Business context and reporting period
The PNC Financial Services Group, Inc. is a diversified U.S. financial services company with Retail Banking, Corporate & Institutional Banking, Asset Management Group and BlackRock reporting segments. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods unless otherwise noted.
Financial performance and condition
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $4.357B | $4.125B | $12.792B | $12.069B |
| Net interest income | $2.466B | $2.345B | $7.240B | $6.763B |
| Noninterest income | $1.891B | $1.780B | $5.552B | $5.306B |
| Provision for credit losses | $88M | $130M | $260M | $316M |
| Noninterest expense | $2.608B | $2.456B | $7.719B | $7.337B |
| Net income | $1.400B | $1.126B | $3.995B | $3.297B |
| Diluted EPS | $2.82 | $2.16 | $7.96 | $6.21 |
| Net interest margin, taxable-equivalent | 2.99% | 2.91% | 2.95% | 2.84% |
| Efficiency ratio | 60% | 60% | 60% | 61% |
| Effective tax rate | 15.7% | 26.8% | 17.0% | 25.3% |
- Balance sheet at September 30, 2018: assets $380.1B; loans $223.1B; deposits $264.9B; borrowed funds $58.0B; shareholders’ equity $47.1B. Loans-to-deposits were 84%.
- Cash flows for the first nine months: operating activities provided $5.7B, investing activities used $1.7B, and financing activities used $4.1B. Cash and due from banks was $5.25B at period-end. These cash-flow categories should be considered in light of the balance-sheet movements and the nature of banking operations.
- Credit quality: nonperforming assets were $1.825B, down 10% from year-end 2017; nonperforming loans were 0.76% of loans. Third-quarter net charge-offs were $91M versus $106M a year earlier. The allowance for loan and lease losses was $2.584B, or 1.16% of loans, and 153% of nonperforming loans.
- Capital and liquidity: fully phased-in Basel III common equity Tier 1 ratio was 9.3%, down from 9.8% at year-end 2017; total risk-based capital was 12.7% and supplementary leverage was 7.7%. PNC and PNC Bank exceeded the 100% minimum Liquidity Coverage Ratio. PNC reported $24.5B in short-term investments, $61.2B in available-for-sale securities and $42.1B of unused secured borrowing capacity.
Material changes versus comparable periods
- Third-quarter net income rose 24% and diluted EPS rose from $2.16 to $2.82. For the first nine months, net income increased 21% and diluted EPS rose from $6.21 to $7.96.
- Higher loan and securities balances and yields lifted net interest income; higher interest rates also widened net interest margin. These benefits were partly offset by higher deposit and borrowing costs.
- Noninterest income increased, supported by asset management and corporate services, including BlackRock earnings, advisory and treasury management fees. Residential mortgage revenue fell, reflecting lower loan-sale margins and servicing-related revenue.
- Noninterest expense increased 6% in the quarter, primarily from personnel, technology, staffing and other business investments. PNC said it was on track to achieve its 2018 target of $250M in continuous-improvement cost savings.
- Federal tax reform reduced the corporate statutory tax rate from 35% to 21%, contributing to lower effective tax rates and higher reported earnings.
- Compared with December 31, 2017, loans rose 1% and securities rose 6%, while interest-earning deposits with banks declined 31%. Total deposits were nearly unchanged, as interest-bearing balances grew but noninterest-bearing deposits declined. AOCI fell to negative $1.260B, principally reflecting unrealized securities losses; common share repurchases also reduced equity.
Outlook, risks and unusual items
- For Q4 2018 versus Q3, management expected modest loan growth, low-single-digit percentage increases in net interest income, fee income and noninterest expense, and provision for credit losses of $100M–$150M. Other noninterest income was expected to run at $225M–$275M per quarter, excluding securities gains or losses and Visa activity. The full-year effective tax rate was expected to be approximately 17%.
- PNC’s economic outlook anticipated above-trend U.S. growth into 2019 and further gradual rate increases: one additional Federal Reserve increase in December 2018 and two 25-basis-point increases in 2019. Management identified trade restrictions as a growing downside risk. Its sensitivity analysis indicated net interest income could benefit from rising rates, but results depend on assumptions about deposit pricing, balance-sheet behavior and the yield curve.
- PNC returned $0.9B to shareholders in Q3 through $0.5B of repurchases and $0.4B of common dividends. The 2018 capital plan authorized repurchases of up to $2.0B over four quarters; future capital actions remain subject to regulatory review and other constraints.
- Legal proceedings: PNC estimated reasonably possible losses in excess of related accruals of up to approximately $125M for certain disclosed matters it could estimate. This is not a maximum exposure estimate for all matters. The filing also discusses an amended interchange-litigation settlement subject to court approval and a government inquiry concerning the Low Income Housing Tax Credit program; PNC said it was cooperating.
- PNC expected adoption of the current expected credit losses standard (CECL) in 2020 to increase its allowance, but said the amount would depend on portfolio characteristics and economic conditions at adoption. It planned to adopt the new lease standard in 2019 and expected to recognize lease liabilities and right-of-use assets; it did not expect a material change in expense timing.
- Other risks include changing economic conditions and interest rates, deposit competition and funding costs, credit deterioration, market-value changes in securities and mortgage servicing rights, legal and regulatory outcomes, cyber and operational events, and the performance of PNC’s BlackRock investment. PNC reported no material changes to the risk factors in its 2017 Form 10-K.
Important facts for investors to verify
- Whether net interest income growth and margin expansion continue as deposit costs rise, and how actual results compare with Q4 guidance.
- Trends in fee income, particularly residential mortgage activity, advisory and treasury management fees, and BlackRock-related earnings.
- Whether expense growth is controlled and the stated $250M cost-savings target is achieved.
- Credit performance in consumer portfolios, especially credit cards and auto loans, and the adequacy of reserves as portfolio conditions change.
- Capital-ratio movements, securities-related AOCI losses, liquidity measures and the regulatory conditions governing planned capital returns.
- Developments in the interchange litigation and other legal or governmental matters, including exposures not captured in the disclosed $125M estimate.