DBRS Comments on PNC’s 3Q12 Earnings – Senior at A (high) – Ratings Unchanged

DBRS, Inc. (DBRS) has today commented that its ratings for PNC Financial Services Group, Inc. (PNC or the Company), including its Issuer & Senior Debt rating of A (high) are unchanged following the release of the Company’s third quarter results. Reflecting some sizable non-core items, PNC reported net income attributable to common shareholders of $876 million for 3Q12, up 66% from $526 million in 2Q12.

Reflective of the difficult business environment, DBRS sees PNC’s 3Q12 earnings as weaker; pressured by net interest margin (NIM) contraction and slowing loan growth. Excluding non-core items, PNC’s DBRS-calculated adjusted income before provision and taxes (IBPT) declined sequentially by 7.3%, as adjusted revenues decreased by 1.5% and expenses expanded by 2.2%. Lower core revenues were attributable to lower spread income, partially offset by modestly higher core fee income.

Importantly, PNC’s balance sheet trends were positive in 3Q12. During the quarter, the Company reported sustained loan growth and asset quality continued to improve. Indeed, PNC achieved its sixth consecutive quarter of average loan growth, with a sequential increase of 1.6% in 3Q12. Higher linked-quarter loans reflected a $2.1 billion, or 2.7% increase in commercial loans and a $738 million or 1.2% increase in consumer loans.

QoQ earnings results reflected significant noise, due to multiple non-recurrent items in 3Q12 and 2Q12. During 3Q12, the Company reported an $89 million (after-tax) gain on the sale of 5 million Visa class B common shares, $61 million (after-tax) noncash charge related to the redemption of trust preferred securities, and $23 million (after tax) of integration expense related to the RBC Bank (USA) transaction. PNC also recorded a $24 million (after tax) provision for residential mortgage repurchase obligations.

Lower spread income was attributable to a 26 bps narrowing of NIM to 3.82%, partially offset by a 1.0% increase in average earning assets. The lower NIM mostly reflected a 16 bps decline in purchase accounting accretion. Additionally, the lower NIM reflected declining earning asset yields outpacing decreasing funding costs. Excluding purchase accounting accretion, the Company’s core NIM narrowed by 10 bps, QoQ, to a still sound 3.43%. Finally, higher average earning assets were attributable to the aforementioned loan growth, partially offset by a modest 0.7% decrease in securities.

During 3Q12, noninterest income benefitted from a solid 9.7% linked-quarter increase in asset management fees, driven by an increase in clients and fees and an improvement in the equity markets. Additionally, core fee income reflected a 5.5% increase in deposit service charges, attributable to customer growth and activity. Going forward, PNC expects to extract revenue synergies from cross-selling its deep product menu to customers in its newer markets.

Although up 2.2%, QoQ, core expenses were relatively well managed, as the Company continues to rationalize its cost base. Indeed, PNC is targeting to exceed $550 million in annual cost saves at legacy PNC and through integration savings at RBC Bank. At 63% efficiency (DBRS calculated), DBRS believes PNC still has room for expense improvement.

PNC’s funding profile remains solid, as deposits more than amply fund loans. Importantly, transaction deposits continue to grow, and increased 1% sequentially while retail CDs and other deposits declined by 7%. The favorable shift in deposit mix coupled with recent trust preferred redemptions should continue to reduce funding costs and benefit future NIM.

Despite the difficult business environment, PNC’s asset quality continues to improve. DBRS notes that without the impact of recent OCC guidance pertaining to accruing exposure related to consumers that have gone through a Chapter 7 bankruptcy, the Company’s non-performing loans and net charge-offs (NCOs) would have been $112 million and $83 million lower in 3Q12, respectively. Overall, non-performing assets (NPAs) declined 4% QoQ to $4.0 billion and represented 2.20% of total loans. Meanwhile NCOs increased a modest $16 million or 2 bps to $331 million, or a moderate 73 bps of average loans. DBRS continues to view PNC as well reserved with an allowance for loan and lease losses (ALLL) to loans ratio of 2.22% at the end of 3Q12 and an ALLL/NPL (excluding purchased impaired loans) ratio of 118%.

Capitalization remains sound with an estimated Basel I Tier I common capital ratio of 9.5% and Tier 1 risk-based capital ratio of 11.7% at 3Q12. With capital levels providing solid loss absorption capacity, PNC continues to target a Basel III Tier 1 Common ratio of between 8.0% and 8.5% by the end of 2013. Finally, in late 3Q12 and early 4Q12, PNC issued $480 million of preferred stock, which bolstered its Tier 1 common position.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organizations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments, Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments, and Rating Bank Preferred Shares and Equivalent Hybrids. All can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents, the Federal Deposit Insurance Corporation and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Mark Nolan
Approver: Roger Lister
Initial Rating Date: 6 April 2006
Most Recent Rating Update: 25 September 2012

For additional information on this rating, please refer to the linking document under Related Research.