DBRS Comments on PNC’s 4Q12 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 fourth quarter results. Reflecting considerable noise, PNC reported net income attributable to common shareholders of $664 million for 4Q12, down 24% from $876 million reported in 3Q12 but up 47% from $451 million in 4Q11.

Despite considerable noise from several non-core items, the Company’s 4Q12 performance was solid, in DBRS’s view. Importantly, PNC’s DBRS calculated adjusted income before provisions and taxes (IBPT) improved, sequentially. Furthermore, PNC’s balance sheet fundamentals were positive in the quarter, as the Company delivered both commercial and consumer loan growth. Indeed, PNC reported its sixth consecutive quarter of average loan growth, with a linked quarter increase of 1.4%. Higher commercial loans were mostly driven by increased levels of healthcare, retail/wholesale and commercial mortgage loans, while the increase in consumer loans primarily reflected higher levels of home equity and automobile loans. Supporting loan growth, deposit growth was sustained, up 1.8% (on an average basis) linked-quarter. Finally, despite the difficult business environment, asset quality continued to improve.

DBRS notes that PNC’s 4Q12 earnings were pressured by several sizable non-core items, similar to the prior quarter. Impacting revenues, the Company reported a $254 million provision for residential mortgage repurchase obligations, which is not unique to PNC, $130 million in gains on the sale of Visa Class B common shares, $45 million in net gains on the sale of securities and $15 million in net other than temporary impairments. Impacting expenses, PNC reported $91 million of expenses for residential mortgage foreclosure related matters (including a charge of approximately $70 million resulting from an agreement to amend consent orders entered into in April 2011). Furthermore, the Company reported $70 million of non-cash charges for unamortized discounts related to redemption of trust preferred securities, a $45 million goodwill impairment charge for its residential mortgage banking segment and $35 million in integration costs related to its 1Q12 purchase of RBC Bank (USA).

The outsized quarterly provision for residential mortgage repurchase obligations, which was absorbed by quarterly earnings, was driven by increased estimates for future buyback requests, spurred by additional information from Freddie-Mac and Fannie-Mae.

Importantly, PNC’s DBRS calculated adjusted IBPT increased 4.7% sequentially, driven by a 4.8% increase in adjusted revenues, which more than offset a 4.9% increase in adjusted expenses. Higher linked-quarter adjusted revenues were led by a 10.6% increase in adjusted noninterest income and to a lesser extent, a 1% increase in net interest income.

Higher adjusted noninterest income, QoQ, reflected an 18% increase in corporate service fees, a 2% increase in consumer service fees and higher revenues from commercial mortgage banking activity, private equity investments and asset sales. Improved corporate service income reflected stronger merger and acquisition advisory fees, while higher consumer services fees were attributable to customer growth, partially offset by the impact of Hurricane Sandy on customer volume and activity.

Despite the low interest rate environment, improved linked-quarter net interest income benefited from loan growth and lower funding costs. PNC’s 1.4%, or $2.5 billion increase in average loans coupled with lower liability costs, drove a 3 bps widening of net interest margin (NIM) to 3.85%.

Higher adjusted expenses were mostly driven by a 3.8% increase in personnel costs, a 6.6% increase in occupancy expenses and a 4.9% increase in equipment costs. Adjusted expense also included several lumpy costs including a $28 million contribution to the PNC Foundation and a $38 million charge, related to accrual adjustments, primarily related to deferred loan origination costs.

Despite the difficult operating environment, credit quality was sound and continued to stabilize. Specifically, nonperforming assets (NPAs) decreased 5.6% to $3.8 billion and represented 2.04% of total loans and OREO at December 31, 2012. Lower NPAs mostly reflected declines in commercial real estate and commercial & industrial nonperforming loans (NPLs). Consumer NPLs increased QoQ, driven by the recent regulatory guidance related to exposure to customers who have gone through chapter 7 bankruptcy. Meanwhile, net charge-offs decreased 6.3% to $310 million and represented a moderate 0.67% of average loans for 4Q12, down from 0.73% for 3Q12. Despite improvements in asset quality, the provision for loan losses increased 39.5% to $318 million, QoQ, driven by a larger loan portfolio and reduced reserve release in commercial lending. Notwithstanding the increase, the loan loss provision remained at a healthy 20% of IBPT. DBRS views the Company as well reserved with an allowance for loan and lease losses (ALLL) to loans ratio of 2.17%, at December 31, 2012, and an ALLL/NPL ratio of 124.0%.

PNC’s funding profile remains solid, as deposits more than amply fund loans. Importantly, average deposits grew 1.8% during 4Q12 and the mix improved, as non-interest bearing, demand, money market and savings deposits increased while time deposits declined.

Capitalization remains sound with an estimated Tier 1 common capital ratio of 9.6% and Tier 1 risk- based capital ratio of 11.7%, at December 31, 2012. PNC’s estimated proforma Basel III Tier 1 common capital ratio was 7.3%, based on the Company’s current understanding of Basel III rules. During 4Q12, the Company purchased $55 million of common stock.

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

[Amended on May the 23rd, 2014 to remove unnecessary disclosures.]