PNC Financial Services Group, Inc. — Q3 2009 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2009. Unaudited. PNC acquired National City on December 31, 2008; 2009 results include National City, so year-over-year growth is not directly comparable and largely reflects the acquisition.
Financial performance and position
| Metric | Q3 2009 | Q3 2008 | Nine months 2009 | Nine months 2008 |
|---|---|---|---|---|
| Total revenue | $4.048 billion | $1.654 billion | $11.906 billion | $5.514 billion |
| Net interest income | $2.222 billion | $1.000 billion | $6.709 billion | $2.831 billion |
| Noninterest income | $1.826 billion | $654 million | $5.197 billion | $2.683 billion |
| Noninterest expense | $2.379 billion | $1.131 billion | $7.365 billion | $3.269 billion |
| Provision for credit losses | $914 million | $190 million | $2.881 billion | $527 million |
| Net income | $559 million | $259 million | $1.296 billion | $1.160 billion |
| Net income attributable to common shareholders | $467 million | $248 million | $992 million | $1.130 billion |
| Diluted EPS | $1.00 | $0.70 | $2.17 | $3.23 |
- Margins and efficiency: Net interest margin was 3.76% in Q3, versus 3.46% a year earlier, and 3.72% for the first nine months, versus 3.34%. Q3 efficiency ratio was 59%, compared with 68% a year earlier.
- Credit costs and asset quality: Q3 provision exceeded net charge-offs by $264 million. Annualized Q3 net charge-offs were 1.59%, down from 1.89% in Q2; the allowance-to-loans ratio rose to 2.99% from 2.77% in Q2. Nonperforming assets were $5.644 billion, or 3.50% of loans and foreclosed assets, versus $2.181 billion and 1.24% at year-end 2008. Purchased impaired loans are excluded from reported nonperforming loans.
- Balance sheet and funding: Total assets were $271.407 billion at September 30, down from $291.081 billion at year-end 2008. Loans were $160.608 billion, deposits $183.809 billion, and borrowed funds $41.910 billion. Loans-to-deposits were 87%.
- Capital and liquidity: Tier 1 risk-based capital ratio was reported at 10.9%, Tier 1 common at 5.5%, and total risk-based capital at 14.5%. Liquid assets totaled $56.3 billion, of which $21.5 billion was pledged; unused Federal Reserve and FHLB borrowing capacity totaled $35.1 billion.
- Cash flow: Nine-month operating cash flow was $2.529 billion, versus $5.404 billion in 2008; investing activities provided $12.338 billion, versus cash use of $6.616 billion; financing activities used $15.912 billion. Cash and due from banks declined $1.045 billion to $3.426 billion.
Material changes and notable items
- National City materially enlarged PNC’s scale and reshaped its business mix. Nine-month revenue more than doubled, but common-share earnings fell from $1.130 billion to $992 million and diluted EPS fell from $3.23 to $2.17, reflecting preferred dividends, dilution, credit costs, and other items.
- Credit deterioration drove the nine-month provision to $2.881 billion. Nonperforming assets rose sharply, particularly in commercial lending, commercial real estate, and residential mortgages. Management said deterioration was progressing more slowly in Q3 but expected to add reserves in Q4.
- Q3 pretax, pre-provision earnings were $1.669 billion. Management said these exceeded provision by more than $750 million. Expenses fell $279 million, or 10%, from Q2.
- Noninterest income included $406 million of securities-sale gains, $433 million of credit-related OTTI charges, and $320 million of mortgage-servicing-rights hedge gains for the first nine months. The noncredit portion of OTTI, $1.107 billion, was recorded in accumulated other comprehensive loss.
- National City integration costs were $265 million pretax in the first nine months, including $89 million in Q3. PNC reported cumulative savings above $460 million and approximately $200 million of Q3 savings; it expected to exceed its $1.2 billion two-year annualized cost-savings goal.
- PNC raised $624 million of common equity in May following the Federal Reserve’s stress test. It had received $7.6 billion of TARP preferred capital and paid $237 million of related preferred dividends in the first nine months. The quarterly common dividend was reduced from $0.66 to $0.10 per share, and TARP restrictions constrain dividend increases and share repurchases.
Outlook, risks, and contingencies
- Management expected Q4 net interest income to be relatively flat, with margin improving as high-cost deposits reprice and some liquidity is invested in securities. It expected Q4 provision to be relatively consistent with Q3 and noninterest expense approximately level with Q3.
- PNC expected loan balances to decline absent stronger economic conditions or loan demand. It did not expect recent mortgage-fee and refinancing results to continue at the same level; it also expected client-related noninterest income to improve in Q4.
- Integration remained a key execution risk: the first major National City customer conversion was scheduled for November 2009, with remaining conversions expected by June 2010. Management cautioned that expected savings and benefits might take longer, cost more, or not be fully achieved.
- PNC estimated a roughly $1 billion FDIC assessment prepayment in December 2009, which would reduce available bank liquidity. It also expected to consolidate Market Street and certain securitization vehicles under accounting guidance effective January 1, 2010, increasing assets by an estimated $5.8 billion based on September balances; management expected minimal capital-ratio impact.
- PNC disclosed significant contingent exposures, including $102.669 billion of net unfunded credit commitments, $9.871 billion of standby letters of credit, and $6.0 billion of potential loss exposure under commercial mortgage recourse programs. The maximum potential payments under standby letters of credit and related participations were $13.2 billion.
- Risk factors include recession and unemployment, real-estate and other credit losses, market liquidity and valuation uncertainty, interest-rate changes, regulatory reforms and TARP conditions, acquisition integration, and legal matters. The SEC continued investigating National City’s pre-acquisition activities; PNC said it was cooperating. A National City acquisition-settlement appeal remained pending.
- PNC’s pending $500 million investment in BlackRock Series D Preferred Stock was conditional on BlackRock’s planned acquisition of Barclays Global Investors. PNC estimated an approximately $650 million after-tax gain from the transaction using BlackRock’s October 30 share price; the realized amount would depend on closing and market conditions.
Most important facts for investors to verify
- Track credit trends, especially nonperforming assets, charge-offs, reserve adequacy, and performance of acquired National City and purchased impaired loans.
- Separate acquisition-driven growth from organic results; verify integration milestones, realized savings, remaining costs, and deposit/customer retention.
- Assess the sustainability of earnings excluding securities gains, mortgage refinancing and hedge gains, OTTI, purchase-accounting accretion, and other unusual items.
- Confirm capital and liquidity measures, including the Tier 1 ratio reported as 10.9% in the highlights (the narrative also cites 10.8%), TARP-related restrictions, and the FDIC prepayment.
- Monitor off-balance-sheet commitments, mortgage repurchase and recourse claims, VIE consolidation, and the outcomes of legal and regulatory matters.