PNC Financial Services Group, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. Unaudited; comparisons are with the corresponding 2010 periods unless noted. Dollar amounts are in billions unless stated otherwise.
Business context and reporting period
PNC is a diversified U.S. financial services company operating in retail and corporate banking, asset management, residential mortgage banking and related businesses. Results include the effects of continued credit improvement, low interest rates and lower purchase-accounting accretion. GIS, sold effective July 1, 2010, is presented as discontinued operations in the 2010 comparisons.
Financial and operating metrics
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Total revenue | $3.544 | $3.598 | $10.777 | $11.273 |
| Net interest income | $2.175 | $2.215 | $6.501 | $7.029 |
| Noninterest income | $1.369 | $1.383 | $4.276 | $4.244 |
| Noninterest expense | $2.140 | $2.158 | $6.386 | $6.273 |
| Provision for credit losses | $0.261 | $0.486 | $0.962 | $2.060 |
| Income from continuing operations before tax and noncontrolling interests | $1.143 | $0.954 | $3.429 | $2.940 |
| Net income | $0.834 | $1.103 | $2.578 | $2.577 |
| Diluted EPS, continuing operations | $1.55 | $1.45 | $4.79 | $3.52 |
| Diluted EPS, total | $1.55 | $2.07 | $4.79 | $4.24 |
| Net interest margin | 3.89% | 3.96% | 3.92% | 4.18% |
Quarterly pretax, pre-provision earnings were $1.404 billion versus $1.440 billion; nine-month results were $4.391 billion versus $5.000 billion. The measure is non-GAAP. The Q3 2010 net income comparison included a $328 million after-tax gain on the GIS sale; continuing-operations income increased in Q3 2011. Nine-month 2010 common earnings were also affected by a $250 million noncash preferred-stock discount accretion associated with the TARP preferred redemption.
Cash flow: For the first nine months, operating activities provided $4.585 billion, investing activities used $3.726 billion and financing activities used $0.174 billion. Cash and due from banks increased $0.685 billion to $3.982 billion. The prior-year cash flows included substantial financing outflows, including the TARP preferred redemption.
Balance sheet and funding at September 30: Assets were $269.470 billion, up from $264.284 billion at year-end 2010. Loans were $154.543 billion, deposits $187.732 billion and borrowed funds $35.102 billion. Deposits rose $4.342 billion and borrowed funds fell $4.386 billion from year-end; the loans-to-deposits ratio was 82%. Noninterest-bearing deposits increased to $55.180 billion from $50.019 billion.
Capital and liquidity: Tier 1 common, Tier 1 risk-based, total risk-based and leverage ratios were 10.5%, 13.1%, 16.5% and 11.4%, respectively, all higher than at year-end 2010. PNC reported $57.2 billion in liquid assets, of which $22.6 billion was pledged; unused secured borrowing capacity was $13.1 billion at the FHLB and $27.6 billion at the Federal Reserve. The bank subsidiary was considered well capitalized under then-applicable Basel I standards.
Credit quality: Q3 net charge-offs were $365 million, down from $614 million; the annualized quarterly charge-off ratio was 0.95%. Nonperforming assets fell to $4.298 billion from $5.123 billion at year-end, and nonperforming loans to total loans declined to 2.39% from 2.97%. The allowance for loan and lease losses was $4.507 billion, or 2.92% of loans and 122% of nonperforming loans, compared with 3.25% and 109% at year-end. Total troubled debt restructurings increased to $2.147 billion from $1.658 billion; $1.062 billion remained nonperforming.
Material changes versus prior periods
- Revenue declined year over year in Q3 and the first nine months, mainly reflecting lower net interest income and purchase-accounting accretion. Nine-month net interest margin fell 26 basis points to 3.92%.
- Credit costs decreased materially: nine-month provision fell to $0.962 billion from $2.060 billion, while nine-month net charge-offs declined to $1.312 billion from $2.145 billion.
