Business context and reporting period
The PNC Financial Services Group, Inc. filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2014. PNC is a diversified U.S. financial services company with retail and commercial banking, asset management, residential mortgage banking, and an equity-method investment in BlackRock. Comparisons below are with the corresponding 2013 period unless otherwise stated.
Financial performance and position
| Metric | Q3 2014 | Nine months 2014 | Prior-year comparison |
|---|---|---|---|
| Total revenue | $3.841 billion | $11.428 billion | Down 2% in Q3; down 4% year to date |
| Net interest income | $2.104 billion | $6.428 billion | Down 6% in Q3; down 7% year to date |
| Net interest margin | 2.98% | 3.12% | 3.47% and 3.62%, respectively |
| Noninterest income | $1.737 billion | $5.000 billion | Up 3% in Q3; down 1% year to date |
| Noninterest expense | $2.357 billion | $6.949 billion | Down 2% and 3%, respectively |
| Provision for credit losses | $55 million | $221 million | Compared with $137 million and $530 million |
| Net income | $1.038 billion | $3.150 billion | Up $10 million in Q3 and $12 million year to date |
| Diluted earnings per share | $1.79 | $5.45 | $1.77 and $5.49, respectively |
Q3 efficiency ratio was 61%, unchanged year over year; nine-month efficiency was 61%, versus 60%. Q3 return on average assets was 1.25% and return on average common equity was 9.52%, compared with 1.34% and 10.40% a year earlier. The nine-month effective tax rate was 26.0%; the Q3 rate was 27.4%, versus 26.0%.
At September 30, 2014, total assets were $334.4 billion, loans $200.9 billion, deposits $226.3 billion, borrowed funds $52.3 billion, and shareholders’ equity $44.5 billion. Since December 31, 2013, loans rose 3%, deposits 2%, and borrowed funds 13%. The loans-to-deposits ratio was 89%. Interest-earning deposits with banks were $26.2 billion, including $25.9 billion held at the Federal Reserve Bank of Cleveland. PNC reported $74.3 billion of liquid assets, of which $17.9 billion was pledged.
Cash flows for the first nine months were $4.580 billion provided by operating activities, $14.547 billion used in investing activities, and $10.088 billion provided by financing activities. Cash and due from banks increased $121 million to $4.164 billion. The investing outflow included a $14.112 billion increase in interest-earning deposits with banks.
Capital ratios at September 30 included a transitional Basel III common equity Tier 1 ratio of 11.1% and estimated fully phased-in standardized-approach common equity Tier 1 of 10.1%. PNC said it and PNC Bank, N.A. were “well capitalized” under applicable requirements.
Material changes versus prior periods
- Net interest income and margin declined, mainly due to lower purchase-accounting accretion, loan and securities yields, spread compression, and higher balances held at the Federal Reserve. Commercial and commercial real estate loan growth partly offset these pressures.
- Fee income strengthened, particularly asset management and corporate services, but year-to-date noninterest income fell slightly. Residential mortgage revenue declined 20% year to date, reflecting lower origination and loan-sale activity and reduced mortgage-servicing-rights hedge gains.
- Credit measures improved: nonperforming assets fell to $2.975 billion from $3.457 billion at year-end 2013; net charge-offs were $413 million year to date, versus $888 million. The allowance for loan and lease losses declined to $3.406 billion, or 1.70% of loans, from $3.609 billion, or 1.84%.
- Total loans increased $5.3 billion from year-end, led by $6.9 billion growth in commercial lending; consumer lending declined $1.7 billion. The allowance covered 130% of nonperforming loans, compared with 117% at year-end.
- PNC repurchased $583 million of shares in Q2 and Q3 under its 2014 capital plan and increased the quarterly common dividend from $0.44 to $0.48 in Q2. Year-to-date dividends declared were $1.40 per share.
Outlook, commentary, risks and unusual items
- Management expected Q4 2014 net interest income to decline modestly. It projected purchase-accounting accretion to be about $275 million lower for full-year 2014 than in 2013, and about $225 million lower in 2015 than in 2014.
- Management expected Q4 fee-based noninterest income to remain stable, with seasonal and other fee activity expected to offset lower merger and acquisition advisory fees. Q4 noninterest expense was expected to rise by low single digits from Q3, reflecting seasonality and continued investment, partly offset by savings. PNC expected Q4 provision for credit losses of $25 million to $75 million, assuming current credit trends continued.
- PNC said it had achieved its full-year 2014 continuous-improvement savings goal of $500 million during the first nine months; savings were funding infrastructure, cybersecurity, and business investments. Its strategy emphasized customer and loan growth, fee income, expense discipline, risk management, and investment in underpenetrated markets.
- Regulatory matters include the Liquidity Coverage Ratio rules beginning in 2015, phased in to 100% by 2017; PNC expected to exceed the initial requirement. The OCC’s risk-governance guidelines required PNC Bank, N.A. to comply by May 2015. New securitization risk-retention rules may affect PNC directly and through loan markets; the magnitude was not yet known.
- Key risks include interest-rate and yield-curve changes, economic and market conditions, credit quality, regulatory change, legal and governmental proceedings, operational and cybersecurity risks, and valuation uncertainty. PNC said disclosed legal matters had reasonably possible aggregate losses of up to approximately $750 million where estimable; this is not presented as a maximum exposure for all matters. It also estimated up to $91 million of possible residential mortgage repurchase losses above the recorded liability.
- Unusual or comparability items include the second-quarter 2014 reclassification of certain commercial facility fees from net interest income to noninterest income; prior-year figures were not adjusted because the impact was not significant. Adoption of ASU 2014-01 reduced opening 2014 retained earnings by $74 million and reclassified certain low-income-housing tax-credit costs to income taxes. PNC also transferred $1.4 billion of securities from available-for-sale to held-to-maturity in Q2 to reduce volatility in accumulated other comprehensive income and certain capital measures.
- Subsequent to quarter-end, PNC established a $5 billion parent-company commercial-paper program and PNC Bank issued $1.25 billion of senior notes in October 2014. The filing said disclosure controls were effective and reported no Q3 change in internal control over financial reporting that materially affected, or was reasonably likely to materially affect, those controls.
Most important facts for investors to verify
- Whether net interest margin and purchase-accounting accretion continue to decline, and whether loan growth and fee income can offset that pressure.
- Whether the Q4 provision, expense, and fee-income outlook was achieved, and how the $500 million savings program translated into recurring expense reductions versus investment spending.
- Credit trends and reserve adequacy, including nonperforming assets, delinquencies, charge-offs, purchased-impaired-loan cash-flow assumptions, and the allowance relative to loans.
- Liquidity and funding composition, including the increase in borrowed funds, pledged liquid assets, regulatory LCR readiness, and capital ratios under both Basel III approaches.
- Mortgage origination, servicing-rights valuations, repurchase claims, and the adequacy of related reserves; also monitor legal and regulatory contingencies and the stated $750 million estimable-loss amount.
- Effects of the commercial-facility-fee reclassification, ASU 2014-01 adoption, and securities transfer when comparing reported results and capital measures.