PNC Financial Services Group, Inc. — Second Quarter 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012; unaudited. PNC is a diversified U.S. financial services company. Comparisons below are with the corresponding 2011 period unless otherwise noted.
Financial results and key metrics
| Metric | Q2 2012 | Q2 2011 | First half 2012 | First half 2011 |
|---|---|---|---|---|
| Total revenue | $3.623 billion | $3.602 billion | $7.355 billion | $7.233 billion |
| Net interest income | $2.526 billion | $2.150 billion | $4.817 billion | $4.326 billion |
| Noninterest income | $1.097 billion | $1.452 billion | $2.538 billion | $2.907 billion |
| Noninterest expense | $2.648 billion | $2.176 billion | $5.103 billion | $4.246 billion |
| Provision for credit losses | $256 million | $280 million | $441 million | $701 million |
| Net income | $546 million | $912 million | $1.357 billion | $1.744 billion |
| Diluted EPS | $0.98 | $1.67 | $2.42 | $3.24 |
| Net interest margin | 4.08% | 3.93% | 3.99% | 3.93% |
- Q2 net income fell 40%; first-half net income fell 22%. Q2 pretax, pre-provision earnings were $975 million versus $1.426 billion.
- At June 30, total assets were $299.6 billion, loans $180.4 billion, deposits $206.9 billion, borrowed funds $43.7 billion, and shareholders’ equity $37.0 billion. Loans-to-deposits was 87%.
- Cash and due from banks ended at $4.136 billion. First-half operating cash flow was $3.814 billion, investing cash flow was negative $11.241 billion, financing cash flow was positive $7.458 billion, and cash increased $31 million. Acquisition and loan-growth activity were significant investing cash uses.
- Tier 1 common, Tier 1 risk-based, total risk-based and leverage ratios were 9.3%, 11.4%, 14.2% and 10.1%, respectively. Tier 1 common was 10.3% at December 31, 2011.
- Nonperforming assets were $4.176 billion; nonperforming loans were $3.458 billion. The allowance for loan and lease losses was $4.156 billion, 2.30% of loans and 120% of nonperforming loans.
Material changes and drivers
- PNC acquired RBC Bank (USA) and a credit card portfolio on March 2 for $3.6 billion cash. The acquisition added approximately $18.1 billion of deposits, $14.5 billion of loans, and $944 million of goodwill; reported results include RBC activity only after closing. PNC attributed loan, deposit and net interest income growth substantially to the acquisition, alongside organic growth and lower funding costs.
- Net interest margin improved as deposit and borrowing costs declined and acquired loans contributed. Management cautioned that the continuing low-rate environment could pressure margin.
- Noninterest income declined, principally reflecting the residential mortgage repurchase provision and lower debit-card interchange fees. PNC estimated the interchange limits reduced revenue by about $150 million in the first half, including $80 million in Q2.
- Higher expenses reflected RBC operating and integration costs, trust-preferred redemption charges, legal reserves, real-estate-owned and foreclosure-related costs, and pension expense. Q2 included $149 million of RBC operating costs, $52 million of integration costs, and a $130 million noncash trust-preferred discount charge.
- Credit indicators generally improved: first-half net charge-offs were $648 million versus $947 million, and the annualized charge-off ratio was 0.76% versus 1.27%. The allowance declined from $4.347 billion at year-end. Changes in home-equity delinquency classification affect comparability: beginning in Q1, loans 90 or more days past due were placed on nonaccrual, versus 180 days previously.
Outlook, risks and unusual items
- Management expected full-year 2012 net interest income to increase 10%–12% from 2011, noninterest income to be essentially flat, and total revenue to grow at a high-single-digit percentage rate excluding future significant mortgage repurchase provisions. These expectations assumed recent economic trends continued.
- Management expected full-year provision for credit losses to improve versus 2011, subject to economic conditions and unexpected legal or regulatory contingencies. Excluding trust-preferred charges and integration costs, it expected full-year noninterest expense to rise at a high-single-digit rate, largely due to RBC.
- Management projected $550 million of annualized cost savings at PNC and integration savings at RBC. Expected integration costs were $68 million in Q3 and $28 million in Q4. Further trust-preferred redemption charges were anticipated.
- Residential mortgage repurchase claims rose sharply, particularly on 2006–2008 loans and claims on loans defaulted more than two years earlier. PNC recorded a $438 million Q2 provision; the residential mortgage repurchase liability was $462 million at June 30, up from $83 million at year-end. Management estimated up to approximately $350 million of reasonably possible additional losses above the residential mortgage accrual.
- PNC reported that aggregate reasonably possible losses for certain disclosed legal matters could reach approximately $475 million, while noting that this estimate excludes matters for which losses could not be estimated and is not a maximum exposure. A $90 million overdraft-litigation settlement was agreed in principle, subject to documentation and court approval. An industry interchange settlement was estimated at $6.6 billion collectively; PNC expected no material financial impact.
- PNC had $59.1 billion of liquid assets, of which $22.3 billion was pledged. It reported $1.3 billion of capacity for bank dividends to the parent without prior regulatory approval and $3.2 billion of parent-company cash and investments. Funding, capital actions, and dividends remain subject to regulatory, contractual and market constraints.
- PNC raised its quarterly common dividend from $0.35 to $0.40 per share and planned up to $250 million of 2012 common-stock repurchases; about $50 million had been repurchased by June 30. It issued $1.5 billion of preferred stock and redeemed or announced redemption of approximately $1.8 billion of trust-preferred securities. Proposed Basel III rules and other regulatory changes could affect capital requirements and treatment of capital instruments.
- The planned sale of Smartstreet, acquired with RBC and carrying about $1 billion of assets and deposits, was expected to close in fall 2012, subject to conditions including regulatory approval.
Most important facts for investors to verify
- Whether elevated mortgage repurchase claims persist and whether the $462 million reserve, including the estimated additional exposure, adequately captures probable losses.
- How much of loan, deposit and revenue growth is organic versus acquisition-related, and whether RBC integration savings and the $550 million savings target are achieved.
- Whether credit quality continues to improve, taking account of purchased impaired loans, government-guaranteed delinquencies and the home-equity nonaccrual policy change.
- Whether revenue and expense guidance holds under continued low interest rates, regulatory fee constraints and potential legal or regulatory costs.
- Capital and liquidity trends after RBC, trust-preferred redemptions, planned repurchases and evolving capital rules; also confirm the Smartstreet transaction’s closing and terms.