- Q3 expenses were slightly lower, partly because Q3 2010 included integration costs. Nine-month expenses rose $113 million, including higher foreclosure-related costs and approximately $40 million of second-quarter legal-contingency accruals, net of anticipated insurance recoveries.
- Loans increased $3.948 billion from year-end, with growth in commercial lending and auto loans partly offset by declines in commercial real estate, residential real estate and home equity. Transaction deposits grew while higher-cost retail CDs ran off.
- Available-for-sale securities had a net unrealized gain of $83 million at September 30, versus a net unrealized loss of $861 million at year-end, primarily reflecting lower market interest rates. PNC transferred $2.9 billion of securities from available-for-sale to held-to-maturity in Q3, following a $3.4 billion transfer in Q2; these reclassifications did not affect net income.
Outlook, commentary, risks and contingencies
- Management expected Q4 net interest income to remain stable versus Q3 as core growth was expected to offset declining purchase-accounting accretion. It expected Q4 provision to remain near Q3 levels, noninterest income to be relatively flat and noninterest expense to be relatively consistent, before specified legal or regulatory contingencies and the trust-preferred redemption charge. The expected Q4 effective tax rate was approximately 27%.
- Debit-card interchange limits effective October 1, 2011 were expected to reduce revenue by about $75 million in Q4 and by an additional approximately $175 million in future annual revenue, based on 2011 transaction volumes. Management also expected a $198 million noncash Q4 charge related to the planned redemption of $750 million of trust preferred securities.
- PNC had agreed to acquire RBC Bank (USA) for $3.45 billion, with closing expected in March 2012 subject to regulatory and other conditions. The transaction was expected to add approximately $19 billion of deposits and $16 billion of loans. PNC also agreed to acquire 27 Flagstar branches in Atlanta, expected to close in December 2011. The Flagstar transaction included approximately $240 million of deposits and no loans. PNC’s 19-branch BankAtlantic acquisition in Tampa closed in June 2011.
- PNC issued $1.0 billion of Series O preferred stock in July and $1.25 billion of five-year senior notes in September. Planned 2011 common-stock repurchases of up to $500 million were on hold pending regulatory approval of the RBC acquisition. The quarterly common dividend had increased to $0.35 per share.
- Foreclosure servicing practices remain subject to regulatory oversight. PNC and PNC Bank entered into consent orders requiring control improvements, independent review and remediation; the orders do not preclude civil money penalties. Other governmental and regulatory inquiries were ongoing.
- For disclosed legal matters where losses could be estimated, PNC said aggregate reasonably possible losses could reach approximately $435 million; this estimate excluded matters PNC could not estimate and was not its maximum exposure. Separately, management estimated reasonably possible residential mortgage and home-equity repurchase losses of up to $110 million above the recorded liability. The recorded combined liability was $136 million.
- Key risks include weak or worsening economic conditions, market volatility and sovereign-debt concerns, low rates and yield-curve changes, credit deterioration, securities valuation and impairment, regulatory reform and compliance costs, mortgage servicing and repurchase claims, and execution, integration, credit-loss and deposit-retention risks related to acquisitions. Management noted that actual outcomes could differ materially from forward-looking estimates.
Most important facts for investors to verify
- Whether credit improvement continues, particularly in commercial real estate, home equity, residential mortgages and restructured loans, and whether allowance levels remain adequate.
- Whether core revenue and net interest income offset lower purchase-accounting accretion, low-rate pressure and the anticipated debit-interchange revenue reductions.
- Regulatory approvals, purchase price adjustments, integration costs, acquired credit quality and deposit retention for the RBC transaction; and completion and economics of the Flagstar branch acquisition.
- Whether foreclosure consent-order remediation is completed and whether legal, regulatory or mortgage repurchase exposures exceed recorded reserves.
- Capital and liquidity effects of the acquisitions, preferred-stock and debt issuance, trust-preferred redemption, dividend policy and any resumption of share repurchases.