PNC Financial Services Group, Inc. — Q2 2018 Form 10-Q
Business context and reporting period. PNC is a diversified U.S. financial services company with Retail Banking, Corporate & Institutional Banking, Asset Management Group and BlackRock reporting segments. This filing covers the quarter and six months ended June 30, 2018; balance-sheet comparisons are primarily with December 31, 2017.
Financial performance and condition
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $4.324B | $4.060B | $8.435B | $7.944B |
| Net interest income (GAAP) | $2.413B | $2.258B | $4.774B | $4.418B |
| Net interest margin (taxable-equivalent, non-GAAP) | 2.96% | 2.84% | 2.94% | 2.81% |
| Provision for credit losses | $80M | $98M | $172M | $186M |
| Noninterest expense | $2.584B | $2.479B | $5.111B | $4.881B |
| Net income | $1.356B | $1.097B | $2.595B | $2.171B |
| Diluted EPS | $2.72 | $2.10 | $5.15 | $4.05 |
| Effective tax rate | 18.3% | 26.0% | 17.7% | 24.5% |
Q2 net income rose 24% and diluted EPS rose 30%. Higher net interest and fee income, a lower provision and reduced taxes more than offset higher expenses. Revenue increased 7% in Q2 and 6% year to date. Fee income rose 6% in Q2, led by asset management; residential mortgage revenue declined 19%. Personnel costs were the largest contributor to expense growth, alongside technology, staffing and employee benefit investments. The efficiency ratio was 60% in Q2 versus 61% a year earlier.
Balance sheet at June 30: assets were $380.7B; loans $222.9B; deposits $264.9B; borrowed funds $59.2B; and shareholders’ equity $46.9B. Loans rose 1% and investment securities rose 5% from year-end, while total deposits were nearly flat. Loan-to-deposit ratio was 84%. Commercial lending growth was partly offset by declining home equity and education balances. Book value per common share was $92.26.
Cash flow and liquidity: For the first six months, operating cash flow was $4.539B, investing cash flow was negative $2.459B and financing cash flow was negative $1.904B. Cash and due from banks ended at $5.425B. PNC reported $26.1B of short-term investments and $60.3B of available-for-sale securities as liquid assets, and $41.2B of unused secured borrowing capacity. PNC and PNC Bank’s liquidity coverage ratios exceeded the 100% regulatory minimum.
Capital and credit: Basel III common equity Tier 1 ratio was 9.5%, down from 9.8% at year-end on a comparable fully phased-in basis; PNC and PNC Bank were described as well capitalized. Nonperforming assets fell 9% from year-end to $1.854B; nonperforming loans were 0.77% of loans. The allowance for loan and lease losses was $2.581B, or 1.16% of loans. Annualized net charge-offs were 0.20% of average loans for the first six months.
Material changes and notable items
- Net interest income benefited from loan growth and higher loan and securities yields, while deposit and borrowing costs also increased. Average loans grew 3% year over year in Q2; average commercial loans were the main driver.
- The 2018 federal corporate tax rate fell from 35% to 21%, contributing to lower effective tax rates and higher reported earnings. Tax reform also affected comparisons of investment and other income.
- Accumulated other comprehensive loss widened to $940M from $148M at year-end, primarily reflecting unrealized securities losses. Shareholders’ equity declined $609M, as repurchases, dividends and lower AOCI largely offset retained earnings.
- PNC repurchased 5.7 million shares for $0.8B in Q2. It announced up to $2.0B of repurchases for the four-quarter period beginning Q3 2018. In July, the board raised the quarterly common dividend to $0.95 per share from $0.75, effective with the August payment; capital actions remain subject to regulatory processes.
- Other noninterest income included a $27M Q2 benefit from Visa Class B-related derivative fair-value adjustments, partly offset by lower securities gains. The Visa interchange litigation parties reached an agreement in principle on class damages, subject to a formal agreement and court approval.
Outlook, risks and contingencies
For Q3 2018 versus Q2, management expected modest loan growth; low-single-digit percentage increases in net interest income and fee income; provision expense of $100M–$150M; and stable noninterest expense. The expected quarterly run rate for other noninterest income was $225M–$275M, excluding securities gains or losses and Visa activity.
For full-year 2018 versus adjusted 2017, PNC expected mid-single-digit loan growth, revenue growth at the upper end of mid-single digits, expense growth at the lower end of mid-single digits and an effective tax rate of approximately 17%. Management’s economic outlook anticipated somewhat faster U.S. growth and rising interest rates, but identified trade restrictions as a downside risk. These are forward-looking expectations, not guarantees.
Key exposures include changes in interest rates, deposit competition and funding costs, economic and credit deterioration, securities valuations, market liquidity, legal and regulatory developments, cyber and operational risks, and dependence in part on BlackRock earnings. PNC noted that higher rates or wider credit spreads could adversely affect securities values; its interest-rate simulations indicated benefit from rising rates in the base analysis but losses under certain rate and yield-curve scenarios.
For disclosed legal matters where PNC could estimate possible losses, it estimated aggregate reasonably possible losses of up to approximately $100M; this excludes matters for which losses could not be estimated and is not a maximum exposure estimate. A July 2018 settlement of captive mortgage reinsurance litigation was described as immaterial. PNC also said adoption of the expected-credit-loss standard (CECL), planned for 2020, is expected to increase its loan-loss allowance; the amount was not yet clear.
Subsequent to quarter-end, PNC Bank issued $750M of subordinated notes on July 26, 2018, at a fixed 4.05% rate, due in 2028. PNC reported no material change in risk factors from its 2017 Form 10-K.
Important facts for investors to verify
- Whether Q3 and full-year guidance is achieved, particularly loan and fee growth, expense control and credit provisions.
- How rising deposit costs and other funding expenses affect net interest margin as rates change.
- Credit trends by portfolio, especially consumer charge-offs, commercial criticized loans and real-estate exposures, and the adequacy of the allowance.
- The impact of securities valuation losses on AOCI, regulatory capital and future capital distributions.
- Resolution and financial consequences of Visa-related litigation and other legal or regulatory matters; the disclosed $100M estimate is incomplete by design.
- The final effect of CECL adoption on reserves and retained earnings, and the ongoing ability to maintain capital and liquidity above regulatory requirements.