Business context and reporting period
The PNC Financial Services Group, Inc. filed this unaudited Form 10-Q for the quarter ended June 30, 2009. Results include National City, acquired December 31, 2008; therefore, comparisons with 2008 are not like-for-like. PNC reported seven business segments following its reorganization around the acquisition.
Financial performance and condition
Dollars are in millions except per-share data. Second-quarter and first-half income statement figures compare with the corresponding 2008 periods.
| Metric | Q2 2009 | Q2 2008 | Six months 2009 | Six months 2008 |
|---|---|---|---|---|
| Total revenue | $3,987 | $2,039 | $7,858 | $3,860 |
| Net interest income | $2,182 | $977 | $4,487 | $1,831 |
| Noninterest income | $1,805 | $1,062 | $3,371 | $2,029 |
| Noninterest expense | $2,658 | $1,103 | $4,986 | $2,138 |
| Provision for credit losses | $1,087 | $186 | $1,967 | $337 |
| Net income | $207 | $517 | $737 | $901 |
| Net income attributable to common shareholders | $65 | $505 | $525 | $882 |
| Diluted EPS | $0.14 | $1.45 | $1.16 | $2.54 |
| Net interest margin | 3.60% | 3.47% | 3.70% | 3.28% |
Q2 pretax, pre-provision earnings were $1.329 billion, exceeding the $1.087 billion credit provision. The efficiency ratio was 67% in Q2 versus 54% a year earlier; return on average assets was 0.30% versus 1.47%. The effective tax rate was 14.5% in Q2 and 18.6% for the first half.
At June 30, 2009, total assets were $279.8 billion, loans $165.0 billion, deposits $190.4 billion, borrowed funds $44.7 billion, and shareholders’ equity $27.3 billion. Compared with December 31, 2008, assets declined $11.3 billion, loans declined $10.5 billion, deposits declined $2.4 billion, and borrowed funds declined $7.6 billion. The loan-to-deposit ratio was 87%.
Credit quality weakened: nonperforming assets rose to $4.532 billion from $2.181 billion at year-end, and nonperforming loans were 2.44% of loans versus 0.95%. The allowance for loan and lease losses was $4.569 billion, or 2.77% of loans, compared with $3.917 billion, or 2.23%, at year-end. Net charge-offs were $795 million in Q2; the annualized Q2 net charge-off ratio was 1.89%.
Capital ratios at June 30 were 10.5% Tier 1 risk-based, 5.3% Tier 1 common, 14.1% total risk-based, and 9.1% leverage. PNC raised $624 million of common equity in May. It held $7.6 billion of Treasury TARP preferred stock, with a 5% dividend rate for the first five years and 9% thereafter if still outstanding. The quarterly common dividend was reduced from $0.66 to $0.10 per share.
For the first six months, operating cash flow was $1.350 billion, investing cash flow was positive $7.714 billion, and financing cash flow was negative $9.738 billion. Cash and due from banks declined $674 million to $3.797 billion. Liquid assets totaled $60.8 billion, of which $21.7 billion was pledged.
Material changes versus comparable periods
- National City materially increased the scale of reported assets, revenue, expenses, and lending; the acquisition makes year-over-year comparisons substantially non-comparable.
- Despite higher reported revenue, net income and diluted EPS fell sharply year over year, primarily amid substantially higher credit provisions, acquisition-related expenses, and preferred dividends.
- Q2 noninterest expense included a $133 million special FDIC assessment. First-half National City integration costs were $177 million, including $125 million in Q2.
- Net interest margin improved year over year as deposit funding costs fell, but PNC said lower asset yields partly offset the benefit. Loans declined from year-end amid weaker demand, paydowns, and deleveraging.
- Capital strengthened, including through the May common stock issuance and retained earnings. The Tier 1 risk-based ratio rose from 9.7% at year-end to 10.5%.
- PNC recognized $304 million of net credit-related securities impairment charges in first-half earnings; total first-half OTTI was $1.1 billion, with $835 million of the noncredit component recorded in accumulated other comprehensive loss.
Outlook, management commentary, risks, and unusual items
- PNC expected net interest income and margin for the remainder of 2009 to be flat to down versus the first half, as maturities and paydowns of higher-yielding assets were expected to offset deposit repricing benefits.
- Management did not expect credit costs to abate in Q3, though it believed the rate of deterioration might slow. It cited recession-related weakness across commercial and consumer portfolios, including commercial real estate and residential mortgages.
- PNC reported approximately $500 million of annualized National City cost savings by Q2, ahead of plan. It targeted $600 million for 2009 and $1.2 billion of annualized savings over two years; the acquisition was expected to be accretive to full-year 2009 earnings. National City customer conversion to PNC systems was planned to begin in November, and 61 branches were to be divested in Q3.
- Mortgage refinancing and servicing-rights hedging boosted first-half residential mortgage results; management warned these gains and origination volumes were unlikely to recur at the same level, with lower refinance activity expected in the second half.
- Market, credit, and liquidity risks include a severe recession, low rates, market illiquidity, asset valuation uncertainty, regulatory changes, and potential further securities impairments. PNC also identified integration execution, acquired-loan losses, deposit and client attrition, and legacy National City legal matters as risks.
- PNC had $103.1 billion of net unfunded credit commitments and $10.1 billion of net standby letters of credit. Its Market Street conduit exposure included $6.3 billion of liquidity facilities and $0.6 billion of other credit enhancements. New consolidation guidance was expected to bring Market Street and certain acquired securitization entities onto the balance sheet beginning January 1, 2010; PNC expected minimal capital-ratio impact.
- Other items include a pending BlackRock acquisition of Barclays Global Investors, expected to close in late 2009 or early 2010; PNC agreed to invest up to $500 million in BlackRock preferred stock if the transaction closes. A July Visa escrow contribution was expected to reduce PNC’s indemnification liability in Q3. PNC reported that disclosure controls were effective and that there had been no material second-quarter change in internal control over financial reporting; acquired National City operations were still using pre-acquisition systems.
Important facts for investors to verify
- Separate acquisition effects from underlying trends when assessing revenue, earnings, expenses, loan growth, and comparisons with 2008.
- Track nonperforming assets, charge-offs, allowance coverage, acquired impaired-loan cash-flow estimates, and subsequent credit provisions.
- Test whether National City cost savings, integration milestones, branch divestitures, and full-year earnings accretion are achieved.
- Review the sustainability of mortgage revenue and servicing-rights valuations, securities impairment assumptions, and Level 3 fair values.
- Monitor capital and liquidity, dividend restrictions under TARP, funding costs, and the potential effects of future VIE and securitization consolidation.
- Follow material legal proceedings, Visa indemnification developments, and the conditions and timing of the proposed BlackRock transaction.