PNC Financial Services Group, Inc. — Second Quarter 2011 Form 10-Q
Business context and period. PNC is a diversified U.S. financial services company with retail and corporate banking, asset management, residential mortgage banking and other businesses. This unaudited report covers the three and six months ended June 30, 2011; comparisons are with the corresponding 2010 periods unless noted. Prior-year results include GIS only through June 30, 2010, as PNC sold that business effective July 1, 2010.
Financial performance
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Total revenue | $3.602 billion | $3.912 billion | $7.233 billion | $7.675 billion |
| Net interest income | $2.150 billion | $2.435 billion | $4.326 billion | $4.814 billion |
| Noninterest income | $1.452 billion | $1.477 billion | $2.907 billion | $2.861 billion |
| Noninterest expense | $2.176 billion | $2.002 billion | $4.246 billion | $4.115 billion |
| Provision for credit losses | $280 million | $823 million | $701 million | $1.574 billion |
| Net income | $912 million | $803 million | $1.744 billion | $1.474 billion |
| Diluted EPS | $1.67 | $1.47 | $3.24 | $2.15 |
| Net interest margin | 3.93% | 4.35% | 3.93% | 4.29% |
- Second-quarter net income increased despite revenue falling about 8%; lower credit-loss provisioning more than offset lower net interest income and higher expenses. First-half net income rose to $1.744 billion from $1.474 billion.
- Net interest margin contracted as asset yields and purchase-accounting accretion declined amid soft loan demand and low rates. Noninterest income was broadly flat in Q2; lower deposit service charges, mainly from Regulation E overdraft rules, were partly offset by higher asset management fees.
- Noninterest expense rose $174 million in Q2 year over year. The comparison was affected by prior-year reversals of $73 million for a franchise tax settlement and $47 million for a Visa litigation indemnification liability; 2011 expense also included an approximately $40 million legal-contingency charge, partly offset by anticipated insurance recoveries.
- Q2 effective tax rate was 20.4%, versus 28.2%, primarily reflecting a $54 million benefit from reversing deferred tax liabilities. First-half rates were 23.7% and 28.0%, respectively.
- First-half operating cash flow was $3.705 billion, investing cash flow $3.231 billion and financing cash flow negative $6.368 billion; cash and due from banks increased $568 million to $3.865 billion. The filing presents cash flows on a consolidated basis.
Balance sheet, credit and capital
- At June 30, total assets were $263.1 billion, loans $150.3 billion, deposits $181.9 billion and borrowed funds $35.2 billion. Compared with December 31, 2010, loans were nearly flat, deposits declined $1.5 billion and borrowed funds declined $4.3 billion. The loan-to-deposit ratio was 83%.
- Shareholders’ equity was $32.2 billion. Tier 1 common capital was 10.5%, Tier 1 risk-based capital 12.8%, total risk-based capital 16.2% and leverage 11.0%, all higher than at year-end 2010. PNC Bank was reported as well capitalized under applicable regulatory requirements.
- Credit quality improved: nonperforming assets fell 13% from year-end to $4.5 billion; nonperforming loans were $3.9 billion, or 2.57% of loans. First-half net charge-offs were $947 million, down from $1.531 billion; Q2 charge-offs were $414 million, down from $840 million. The allowance was $4.627 billion, or 3.08% of loans and 120% of nonperforming loans.
- Total troubled debt restructurings increased 14% from year-end to $1.919 billion. Nonperforming TDRs were $845 million, 22% of nonperforming loans. PNC notes that purchased impaired loans are treated as performing for reporting purposes, affecting asset-quality ratios.
- Liquidity resources included $58.6 billion of liquid assets, of which $23.1 billion was pledged. PNC also reported $14.6 billion of unused secured FHLB borrowing capacity and $26.6 billion of unused secured Federal Reserve borrowing capacity.
Outlook, material developments and risks
- Management expected 2011 purchase-accounting accretion to decline by about $700 million versus 2010; excluding that effect, it expected full-year net interest income and margin to be stable. Approximately $11.3 billion of higher-cost retail CDs were due to mature in the second half, expected to be redeemed or repriced at lower rates.
- Management expected full-year 2011 provision for credit losses to be at least $1 billion below 2010, assuming budgeted loan growth and modest GDP growth. It expected full-year noninterest expense to be flat versus 2010, excluding possible legal and regulatory contingencies.
- Excluding expected regulatory impacts, management expected full-year noninterest income to grow at a low-to-mid-single-digit percentage rate versus 2010. Regulation E was expected to reduce 2011 revenue by about $200 million; debit interchange limits were expected to reduce 2011 revenue by about $75 million and annual revenue in future periods by about $175 million.
- PNC agreed to acquire RBC Bank (USA) for $3.45 billion, subject to closing adjustments and approvals; the transaction was expected to close in March 2012 and add approximately $19 billion of deposits and $16 billion of loans. A July 2011 agreement to acquire 27 Flagstar branches and about $240 million of deposits was expected to close in December 2011. PNC also completed its acquisition of 19 BankAtlantic branches in June.
- After quarter-end, PNC issued $1 billion of Series O preferred stock, intended partly to support the RBC acquisition. The common dividend rose to $0.35 per quarter. Planned 2011 common-stock repurchases of up to $500 million were on hold pending regulatory approval of the RBC transaction.
- Mortgage-servicing and foreclosure controls are subject to Federal Reserve and OCC consent orders, including independent review and remediation requirements; further penalties or remedies remain possible. Other material exposures include mortgage repurchase and indemnification claims, Visa-related obligations, and legal proceedings. PNC estimated up to approximately $425 million of reasonably possible losses for certain disclosed legal matters, but this estimate excludes matters for which losses could not be estimated and is not a maximum exposure.
- Management cited ongoing risks from economic conditions, interest rates, asset quality, regulatory reform and capital requirements, and acquisition approvals, integration costs, acquired-credit losses and deposit attrition. The filing also warns of valuation risk in securities, including potential additional credit impairments if housing, economic or market conditions worsen.
Most important facts for investors to verify
- Whether credit-quality improvement continues and how TDRs, purchased impaired loans and reserve coverage affect reported asset-quality measures.
- Whether loan growth, deposit mix and funding costs can offset lower purchase-accounting accretion and pressure on net interest margin.
- Actual revenue effects of Regulation E, debit interchange rules and other Dodd-Frank requirements versus management’s estimates.
- Regulatory approvals, purchase price adjustments, integration plans and realized costs and benefits for the RBC and Flagstar transactions.
- Developments in foreclosure consent-order remediation, mortgage repurchase claims, legal contingencies and securities impairment estimates.