, and other businesses.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $3.829 billion | $3.775 billion | $11.288 billion | $11.372 billion |
| Net interest income | $2.095 billion | $2.062 billion | $6.261 billion | $6.186 billion |
| Noninterest income | $1.734 billion | $1.713 billion | $5.027 billion | $5.186 billion |
| Provision for credit losses | $87 million | $81 million | $366 million | $181 million |
| Noninterest expense | $2.394 billion | $2.352 billion | $7.035 billion | $7.067 billion |
| Net income | $1.006 billion | $1.073 billion | $2.938 billion | $3.121 billion |
| Diluted earnings per common share | $1.84 | $1.90 | $5.33 | $5.52 |
- Quarterly net interest margin was 2.68%, versus 2.67%; the nine-month margin was 2.71%, versus 2.74%. Efficiency ratio was 63% for Q3 and 62% for the nine-month period, compared with 62% in each prior-year period.
- Quarterly return on average assets was 1.10%, versus 1.19%; nine-month return on average common equity was 8.69%, versus 9.56%.
- At September 30, 2016, total assets were $369.3 billion, loans $210.4 billion, deposits $259.9 billion, borrowed funds $51.5 billion, and shareholders’ equity $45.7 billion. Since year-end 2015, loans rose $3.8 billion, deposits rose $10.9 billion, and borrowed funds declined $3.0 billion. Loans-to-deposits was 81%.
- Transitional Basel III common equity Tier 1 capital ratio was 10.6%; estimated fully phased-in ratio was 10.2%. PNC and PNC Bank were described as well capitalized. Their liquidity coverage ratios exceeded the 2017 fully phased-in 100% requirement.
- Liquid assets totaled $92.3 billion, including short-term investments and available-for-sale securities. Parent-company available liquidity was $3.3 billion.
- For the first nine months, operating cash flow was $2.3 billion, investing cash flow was negative $7.6 billion, and financing cash flow was positive $5.8 billion. Cash and due from banks ended at $4.5 billion.
Changes versus comparable periods
- Q3 net income declined 6% year over year as modest revenue growth was outweighed by higher expenses and a higher effective tax rate (25.4%, versus 20.0%). The prior-year quarter included tax benefits from settling acquired-entity tax contingencies.
- Nine-month net income fell 6%. Higher credit-loss provision and lower noninterest income outweighed modest net interest income growth and slightly lower expenses. Noninterest income fell 3%, partly reflecting lower BlackRock earnings and smaller Visa-share gains.
- Commercial lending grew $4.6 billion from year-end 2015, while consumer lending declined $0.9 billion. Commercial real estate and commercial loans drove growth; home equity and education balances declined.
- Credit indicators were mixed: nonperforming assets decreased to $2.4 billion from $2.4 billion at year-end (down $50 million), and delinquencies declined 11% to $1.5 billion. However, nine-month net charge-offs increased to $437 million from $266 million, and the allowance for loan and lease losses declined to $2.6 billion from $2.7 billion.
- Energy-related lending was a significant credit concern: the nine-month provision included $130 million for oil, gas and coal exposures, versus $86 million a year earlier. Energy-related loans also contributed to higher commercial nonperforming loans and charge-offs.
Outlook, commentary and risks
- For Q4 2016, management expected modest loan growth; stable net interest income, with about $50 million of purchase-accounting accretion; stable fee income; provision for credit losses of $75 million to $125 million; and low-single-digit percentage growth in noninterest expense versus Q3.
- Management expected full-year 2016 noninterest expense to remain stable versus 2015 and the full-year effective tax rate to be about 25%. It anticipated moderate U.S. economic growth and a 25-basis-point Federal Reserve rate increase in December 2016. These are forward-looking expectations, not guarantees.
- PNC reported completing actions to capture more than 75% of its $400 million 2016 continuous-improvement savings goal. The new FDIC deposit-insurance surcharge raised PNC Bank’s quarterly assessment by approximately $25 million compared with Q2.
- PNC returned approximately $0.8 billion to common shareholders in Q3 through $0.5 billion of repurchases and $0.3 billion of dividends. The quarterly dividend was raised to $0.55 per share; the board declared the same rate for the November 2016 payment. Repurchases remain subject to capital planning and regulatory constraints.
- Legal proceedings: PNC estimated reasonably possible losses in excess of related accruals of up to approximately $525 million for disclosed matters, but said this did not represent maximum exposure and excluded some matters. A CBNV mortgage-litigation settlement would result in an arbitration award of either $24 million or $70 million, subject to court approval. PNC also settled an SBA-related investigation for $9.5 million without admitting liability.
- On November 1, 2016, PNC issued $525 million of Series S preferred depositary shares; proceeds were intended for general corporate purposes.
- Principal risks include economic and interest-rate changes, energy and other borrower credit deterioration, market and valuation volatility, legal and regulatory proceedings, evolving capital and liquidity rules, competition, operational and cyber risks, and dependence in part on BlackRock investment results. The filing reported no material change in risk factors from the 2015 Form 10-K.
Important facts for investors to verify
- Whether energy-sector credit deterioration continues to affect provisions, charge-offs, nonperforming loans, and reserve adequacy.
- Whether Q4 performance meets management’s loan-growth, net-interest-income, fee-income, credit-provision, expense, and tax-rate expectations.
- How deposit mix, funding costs, interest rates, and purchase-accounting accretion affect net interest margin and earnings.
- Capital and liquidity levels, including the fully phased-in Basel III estimate, LCR, and regulatory conditions on dividends and repurchases.
- Developments in disclosed legal matters, including the CBNV arbitration outcome and the potential loss estimate, which the filing says is not a maximum exposure.
- The effect of the November 2016 preferred-stock issuance and ongoing share repurchases on capital, share count, and per-share results.