PNC FINANCIAL SERVICES GROUP, INC. quarterly report, Q3 FY2015

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PNC Financial Services Group, Inc. — Third Quarter 2015 Form 10-Q

Business context and reporting period. PNC is a diversified U.S. financial services company with retail banking, corporate and institutional banking, asset management, residential mortgage banking, a BlackRock investment, and a non-strategic assets portfolio. This unaudited filing covers the quarter and nine months ended September 30, 2015; comparisons are to the same 2014 periods unless otherwise noted.

Financial performance and condition

  • Third-quarter results: Revenue was $3.775 billion, down 2%; net income was $1.073 billion, up 3%; and diluted EPS was $1.90, up from $1.79. Net income attributable to common shareholders was $991 million. Pretax, pre-provision earnings were $1.423 billion.
  • Nine-month results: Revenue was $11.372 billion, down less than 1%; net income was $3.121 billion, down 1%; and diluted EPS was $5.52, compared with $5.45. Net income attributable to common shareholders was $2.916 billion.
  • Revenue, margin and expenses: Third-quarter net interest income was $2.062 billion, down 2%, and net interest margin fell to 2.67% from 2.98%. Noninterest income was $1.713 billion, down 1% for the quarter, but rose 4% to $5.186 billion year to date. Noninterest expense was $2.352 billion for the quarter, down slightly, and $7.067 billion year to date, up 2%. The efficiency ratio was 62% for both the quarter and year to date, versus 61% in the comparable 2014 periods.
  • Credit costs and quality: Provision for credit losses was $81 million in the quarter versus $55 million, and $181 million year to date versus $221 million. Third-quarter net charge-offs were $96 million, or 0.19% of average loans annualized; nine-month net charge-offs were $266 million, or 0.17% annualized. Nonperforming assets declined to $2.490 billion from $2.880 billion at year-end 2014; the allowance for loan and lease losses was $3.237 billion, or 1.58% of loans.
  • Balance sheet and funding: At September 30, assets were $362.1 billion, loans $205.0 billion, deposits $245.0 billion, borrowed funds $56.7 billion, and shareholders’ equity $44.9 billion. Since year-end 2014, deposits rose 5%, while total loans were nearly unchanged: commercial lending grew 2% and consumer lending declined 3%. Investment securities rose 22% to $68.1 billion. Loans-to-deposits were 84%.
  • Liquidity and capital: PNC reported a Liquidity Coverage Ratio above 100% for both PNC and PNC Bank, exceeding the 2015 minimum of 80%. Liquid assets totaled $91.4 billion, including $37.7 billion of short-term investments and $53.7 billion of available-for-sale securities. The transitional Basel III common equity Tier 1 ratio was 10.6%; the estimated fully phased-in ratio was 10.1%.
  • Cash flows, nine months: Operating activities provided $3.600 billion, versus $4.580 billion in 2014; investing activities used $13.534 billion, versus $14.547 billion; financing activities provided $9.409 billion, versus $10.088 billion. Cash and due from banks decreased $525 million to $3.835 billion. Investing included $17.546 billion of purchases of available-for-sale securities; financing included $1.598 billion of treasury-stock purchases and $957 million of common and preferred dividends paid.

Material changes versus comparable periods

  • Quarterly earnings increased despite weaker net interest income and fee income, primarily because the effective tax rate fell to 20.0% from 27.4% and expenses edged lower. The tax-rate comparison included a $75 million benefit from effectively settling acquired-entity tax contingencies, partly offset by $10 million of reserves for other tax matters.
  • Lower asset yields, increased liquidity balances and lower purchase-accounting accretion pressured net interest income and margin. PNC expected 2015 purchase-accounting accretion to be approximately $180 million to $200 million below 2014.
  • Year-to-date noninterest income growth in consumer and corporate services, including treasury management, helped offset declines in net interest income. Asset management revenue benefited from a $30 million trust settlement in the second quarter.
  • Credit indicators improved overall: nonperforming assets, delinquencies and nine-month net charge-offs declined from year-end or prior-year levels. Third-quarter net charge-offs nevertheless increased year over year.
  • PNC repurchased $1.6 billion of common stock during the first nine months and redeemed $500 million of Series K preferred stock. The quarterly common dividend was raised to $0.51 per share; a further $0.51 dividend was declared for payment November 5, 2015.

Outlook, commentary, risks and unusual items

  • Management expected fourth-quarter 2015 provision for credit losses of $50 million to $100 million, noninterest expense to remain stable versus the third quarter, and full-year expenses to be approximately 1% below 2014. It expected the fourth-quarter effective tax rate to be about 26% and major fee categories to remain stable versus the third quarter.
  • Management described the balance sheet as well positioned, with strong liquidity and capital, and emphasized organic customer growth, deposit and fee growth, technology and infrastructure investment, expense management, and risk control. PNC’s stated economic outlook assumed U.S. growth near 2.5% in fourth-quarter 2015 and slowly rising short-term rates and bond yields; these are forward-looking expectations, not guarantees.
  • Interest-rate risk remains significant: PNC’s simulation showed first-year net interest income up 2.7% under a gradual 100-basis-point increase and down 0.7% under a 100-basis-point decrease. Outcomes depend on assumptions about rates, customer behavior and balance-sheet composition.
  • PNC planned to change its derecognition policy for pooled purchased-impaired consumer and residential real estate loans effective December 31, 2015. It estimated a roughly $475 million reduction to both recorded loan investment and related allowance, with no material net carrying-value or earnings effect expected.
  • Legal proceedings and regulatory inquiries remain contingencies. For disclosed legal matters, PNC estimated reasonably possible losses in excess of related accruals of up to approximately $725 million, while stating that this estimate excludes some matters and is not a maximum-loss estimate. The filing also describes mortgage repurchase exposure and other litigation; outcomes may be materially different from estimates.
  • Regulatory and industry risks include evolving capital and liquidity rules, elevated supervisory scrutiny, legal and compliance costs, interest-rate and market movements, asset quality, competition, cybersecurity and operational risks. A proposed FDIC deposit-insurance surcharge was estimated to increase PNC Bank’s quarterly assessment by about $20 million if implemented and triggered; it was not final in this filing.
  • PNC reported that disclosure controls were effective and that no third-quarter change in internal control over financial reporting materially affected, or was reasonably likely to materially affect, those controls.

Important facts for investors to verify

  • Whether net interest margin and core revenue stabilize as liquidity balances, yields and purchase-accounting accretion change.
  • Whether management meets its expense, provision, tax-rate and fee-income outlook, and how recurring performance compares with the $75 million tax benefit and other discrete items.
  • Credit trends in commercial real estate, consumer lending, purchased-impaired loans and mortgage repurchase claims; also review allowance coverage and the effects of the planned loan-pool accounting change.
  • Capital and liquidity ratios, deposit growth, funding costs, and the execution and regulatory conditions of planned dividends and share repurchases.
  • Developments in legal proceedings, regulatory inquiries and proposed rules, including whether estimated loss exposures or the proposed deposit-insurance surcharge change.