PNC Financial Services Group, Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Financial amounts are in U.S. dollars; balance-sheet comparisons are to December 31, 2016 unless noted.
Business context
PNC is a diversified U.S. financial services company operating in Retail Banking, Corporate & Institutional Banking, Asset Management Group and BlackRock. It realigned its reportable segments in 2017 and revised prior-period segment presentation. Prior-period financial statements were also reclassified where needed to conform to current presentation.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $4.125 billion | $3.829 billion | $12.069 billion | $11.288 billion |
| Net interest income (GAAP) | $2.345 billion | $2.095 billion | $6.763 billion | $6.261 billion |
| Noninterest income | $1.780 billion | $1.734 billion | $5.306 billion | $5.027 billion |
| Provision for credit losses | $130 million | $87 million | $316 million | $366 million |
| Noninterest expense | $2.456 billion | $2.394 billion | $7.337 billion | $7.035 billion |
| Net income | $1.126 billion | $1.006 billion | $3.297 billion | $2.938 billion |
| Diluted EPS | $2.16 | $1.84 | $6.21 | $5.33 |
| Net interest margin (taxable-equivalent, non-GAAP) | 2.91% | 2.68% | 2.84% | 2.71% |
| Efficiency ratio | 60% | 63% | 61% | 62% |
- Q3 net income rose 12% year over year. Higher loan yields and balances, improved net interest margin and higher noninterest income were partly offset by higher expenses and credit-loss provision. The effective tax rate was 26.8% in Q3 and 25.3% year to date.
- At September 30, total assets were $375.2 billion; loans were $221.1 billion, up 5% from year-end, while deposits were $260.7 billion, up 1%. Commercial lending rose 8%; consumer lending was approximately flat, with home equity and education runoff partly offset by mortgage and auto growth.
- Borrowed funds totaled $57.6 billion, up 9% from year-end. Total shareholders’ equity was $46.4 billion. The loan-to-deposit ratio increased to 85% from 82%.
- Operating cash flow for the first nine months was $4.826 billion, versus $2.295 billion a year earlier; investing cash flow was negative $9.615 billion and financing cash flow was positive $4.646 billion. Cash and due from banks declined $143 million during the period to $4.736 billion. These cash-flow figures reflect bank balance-sheet activity and should be considered in that context.
- Transitional Basel III common equity Tier 1 was 10.3%, down from 10.6% at year-end; estimated fully phased-in common equity Tier 1 was 9.8%, down from 10.0%. PNC and PNC Bank were described as well capitalized.
- PNC reported $86.3 billion in liquid assets and said its Liquidity Coverage Ratio exceeded the 100% 2017 minimum. Parent-company available liquidity was $5.5 billion.
Material changes and notable items
- Net interest income growth reflected higher loan yields and balances and higher rates, partly offset by increased deposit and borrowing costs. Average loans grew 5% year over year in Q3; average deposits grew 3%.
- Q3 noninterest income increased 3%. Higher private-equity investment revenue, underwriting fees and acquired-business operating lease income were partly offset by a 35% decline in residential mortgage revenue, primarily due to lower loan-sale revenue and a smaller MSR valuation benefit.
- The Q3 credit provision increased, reflecting loan growth, consumer credit trends and the impact of Hurricanes Harvey and Irma. Year-to-date provision declined, mainly due to lower provisions for certain oil, gas and coal loans.
- Asset quality improved versus year-end: nonperforming assets fell 13% to $2.067 billion; nonperforming loans were 0.85% of loans versus 1.02%; and nine-month annualized net charge-offs were 0.21% versus 0.28% in 2016. The allowance for loan and lease losses was $2.605 billion, or 1.18% of loans.
- PNC acquired a commercial and vendor finance business in Q2 2017, adding about $1.0 billion of loans and leases; related revenue and expenses affected comparisons.
- PNC returned $0.9 billion to shareholders in Q3 through $0.5 billion of repurchases and $0.4 billion of common dividends. It redeemed $1.0 billion of perpetual trust securities in March. Common shares outstanding were 476 million at September 30, versus 485 million at year-end.
Outlook, risks and contingencies
- For Q4 2017 versus Q3, management expected modest loan growth; low-single-digit percentage increases in net interest income, fee income and noninterest expense; and provision for credit losses of $100 million to $150 million. Other noninterest income was expected at $250 million to $300 million. Management forecast a full-year effective tax rate of 25% to 26%, absent tax reform.
- Management’s economic baseline assumed moderate U.S. growth and rising rates: one 25-basis-point federal funds rate increase in December 2017 and three more in 2018. PNC noted that materially different economic or market conditions could affect results.
- Key risks include credit and asset-quality deterioration, interest-rate and market movements, liquidity and capital requirements, operational and cyber risks, competition, legal and regulatory changes, and risks associated with acquisitions and PNC’s BlackRock investment.
- For disclosed legal matters where losses could be estimated, PNC said aggregate reasonably possible losses could reach approximately $250 million. This estimate excludes matters for which losses could not be estimated and is not a maximum exposure estimate; actual losses could be higher. Regulatory and governmental inquiries may also lead to penalties, business changes, expense or reputational harm.
- PNC had $168.8 billion of commitments to extend credit and other commitments, including $156.6 billion of credit commitments. These are not equivalent to funded balance-sheet liabilities.
- After quarter-end, PNC Bank issued $1.0 billion of senior notes due 2027 and an additional $750 million of notes due 2020. The board declared a $0.75-per-share dividend payable November 5, 2017. Planned capital returns remain subject to regulatory capital-planning requirements.
Important facts for investors to verify
- Whether net interest margin and earnings growth persist as deposit and wholesale funding costs rise.
- Whether commercial loan growth, including acquired balances, maintains PNC’s underwriting standards and does not weaken credit quality.
- Trends in consumer credit, hurricane-related losses, nonperforming assets and reserve adequacy, including the potential future effect of the expected-credit-loss accounting standard.
- Execution of cost savings and technology investments, and the effects of the segment realignment and acquired business on comparable results.
- Capital and liquidity headroom, debt issuance and funding costs, and the capacity to sustain planned dividends and share repurchases.
- Developments in legal proceedings and regulatory inquiries, including the interchange litigation and mortgage repurchase matters, and the uncertainty around unquantified exposures.