PNC Financial Services Group, Inc. — Second Quarter 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Unaudited interim results. PNC is a diversified U.S. financial services company spanning retail and commercial banking, asset management, residential mortgage banking, and its investment in BlackRock.
Financial performance and condition
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Total revenue | $3.794 billion | $3.866 billion | $7.459 billion | $7.597 billion |
| Net interest income | $2.068 billion | $2.052 billion | $4.166 billion | $4.124 billion |
| Net interest margin | 2.70% | 2.73% | 2.73% | 2.78% |
| Noninterest income | $1.726 billion | $1.814 billion | $3.293 billion | $3.473 billion |
| Provision for credit losses | $127 million | $46 million | $279 million | $100 million |
| Noninterest expense | $2.360 billion | $2.366 billion | $4.641 billion | $4.715 billion |
| Net income | $989 million | $1.044 billion | $1.932 billion | $2.048 billion |
| Diluted earnings per share | $1.82 | $1.88 | $3.49 | $3.63 |
- Q2 net income fell about 5%; first-half net income fell about 6%. Higher credit-loss provisions and lower noninterest income were the main pressures. Q2 efficiency ratio was 62%, versus 61% a year earlier; first-half ratio was 62% in both years.
- At June 30, total assets were $361.3 billion, loans $209.1 billion, deposits $249.8 billion, borrowed funds $54.6 billion, and shareholders’ equity $45.6 billion. Compared with year-end 2015, loans rose $2.4 billion and deposits rose $0.8 billion.
- Commercial lending grew $3.5 billion from year-end; consumer lending declined $1.1 billion. The allowance for loan and lease losses was $2.7 billion, or 1.28% of loans.
- Operating cash flow was $761 million in the first half, compared with $1.656 billion in 2015. Investing cash outflow was $89 million versus $8.483 billion; financing cash outflow was $541 million versus $6.879 billion of inflow. Cash and due from banks increased $131 million.
- Transitional Basel III common equity Tier 1 ratio was 10.6%; estimated fully phased-in ratio was 10.2%. PNC and PNC Bank each had an LCR above 100%, compared with the 90% minimum applicable in 2016.
Material changes and notable items
- Credit costs rose sharply: first-half provision increased to $279 million from $100 million, including $128 million related to oil, gas, and coal loans. Q2 net charge-offs were $134 million versus $67 million; first-half net charge-offs were $283 million versus $170 million.
- Nonperforming assets rose 4% from year-end to $2.5 billion. Nonperforming loans were 1.08% of loans, up from 1.03%; overall delinquencies fell 11% to $1.5 billion.
- Noninterest income fell 5% in both comparisons. Lower asset-management revenue reflected weaker equity markets and BlackRock earnings, as well as a $30 million prior-year trust settlement. “Other” income included $51 million of Q2 negative valuation adjustments primarily tied to nonconforming Volcker Rule investments.
- Retail Banking first-half earnings increased to $575 million from $443 million. Corporate & Institutional Banking earnings declined to $921 million from $990 million, primarily reflecting higher credit provisions. Residential Mortgage Banking earnings declined to $33 million from $47 million; Non-Strategic Assets Portfolio earnings declined to $81 million from $137 million.
- Residential mortgage servicing rights fell to $1.2 billion from $1.6 billion at year-end; the filing attributes valuation changes to market factors, including prepayment assumptions. The filing does not provide a single standalone earnings impact for the overall MSR movement.
- PNC repurchased 6.1 million common shares for approximately $0.5 billion in Q2. The five-quarter capital return totaled $4.0 billion. The board announced a quarterly dividend increase from $0.51 to $0.55 per share, payable August 5, 2016, and a new repurchase program of up to $2.0 billion over four quarters beginning Q3, subject to applicable conditions.
Outlook, management commentary, and risks
- Management expected Q3 net interest income, fee income, and noninterest expense to be stable versus Q2; Q3 provision for credit losses was forecast at $100 million to $150 million. Loans were expected to rise modestly in Q3.
- For full-year 2016, management expected total revenue and noninterest expense to be stable versus 2015, an effective tax rate of approximately 25%, and purchase-accounting accretion about $175 million lower than in 2015. PNC said it was on track for its $400 million continuous-improvement savings goal.
- Management described overall credit quality as relatively stable except for certain energy-related loans. Oil and gas loans totaled $2.7 billion and coal loans $0.5 billion at June 30; energy-sector nonperforming loans and additional provisions are key risks.
- PNC reported up to approximately $550 million of reasonably possible losses across certain disclosed legal matters for which it could estimate exposure. This estimate excludes some matters and is not a maximum exposure; actual losses could be higher. The Second Circuit reversed approval of the interchange litigation settlement and remanded the case. A lender-placed insurance class settlement received final approval and was described as not material.
- Other key risks include interest-rate and yield-curve movements, economic and market conditions, asset quality, regulatory and capital requirements, legal contingencies, and operational, cyber, and technology risks. PNC noted that capital distributions remain subject to regulatory review. Its outlook assumed moderate U.S. economic growth in the latter half of 2016 and acknowledged uncertainty, including post-Brexit market conditions.
- Subsequent events: PNC announced redemption of $1.25 billion of senior notes due September 2016, and PNC Bank issued $1.0 billion of senior notes on July 29, 2016.
Important facts for investors to verify
- Whether energy-sector credit deterioration, provisions, and charge-offs continue to develop as management expected.
- Whether revenue, net interest margin, purchase-accounting accretion, and management’s Q3 and full-year outlook track subsequent results.
- How mortgage servicing-rights valuations and related hedges affect earnings and capital.
- The scope and outcome of legal proceedings, including the interchange litigation, and whether estimated legal exposure changes.
- Whether announced repurchases and dividend increases proceed as planned and remain consistent with regulatory capital approvals.
- How reported capital and liquidity ratios compare with applicable regulatory requirements as rules and estimates evolve.