DBRS Comments on PNC’s 2Q13 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 2Q13 results. The trend on all ratings is Stable. PNC reported net income attributable to common shareholders of $1.1 billion for 2Q13, up from $938 million for 1Q13, and $526 million for 2Q12. Earnings for 2Q13 equated to 1.49% of average assets, up from 1.34% for 1Q13. PNC’s improved 2Q13 earnings on a QoQ basis, reflected lower provisions for loan loss reserves, higher gains on asset sales, higher asset valuations, and client fee income growth. Meanwhile, linked-quarter results were negatively impacted by a narrower net interest margin (NIM) and increased provisions for mortgage repurchase obligations.

Despite the difficult business environment, PNC’s balance sheet fundamentals remain solid. During 2Q13, the Company delivered sustained average loan and deposit growth, sound and improved asset quality, and enhanced capital metrics. Importantly, PNC reported its eighth consecutive quarter of average loan growth, with a 1.3% increase during 2Q13. On a period-end basis, loans were up by 1.8%, led by a 2.7% increase in commercial loans, and a more modest 0.4% increase in consumer loans. Higher commercial loans were driven by growth in asset based lending, healthcare, real estate lending and public finance related loans. Meanwhile, growth in consumer lending was driven by higher levels of home equity and automobile loans. Supporting loan growth, average deposits were up a modest 0.2% linked-quarter.

PNC’s QoQ results reflected several non-core items. During 2Q13, the Company reported $83 million of gains related to the sale of Visa Class B common shares, $57 million in gains related to the sale of securities, less net other-than-temporary-impairment charges (OTTI), and a $73 million provision for residential mortgage repurchase obligations. Additionally, 2Q13 results were impacted by a $30 million non-cash charge associated with the redemption of trust preferred securities. Meanwhile, 1Q13 results were impacted by a $4 million provision for residential mortgage repurchase obligations and $4 million of securities gains, less net OTTI charges.

On a QoQ basis, PNC’s 2Q13 DBRS calculated adjusted income before provisions and taxes (IBPT) increased 1.3%, to $1.6 billion, driven by a 1.1% increase in adjusted revenues, partially offset by a 0.9% increase in adjusted expenses. Specifically, higher linked-quarter adjusted revenues reflected an 11.0% increase in adjusted non-interest income, partially offset by a 5.5% decrease in net interest income.

The linked-quarter improvement in non-interest income was fairly broad-based. Overall, corporate services fees increased $49 million, or 17.7%, driven mostly by the impact of higher market interest rates on commercial mortgage servicing rights valuations, and increased capital market activities. Furthermore, asset management (Asset Management Group and BlackRock) fees increased by $32 million, or 10.4%, reflecting higher net securities gains. Consumer service fees were up $18 million, or 6.1%, due to a higher volume of customer-initiated transactions, including higher debit card, merchant services, brokerage, and credit card revenue. Finally, deposit service charges increased by $11.0 million, or 8.1%.

PNC’s NIM remains under pressure in light of macroeconomic headwinds. Indeed, the QoQ decline in net interest income reflected a 23 basis point narrowing of NIM to 3.58%. The narrower NIM was attributable to lower balances of investment securities, a decline in yields on both securities and loans (including the impact of interest rate swap maturities) and a lower level of purchase accounting accretion. The Company anticipates that NIM contraction will moderate in 3Q13.

PNC’s expense base continues to be well managed. Higher 2Q13 core expenses mostly reflected a $22 million, or 48.9%, increase in marketing expense and a $17 million, or 1.5%, increase in personnel expense. The increase in personnel cost was due to higher incentive compensation expenses related to increased business actively and corporate performance. During 1H13, the Company captured $600 million of its $700 million of continuous annual cost savings goal. DBRS notes that a material component of these savings is being used to offset business and infrastructure investments.

The Company’s credit quality remained sound and improved in 2Q13. Overall, nonperforming assets (NPAs) decreased $149 million, or 3.8%, to $3.8 billion and represented 1.99% of total loans and OREO at June 30, 2013, down from 2.10% at March 31, 2013. Meanwhile, 2Q13 net charge-offs (NCO) declined by $248 million or 54.3% to $208 million, and represented a relatively moderate 0.44% of average loans, down from 0.99% for 1Q13. The decrease in charge-offs was fairly broad based, however, the bulk of the decrease was in home equity exposure. DBRS notes that the material level of charge-offs during 1Q13 reflected the impact of an alignment with interagency guidance on practices for home equity loans and lines of credit. Excluding $134 million of NCOs related to the interagency guidance, the Company’s 1Q13 NCO ratio was 0.70%.

Reflecting improved asset quality, provisions for loan losses declined 33.5% to $157 million during 2Q13, and represented a moderate 10% of adjusted IBPT. For 3Q13, the Company anticipates that provisions for loan loss reserves will be between $170 million - $250 million, driven by expectations of an overall increase in credit exposure and slowdown in the pace of commercial credit quality improvement. Finally, DBRS views the Company as being well reserved with an allowance for loan and lease losses (ALLL) to loan ratio of 1.99%, and an ALLL/non-performing loan ratio of 114.0%.

PNC’s funding profile remains solid, as deposits sufficiently fund loans. During 2Q13, average deposits grew 0.2%, driven by a 0.3% increase in interest bearing deposits.

Capitalization remains sound and capital metrics improved during 2Q13. Specifically, PNC’s estimated Tier 1 common capital ratio was 10.1% (9.8% at March 31, 2013), and Tier 1 risk- based capital ratio was 12.0% (11.6% at March 31, 2013). Based on the Company’s current understanding of Basel III rules, PNC estimates its pro-forma Basel III Tier 1 common capital ratio to be 8.2%, as of June 30, 2013.

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

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