DBRS Comments on PNC’s 1Q13 Earnings – Rating 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 1Q13 results. The trend on all ratings is Stable. PNC reported net income attributable to common shareholders of $938 million for 1Q13, up 41.2% from $664 million for 4Q12 and up 22.4% from $766 million in 1Q12.

PNC’s linked-quarter results reflected multiple non-core items. During 1Q13, the Company reported a modest $10 million in other-than-temporary impairment charges (OTTI) and a $14 million gain on securities. Meanwhile, during 4Q12 non-core items included a $254 million provision for residential mortgage repurchase obligations, which was 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 OTTI. Impacting expenses in 4Q12, PNC reported $91 million of expenses for residential mortgage foreclosure related matters, a $70 million non-cash charge for unamortized discounts related to the 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).

Despite the difficult business environment, PNC’s balance sheet fundamentals remain solid. During 1Q13 the Company delivered sustained loan growth, its asset quality remained sound, and capital improved. Importantly, PNC reported its seventh consecutive quarter of average loan growth, with a linked quarter increase of 1.6%. On a period-end basis, loans were up by a more moderate 0.4%, led by a 1.0% increase in commercial loans, partially offset by a 1.0% decrease in consumer loans. Higher commercial loans were driven by PNC’s specialty lending businesses, including public finance, asset based lending, and real estate. Meanwhile, the decline in consumer loans was driven by a decrease in residential real estate, credit card and education loans. Supporting loan growth, average deposits were up 1.1% linked-quarter.

On a QoQ basis, PNC’s DBRS calculated adjusted income before provisions and taxes (IBPT) decreased 1.0%, driven by a 5.0% decrease in adjusted revenues, which more than offset a 7.5% decrease in adjusted expenses. Specifically, lower linked-quarter adjusted revenues reflected a 9.9% decrease in adjusted noninterest income and a 1.4% decrease in net interest income.

Lower QoQ adjusted noninterest income mostly reflected a 20.6% decrease in corporate service fees, a 6.3% decrease in residential mortgage banking revenue and a 9.3% decline in service charges on deposits. The decrease in corporate service fees was attributable to outsized levels of merger & acquisition advisory and capital market activity fees generated in 4Q12. Lower mortgage banking revenue was driven by lower margins and sales volumes, and the decline in service charges on deposits was related to seasonally lower customer activity.

The decline in net interest income was due to a four bps narrowing of net interest margin (NIM) to 3.81%, partially offset by a 1.0% increase in average earning assets. The narrower NIM reflected lower purchase accounting accretion. On a core basis, PNC’s NIM was stable sequentially, at 3.43%. Meanwhile, the increase in average earning assets reflected higher levels of average loans partially offset by a moderate decline in average investment securities. Finally, lower adjusted expenses were mostly driven by a 3.9% decrease in personnel costs along with a 35.7% decline in marketing cost. Lower personnel costs reflected a decrease in incentive compensation

Despite the impact of an alignment with interagency guidance on practices for home equity loans and lines of credit, the Company’s credit quality remains sound. Overall, nonperforming assets (NPAs) increased $133 million, or 3.5%, to $3.9 billion and represented 2.10% of total loans and OREO at March 31, 2013, up slightly from 2.04% at December 31, 2012. DBRS notes that approximately $426 million of non-performing loans were related to the adoption of the policy to classify performing second lien consumer loans as non-performing when the first lien is 90 days or more past due. Meanwhile, 1Q13 net charge-offs increased 47.1% sequentially to $456 million, and represented a somewhat elevated 0.99% of average loans, up from 0.67% for 4Q12. The increase in NCOs was fairly broad based across most loan segments. However, the bulk of the increase was in home equity and commercial real estate loans. Excluding $134 million of NCOs related to the before mentioned interagency guidance, the Company’s 1Q13 NCO ratio was 0.70%. Positively, criticized commercial loans and early stage delinquencies continued to contract, indicating stabilizing asset quality.

Finally, the provision for loan losses decreased 25.8%, QoQ, to $236 million, and represented a moderate 15% of adjusted IBPT. DBRS views the Company as well reserved with an allowance for loan and lease losses (ALLL) to loans ratio of 2.05%, and an ALLL/NPL ratio of 112.0%.

PNC’s funding profile remains solid, as deposits easily fund loans. During 1Q13, average deposits grew 1.1%. Meanwhile on a period-end basis, deposits declined by 0.7% sequentially, driven by a 7.6% decrease in non-interest bearing deposits, partially offset by a 2.7% increase in interest bearing deposits.

Capitalization remains sound and improved during the quarter from retained earnings. Specifically, PNC had an estimated Tier 1 common capital ratio of 9.8% and Tier 1 risk- based capital ratio of 11.7%, at March 31, 2013. Based on the Company’s current understanding of Basel III rules, PNC estimates its proforma Basel III Tier 1 common capital ratio to be 7.9%, without the benefit of phase-ins.

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

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