PNC FINANCIAL SERVICES GROUP, INC. quarterly report, Q1 FY2016

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PNC Financial Services Group, Inc. — Q1 2016 Form 10-Q

Business context and period: Diversified U.S. financial services company with retail and commercial banking, asset management, residential mortgage banking, and an equity-method investment in BlackRock. This unaudited quarterly report covers the three months ended March 31, 2016; comparisons are generally with Q1 2015 for earnings and December 31, 2015 for balance-sheet data.

Financial performance and condition

  • Earnings and revenue: Net income was $943 million and diluted EPS was $1.68, down 6% and 4%, respectively, year over year. Revenue fell 2% to $3.665 billion: net interest income rose 1% to $2.098 billion, while noninterest income declined 6% to $1.567 billion. Pretax, pre-provision earnings, a non-GAAP measure, were essentially flat at $1.384 billion.
  • Expenses and margins: Noninterest expense decreased 3% to $2.281 billion. The efficiency ratio improved to 62% from 63%; net interest margin declined to 2.75% from 2.82%. The effective tax rate was 23.5%, compared with 24.4%.
  • Cash flow: Net cash provided by operating activities was $276 million, investing activities used $908 million, and financing activities provided $428 million. Cash and due from banks decreased $204 million during the quarter to $3.861 billion. Cash flows reflect banking balance-sheet movements and should be read with the full cash flow statement.
  • Balance sheet and funding: Assets were $361.0 billion, loans $207.5 billion, deposits $250.4 billion, and borrowed funds $54.2 billion at quarter-end. Loans increased $789 million and deposits increased $1.357 billion from year-end; commercial lending growth was partly offset by consumer loan runoff. Loans-to-deposits were 83%.
  • Capital and liquidity: Transitional Basel III common equity Tier 1 ratio was 10.6%; estimated fully phased-in standardized-approach CET1 was 10.1%. PNC and PNC Bank each had an LCR above 100%, versus a 90% phased-in minimum. The company reported $89.9 billion of liquid assets, including $32.5 billion in short-term investments and $57.4 billion in available-for-sale securities.
  • Credit quality: Provision for credit losses was $152 million versus $54 million a year earlier, including $80 million for oil, gas, and coal exposures. Net charge-offs were $149 million, or 0.29% annualized of average loans, compared with $103 million and 0.20%. Nonperforming assets were $2.552 billion, 0.71% of assets, up from $2.425 billion and 0.68% at year-end. The allowance for loan and lease losses was $2.711 billion, 1.31% of loans and 119% of nonperforming loans.
  • Shareholder returns: PNC repurchased 5.9 million shares for approximately $500 million and paid $260 million in common dividends during the quarter. The declared quarterly dividend was $0.51 per share; capital actions remain subject to Federal Reserve review.

Material changes versus comparable periods

  • Lower earnings reflected increased credit provision and weaker noninterest income, partly offset by higher net interest income and lower expenses.
  • Fee pressures included weaker equity markets and capital-markets activity and lower residential mortgage revenue. Residential mortgage income fell to $100 million from $164 million; the segment reported a $13 million loss versus $28 million earnings.
  • Commercial lending nonperforming loans increased, with energy-related exposures a principal factor. Overall delinquencies nevertheless declined 9% from year-end to $1.497 billion.
  • Average investment securities increased 23% year over year, while average interest-earning deposits with banks decreased 16%; management cited a shift toward higher-yielding assets.
  • Accumulated other comprehensive income rose to $532 million from $130 million at year-end, principally reflecting securities-related gains. Residential mortgage servicing rights fell to $1.323 billion from $1.589 billion, reflecting valuation changes.

Outlook, commentary, risks, and unusual items

  • Management outlook: For Q2 2016, PNC expected modestly higher net interest income, fee-income categories up approximately 10%–12%, provision for credit losses of $125–$175 million, and noninterest expense up mid-single digits from Q1. For full-year 2016, it expected modest revenue growth, stable noninterest expense versus 2015, an effective tax rate near 25%, and purchase accounting accretion approximately $175 million below 2015. Management expected loans to increase modestly in Q2.
  • Expense program and pension: PNC reported completing actions to capture more than one-third of its $400 million 2016 continuous-improvement savings goal and said it remained on track. Estimated 2016 pretax qualified pension expense was $43 million versus $9 million in 2015.
  • Unusual items: Other noninterest income included a $44 million gain on the sale of 0.5 million Visa Class B shares. The Non-Strategic Assets Portfolio recorded higher noninterest income partly from a release of excess reserves for estimated repurchase-obligation losses related to a settlement.
  • Legal contingencies: For disclosed matters where PNC could estimate exposure, it said reasonably possible losses above related accruals could total up to approximately $550 million. This estimate excludes matters for which losses could not be estimated and is not a maximum exposure; actual losses could be higher. The filing also describes ongoing regulatory and governmental inquiries.
  • Regulatory and operating risks: Key sensitivities include energy-sector credit deterioration, economic and market conditions, interest rates and yield-curve changes, asset valuations, customer demand, and legal, regulatory, cyber, and operational risks. A proposed FDIC deposit-insurance surcharge was estimated to increase PNC Bank’s quarterly assessment by about $22 million beginning no earlier than Q3 2016. Management said the impact of proposed stable-funding rules was not yet fully known but expected PNC to comply.
  • Other disclosures: The Federal Reserve’s response to PNC’s 2016 capital plan was expected in June 2016. PNC reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

  • Whether energy-related credit deterioration, provisions, charge-offs, and nonperforming commercial loans continue to rise, and how reserves compare with realized losses.
  • Whether management’s Q2 and full-year revenue, credit-cost, expense, tax, loan-growth, and purchase-accounting expectations are achieved.
  • How mortgage-servicing-rights valuations and other market-sensitive income affect reported results and capital.
  • The status and potential financial impact of legal proceedings and regulatory inquiries, including the limits of the disclosed $550 million estimate.
  • The Federal Reserve’s CCAR decision and the sustainability of dividends and repurchases, alongside capital and liquidity levels.
  • The effect of deposit-insurance and other evolving regulatory requirements on costs, funding, and liquidity.