PNC FINANCIAL SERVICES GROUP, INC. quarterly report, Q2 FY2013

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PNC Financial Services Group, Inc. — Second Quarter 2013 Form 10-Q

Business context and reporting period

PNC is a diversified U.S. financial services company with retail and corporate banking, asset management, residential mortgage banking, and an investment in BlackRock. This unaudited filing covers the three and six months ended June 30, 2013; balance-sheet comparisons are primarily with December 31, 2012. Results are reported in U.S. dollars.

Financial performance and condition

  • Second-quarter results: Revenue was $4.064 billion, up 12% year over year. Net income was $1.123 billion versus $546 million; diluted EPS was $1.99 versus $0.98. Net income attributable to common shareholders was $1.069 billion.
  • First-half results: Revenue was $8.019 billion, up 9%; net income was $2.127 billion versus $1.357 billion; diluted EPS was $3.76 versus $2.42.
  • Revenue mix and margins: Second-quarter net interest income was $2.258 billion, down 11%, and net interest margin was 3.58% versus 4.08%. Noninterest income rose to $1.806 billion from $1.097 billion. First-half net interest income was $4.647 billion, down 4%, and margin was 3.69% versus 3.99%.
  • Expense and credit costs: Second-quarter noninterest expense fell 8% to $2.435 billion; provision for credit losses declined to $157 million from $256 million. First-half expense fell 5% to $4.830 billion and provision was $393 million versus $441 million.
  • Balance sheet and funding: At June 30, assets were $304.4 billion, loans $189.8 billion, deposits $212.3 billion, and borrowed funds $39.9 billion. Loans grew $3.9 billion and deposits declined $0.9 billion from year-end. The loans-to-deposits ratio was 89%. Shareholders’ equity was $40.3 billion.
  • Capital and liquidity: Basel I Tier 1 common, Tier 1 risk-based, total risk-based, and leverage ratios were 10.1%, 12.0%, 15.2%, and 10.9%, respectively. Estimated pro forma Basel III Tier 1 common was 8.2%, based on PNC’s understanding of prior proposals, not the final rules. Liquid assets were $55.4 billion, including $23.1 billion pledged as collateral; management described liquidity as strong.
  • Cash flows: For the first half, operating cash flow was $1.796 billion, investing cash flow was negative $643 million, and financing cash flow was negative $2.322 billion. The filing reports these flows but does not present a bank-style free-cash-flow measure.

Material changes versus comparable periods

  • Reported earnings increased substantially, principally reflecting lower residential mortgage repurchase provisions, higher customer fee income and gains on asset sales and valuations, lower expenses, and lower credit-loss provisions. These factors more than offset weaker net interest income.
  • Residential mortgage repurchase provision was $73 million in the second quarter versus $438 million a year earlier; for the first half it was $77 million versus $470 million. The comparison materially benefited from this reduction.
  • Net interest income and margin weakened as purchase-accounting accretion and loan and securities yields declined. Commercial loan growth supported balances, while securities balances were lower.
  • Credit indicators generally improved, particularly commercial credit. Second-quarter net charge-offs were $208 million versus $315 million, but first-half net charge-offs rose to $664 million from $648 million.
  • PNC implemented consumer loan classification and charge-off changes in Q1 2013 to align with interagency guidance. The change added $426 million to nonperforming loans and $134 million of charge-offs, affecting comparisons with prior periods.
  • Commercial lending grew $4.3 billion from year-end; consumer lending declined $0.4 billion. The 2012 RBC Bank (USA) acquisition also affects some year-over-year comparisons.

Outlook, commentary, risks and unusual items

  • Outlook: PNC expected third-quarter net interest income to be modestly lower than Q2 and full-year 2013 net interest income to decline from 2012, including an expected approximately $350 million reduction in purchase-accounting accretion. Management expected full-year noninterest income and total revenue to increase, noninterest expense to decline at least 5%, and Q3 expenses to be modestly higher than Q2. The Q3 provision forecast was $170 million to $250 million.
  • Management said it expected to exceed its $700 million continuous-improvement savings goal for 2013, reporting approximately $600 million of annualized savings captured through the first half.
  • The board raised the quarterly common dividend from $0.40 to $0.44 per share; it declared another $0.44 dividend for August 2013. PNC said it did not expect common-stock buybacks in 2013.
  • Mortgage repurchase exposure remains significant: the residential mortgage liability was $523 million at June 30, and management estimated reasonably possible additional losses above that accrual of up to approximately $355 million. The separate home-equity repurchase liability was $24 million.
  • For disclosed legal matters where losses could be estimated, PNC reported aggregate reasonably possible losses of up to approximately $400 million; this excludes matters for which an estimate could not be made and is not a maximum exposure estimate. Matters include interchange, mortgage-related, overdraft, insurance and patent litigation, as well as regulatory inquiries.
  • On July 31, 2013, a federal court vacated debit-card interchange and network-processing rules, but temporarily stayed its decision. PNC said the ultimate impact and timing were unknown; an effective ruling could materially affect debit interchange revenue. PNC reported 2012 debit interchange revenue of approximately $305 million.
  • Basel III final U.S. rules were issued in July 2013. PNC noted possible effects on capital requirements, capital volatility and distributions; its 8.2% pro forma ratio had not yet been recalculated using the final rules.
  • Other market risks include a low-rate environment, interest-rate and securities valuation changes, credit and liquidity conditions, regulatory costs, and uncertainty in estimates for loan-loss allowances, mortgage servicing rights and repurchase obligations. Second-quarter other comprehensive income was negative $722 million, largely reflecting unrealized valuation changes; accumulated other comprehensive income fell to $45 million from $834 million at year-end.

Important facts for investors to verify

  • How much of earnings growth is repeatable, given the large year-over-year reduction in mortgage repurchase provisions and gains on asset sales and valuations?
  • Whether net interest income and margin stabilize, and whether loan growth and planned securities purchases offset lower yields and declining purchase-accounting accretion.
  • Whether consumer and commercial credit trends continue to improve, considering the Q1 policy-driven reclassifications, first-half charge-offs, and lower allowance coverage ratio.
  • The adequacy of mortgage repurchase reserves and the outcome of GSE claims, legal proceedings and regulatory inquiries; the filing’s legal-loss estimate excludes unquantifiable matters.
  • PNC’s capital position after applying final Basel III requirements, and the effect of interest-rate changes on capital and available-for-sale securities.
  • Cash-flow movements, deposit trends, collateralized liquidity, and the maturity profile of borrowed funds and other commitments.