PNC Financial Services Group, Inc. — First-Quarter 2015 Form 10-Q
Business context and period. PNC is a diversified U.S. financial services company spanning retail banking, corporate and institutional banking, asset management, residential mortgage banking, its investment in BlackRock, and a non-strategic assets portfolio. This unaudited report covers the three months ended March 31, 2015; year-over-year comparisons are to the first quarter of 2014 unless noted.
Financial performance and position
| Metric | Q1 2015 | Q1 2014 / comparison |
|---|---|---|
| Total revenue | $3.731 billion | $3.777 billion; down 1% |
| Net interest income | $2.072 billion | $2.195 billion; down 6% |
| Net interest margin | 2.82% | 3.26% |
| Noninterest income | $1.659 billion | $1.582 billion; up 5% |
| Noninterest expense | $2.349 billion | $2.264 billion; up 4% |
| Pretax, pre-provision earnings | $1.382 billion | $1.513 billion |
| Provision for credit losses | $54 million | $94 million |
| Net income | $1.004 billion | $1.060 billion |
| Net income attributable to common shareholders | $933 million | $992 million |
| Diluted earnings per common share | $1.75 | $1.82 |
| Cash dividends declared per common share | $0.48 | $0.44 |
Management attributed weaker net interest income and margin mainly to lower loan yields, reduced purchase-accounting accretion, and balance-sheet positioning for regulatory liquidity requirements. Fee growth and higher securities gains partly offset these pressures. The effective tax rate was 24.4%, versus 25.3%.
Cash flow. Operating activities provided $242 million, compared with $1.920 billion in Q1 2014; investing activities used $3.886 billion, versus $2.985 billion; financing activities provided $3.435 billion, versus $1.745 billion. Cash and due from banks ended the quarter at $4.151 billion. These banking-company cash flows reflect substantial investment and funding movements and should not be read like those of a nonfinancial company.
Balance sheet and funding, March 31, 2015. Total assets were $350.960 billion, up 2% from year-end 2014. Loans were $204.722 billion, essentially flat from year-end; commercial lending rose $1.3 billion while consumer lending fell $1.4 billion. Deposits increased 2% to $236.503 billion, and borrowed funds were $56.829 billion, little changed. The loans-to-deposits ratio was 87%. Total shareholders’ equity was $45.025 billion; book value per common share was $78.99.
PNC reported $82.8 billion in liquid assets, including short-term investments and available-for-sale securities. Its and PNC Bank’s Liquidity Coverage Ratios exceeded 100%, above the 80% minimum phased in for 2015. Transitional Basel III common equity Tier 1 was 10.5%; estimated fully phased-in standardized-approach common equity Tier 1 was 10.0%. PNC and PNC Bank were described as well capitalized.
Credit quality. Nonperforming assets declined to $2.754 billion from $2.880 billion at year-end; nonperforming assets were 0.78% of total assets. Net charge-offs were $103 million, down from $186 million, and 0.20% of average loans on an annualized basis, versus 0.38%. The allowance for loan and lease losses was $3.306 billion, or 1.61% of loans and 137% of nonperforming loans. Total troubled debt restructurings were $2.530 billion.
Material changes and business results
- Revenue declined slightly and expenses rose, reducing net income 5% and diluted EPS from $1.82 to $1.75. Lower credit costs provided a partial offset.
- Noninterest income growth reflected client fees and $42 million of securities gains, while the comparison was affected by a $62 million Visa Class B share-sale gain in Q1 2014. PNC held about 7 million Visa Class B shares with an estimated fair value of $740 million at quarter-end.
- Segment earnings were $202 million for Retail Banking (up from $158 million), $482 million for Corporate & Institutional Banking (down from $523 million), $37 million for Asset Management (unchanged), $28 million for Residential Mortgage Banking (versus a $4 million loss), $135 million for BlackRock (up from $123 million), and $81 million for Non-Strategic Assets (down from $110 million).
- Average loans grew 4% year over year, chiefly from commercial and commercial real estate lending; average interest-earning deposits with banks also increased markedly, partly reflecting new liquidity requirements. Investment securities were up $4.9 billion from year-end, principally funded by deposit growth.
- New regulatory liquidity standards took effect in January 2015. PNC also changed its internal funds-transfer-pricing methodology for liquidity costs; management estimated a $55 million Q1 net-interest-income benefit to Retail Banking and a $60 million reduction to Corporate & Institutional Banking, with prior periods not recast.
Outlook, risks and unusual items
- Management expected Q2 2015 net interest income to remain stable versus Q1. For full-year 2015, purchase-accounting accretion was expected to decline about $225 million from 2014, and revenue was expected to remain under pressure amid delayed rate increases.
- Management expected Q2 fee-income categories to rise low single digits versus Q1; Q2 noninterest expense was expected to increase low single digits due to seasonality. Full-year 2015 noninterest expense was expected to be stable versus 2014, with the $400 million continuous-improvement savings goal expected to be achieved. The 2015 effective tax rate was expected to be approximately 25%.
- Q2 2015 provision for credit losses was expected to be $50 million to $100 million. These are management expectations, not guarantees.
- The Federal Reserve accepted PNC’s 2015 CCAR capital plan without objection. PNC announced repurchase programs of up to $2.875 billion over five quarters beginning Q2 2015, and in April raised the quarterly common dividend to $0.51, effective with the May payment. On May 4, 2015, it redeemed $500 million of Series K preferred stock.
- Legal proceedings remain a significant contingency. For disclosed matters where losses could be estimated, PNC reported reasonably possible aggregate losses of up to approximately $725 million; the estimate excludes some matters and is not a maximum exposure. In a pre-need funeral arrangements case, a March 2015 judgment awarded $355.5 million compensatory and $35.6 million punitive damages; plaintiffs sought $178.8 million in prejudgment interest, and PNC filed motions seeking relief and stated it intended to appeal if necessary.
- Residential mortgage repurchase and indemnification liabilities were $106 million; management estimated possible additional losses above the residential mortgage accrual of up to approximately $94 million. The filing notes estimation uncertainty, regulatory and governmental inquiries, and risks from interest rates, credit quality, economic conditions, litigation, regulation, and capital or liquidity requirements.
- PNC estimated purchase-impaired-loan cash flows of $5.3 billion, including $3.8 billion carrying value and $1.5 billion accretable yield. These estimates depend on borrower performance, collateral values and economic assumptions.
Most important facts for investors to verify
- Whether net interest margin, core net interest income, and revenue stabilize as purchase-accounting accretion declines and regulatory liquidity costs continue.
- Whether fee growth and planned expense savings offset technology, infrastructure, and personnel costs.
- Whether credit-quality improvement persists, particularly in home equity, residential real estate, and purchased-impaired loans, and whether the allowance remains adequate.
- Actual capital distributions versus the announced repurchase and dividend plans, including the effects on capital ratios and regulatory approval.
- Developments in the funeral-arrangements judgment, other legal and regulatory matters, and mortgage repurchase exposures, including any changes in reserves or reasonably possible losses.