PNC Financial Services Group, Inc. — Second Quarter 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. PNC is a diversified U.S. financial services company with retail banking, corporate and institutional banking, asset management, and an equity interest in BlackRock.
Financial results and key metrics
| Metric | Q2 2019 | Q2 2018 | Change |
|---|---|---|---|
| Total revenue | $4.439 billion | $4.324 billion | Up 3% |
| Net interest income (GAAP) | $2.498 billion | $2.413 billion | Up 4% |
| Noninterest income | $1.941 billion | $1.911 billion | Up 2% |
| Provision for credit losses | $180 million | $80 million | Up $100 million |
| Noninterest expense | $2.611 billion | $2.584 billion | Up 1% |
| Net income | $1.374 billion | $1.356 billion | Up 1% |
| Diluted EPS | $2.88 | $2.72 | Up 6% |
For the first six months, revenue was $8.725 billion, net income was $2.645 billion, and diluted EPS was $5.49, versus $8.435 billion, $2.595 billion, and $5.15, respectively, in 2018. Q2 net interest margin was 2.91%, down from 2.96%; the six-month margin was unchanged at 2.94%. The efficiency ratio improved to 59% from 60% in Q2, and management reported positive operating leverage.
Cash flow: For the six months, operating activities provided $3.644 billion, investing activities used $17.483 billion, and financing activities provided $13.647 billion. Cash and due from banks ended at $5.416 billion. Investing outflows principally reflected loan growth and increased interest-earning deposits; financing inflows included increased borrowings and interest-bearing deposits.
Balance sheet and funding: At June 30, assets were $405.8 billion, up 6% from year-end 2018; loans were $237.2 billion, up 5%; deposits were $273.3 billion, up 2%; and shareholders’ equity was $49.3 billion. Loans-to-deposits were 87%, versus 84% at year-end. Borrowed funds were $69.0 billion, up $11.6 billion, including higher FHLB borrowings. Senior and subordinated debt totaled $33.1 billion at quarter-end.
PNC reported $23.7 billion of short-term investments and $69.4 billion of available-for-sale securities as liquid assets, plus $35.2 billion of unused secured borrowing capacity. Its LCR exceeded the 100% minimum; the filing does not provide a specific LCR value in the text supplied. Parent-company available liquidity was $5.3 billion.
Capital and credit: Standardized Basel III common equity Tier 1 was 9.7%, Tier 1 risk-based capital 10.9%, total risk-based capital 12.8%, and leverage 9.6%. PNC and PNC Bank were described as well capitalized. Nonperforming assets were $1.85 billion, up $42 million from year-end, while nonperforming loans to total loans improved to 0.73% from 0.75%. The allowance for loan and lease losses was $2.72 billion, or 1.15% of loans. Q2 annualized net charge-offs were 0.24% of average loans, versus 0.20% a year earlier.
Material changes and management commentary
- Loan growth, higher loan and securities yields, and fee income lifted revenue, but higher deposit and borrowing costs pressured margin. Average interest-bearing deposit costs rose to 1.03% from 0.57% year over year in Q2.
- Credit-loss provision rose substantially, reflecting loan growth and increased utilization; the six-month comparison also included reserve increases in auto loans. Management said overall credit quality remained strong, while commercial nonperforming loans and charge-offs increased from recent historical lows.
- Other noninterest income benefited from asset-sale gains, including the retirement recordkeeping business sale in Q2, and higher securities gains. Visa Class B share derivative valuation adjustments were negative in 2019 compared with a benefit in 2018. Residential mortgage servicing rights results also weakened.
- PNC repurchased 6.0 million shares for $802 million in Q2 and paid $431 million in common dividends. It announced up to $4.3 billion of repurchases over the four quarters beginning Q3 2019; the board raised the quarterly common dividend to $1.15 effective with the August 2019 payment. Capital actions remain subject to regulatory conditions.
- Management’s 2019 outlook versus 2018: average loans up about 5%; revenue growth at the higher end of low single digits; expense growth at the lower end of low single digits; effective tax rate about 17%; and positive operating leverage. For Q3 versus Q2, management expected average loans up about 1%, net interest income stable, fee income up low single digits, other noninterest income of $250–$300 million per quarter excluding specified items, provision of $150–$200 million, and stable expenses.
Outlook, risks, contingencies, and unusual items
- The economic baseline anticipated slower U.S. growth through 2019 and into 2020 and two 25-basis-point Federal Reserve rate cuts in July and October 2019. Slower global growth, trade restrictions, geopolitical concerns, and materially different-than-expected market conditions were identified as risks. Rate sensitivity analysis indicated potential benefit from rising rates and an upward-sloping yield curve, but results depend on modeling assumptions.
- PNC planned to adopt CECL on January 1, 2020. Based on June 30 balances and forecasts, it estimated an allowance increase of 15%–25% versus current aggregate reserves; the estimate was preliminary and could change with model refinement, balances, and economic conditions.
- In a Missouri pre-need funeral arrangements lawsuit, a July 2019 judgment awarded $72 million in compensatory damages, $15 million in interest, and $15 million in punitive damages; PNC Bank and National City Bank appealed. For disclosed legal matters where PNC could estimate possible losses, it estimated aggregate losses below $100 million, but stated this was not a maximum exposure and excluded matters it could not estimate.
- PNC adopted the new lease standard in Q1 2019, recording operating lease assets and liabilities; adoption included a one-time pretax retained-earnings adjustment of $83 million, primarily for deferred gains on prior sale-leaseback transactions.
- Subsequent to quarter-end, PNC and PNC Bank issued additional senior notes in July 2019. The filing also reported the final, nonmaterial PNC contribution to a settlement relating to the DD Growth fund litigation.
Important facts for investors to verify
- Whether loan growth and management’s revenue and margin outlook are sustained as deposit costs, funding mix, and interest rates change.
- Whether elevated provisions, auto-loan reserves, commercial credit indicators, and net charge-offs remain consistent with management’s characterization of strong overall credit quality.
- The final CECL allowance impact at adoption, including changes from the preliminary 15%–25% estimate.
- The execution and regulatory conditions for planned share repurchases and the increased dividend, alongside capital and liquidity levels.
- Developments in the appealed Missouri judgment and other legal or regulatory matters, including exposures PNC said it could not estimate.
- The contribution and valuation volatility of the BlackRock investment, mortgage servicing rights, and Visa-related positions to reported earnings and equity.