PNC Financial Services Group, Inc. — First Quarter 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; comparisons are primarily with the first quarter of 2013. PNC is a diversified U.S. financial services company with retail and commercial banking, asset management, residential mortgage banking and other operations.
Financial performance and condition
- Earnings: Net income was $1.060 billion, up 7%; net income attributable to common shareholders was $992 million, and diluted EPS was $1.82 versus $1.74.
- Revenue and margins: Revenue was $3.777 billion, down 5%. Net interest income fell 8% to $2.195 billion; net interest margin declined 55 basis points to 3.26%. Noninterest income rose 1% to $1.582 billion.
- Expenses and credit costs: Noninterest expense decreased 4% to $2.264 billion. Provision for credit losses declined to $94 million from $236 million. Pretax, pre-provision earnings were $1.513 billion versus $1.587 billion. The efficiency ratio was 60% in both periods.
- Cash flow: Operating activities provided $1.920 billion; investing activities used $2.985 billion; financing activities provided $1.745 billion. Cash and due from banks ended the quarter at $4.723 billion, up from $4.043 billion at year-end.
- Balance sheet and funding: Total assets were $323.4 billion; loans were $198.2 billion, up $2.6 billion from year-end; deposits were $222.4 billion, up $1.5 billion. Borrowed funds totaled $46.8 billion, up $0.7 billion. Loans-to-deposits were 89%.
- Liquidity and capital: Liquid assets totaled $65.9 billion, of which $17.3 billion was pledged. Transitional Basel III common equity Tier 1 capital was 10.8%; estimated fully phased-in standardized-approach common equity Tier 1 was 9.7%. PNC and PNC Bank were considered well capitalized.
- Asset quality: Nonperforming assets were $3.304 billion, down from $3.457 billion at year-end; nonperforming assets to total assets were 1.02%. Net charge-offs were $186 million, or 0.38% annualized, versus $456 million, or 0.99%, a year earlier. The allowance for loan and lease losses was $3.530 billion, or 1.78% of loans.
Material changes and business trends
- Lower loan and securities yields, reduced purchase-accounting accretion and higher borrowed-fund balances drove lower net interest income and margin; loan growth and lower deposit funding costs partly offset these effects.
- Fee income was broadly stable: stronger asset management and corporate services, and a $62 million gain on Visa Class B shares, were largely offset by weaker residential mortgage revenue. Mortgage origination volume fell to $1.9 billion from $4.2 billion.
- Commercial lending grew $3.6 billion from year-end, while consumer lending declined $1.0 billion. Average loans were up 6% year over year, and average interest-earning deposits with banks rose substantially as PNC built liquidity.
- Residential Mortgage Banking reported a $4 million loss versus $45 million of earnings a year earlier, primarily reflecting lower loan-sale revenue. Retail Banking earnings increased to $158 million from $120 million; Corporate & Institutional Banking earnings declined to $523 million from $541 million.
- Net charge-offs and provisions improved substantially year over year, but comparisons are affected by $134 million of additional consumer charge-offs taken in first-quarter 2013 under interagency guidance.
Outlook, management commentary and risks
- Management expected second-quarter net interest income to be modestly below first-quarter levels and full-year purchase-accounting accretion to decline about $300 million from 2013.
- Management expected second-quarter fee-based noninterest income to rise in the low single digits, provision for credit losses of $100 million to $150 million, and noninterest expense to increase in the low single digits due partly to seasonality. Full-year 2014 revenue was expected to remain under pressure and could decline from 2013; expenses were expected to be lower, excluding potential legal and regulatory contingencies. The expected 2014 effective tax rate was approximately 26%.
- PNC reported that the Federal Reserve did not object to its 2014 capital plan. In April, the Board raised the quarterly dividend from $0.44 to $0.48 per share and approved repurchase programs of up to $1.5 billion for the four quarters beginning in Q2 2014, subject to applicable conditions.
- Key risks include interest-rate and spread changes, economic conditions and credit quality, evolving regulation and capital/liquidity requirements, cybersecurity and operational risks, and legal or governmental matters. Management cautioned that first-quarter credit trends may not persist.
- For disclosed legal matters where losses could be estimated, PNC said reasonably possible aggregate losses could reach approximately $725 million. This estimate excludes matters that could not be estimated and is not a maximum exposure. Separately, possible residential mortgage repurchase losses above the $103 million reserve were estimated at up to approximately $87 million.
- Accounting changes included early adoption of ASU 2014-01 for qualifying low-income housing tax-credit investments, reducing retained earnings by $74 million cumulatively at adoption and changing expense and tax presentation. Commercial mortgage servicing rights also moved to recurring fair-value measurement from January 1, 2014.
Important facts for investors to verify
- Whether net interest margin and purchase-accounting accretion continue to decline, and how that affects full-year revenue and earnings.
- Whether management’s credit-cost outlook is met and whether asset-quality improvements continue, considering the unusual 2013 charge-off comparison.
- How mortgage production, servicing-rights valuations and repurchase claims affect mortgage results and reserves.
- Execution and regulatory conditions for the announced dividend increase and up-to-$1.5 billion share repurchase programs.
- Developments in legal and regulatory matters, including the limits of the disclosed $725 million possible-loss estimate and the additional residential mortgage repurchase exposure.