UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
For the quarterly period ended March 31, 2015
or
For the transition period from to
Commission file number 001-09718
The PNC Financial Services Group, Inc.
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
One PNC Plaza, 249 Fifth Avenue, Pittsburgh, Pennsylvania 15222-2707
(Address of principal executive offices, including zip code)
(412) 762-2000
(Registrant’s telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of April 24, 2015, there were 517,920,355 shares of the registrant’s common stock ($5 par value) outstanding.
THE PNC FINANCIAL SERVICES GROUP, INC.
Cross-Reference Index to First Quarter 2015 Form 10-Q
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Income Statement
Consolidated Statement of Comprehensive Income
Consolidated Balance Sheet
Consolidated Statement Of Cash Flows
Notes To Consolidated Financial Statements (Unaudited)
Note 1 Accounting Policies
Note 2 Loan Sale and Servicing Activities and Variable Interest Entities
Note 3 Asset Quality
Note 4 Purchased Loans
Note 5 Allowances for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit
Note 6 Investment Securities
Note 7 Fair Value
Note 8 Goodwill and Intangible Assets
Note 9 Capital Securities of a Subsidiary Trust and Perpetual Trust Securities
Note 10 Certain Employee Benefit And Stock Based Compensation Plans
Note 11 Financial Derivatives
Note 12 Earnings Per Share
Note 13 Total Equity And Other Comprehensive Income
Note 14 Income Taxes
Note 15 Legal Proceedings
Note 16 Commitments and Guarantees
Note 17 Segment Reporting
Note 18 Subsequent Events
Statistical Information (Unaudited)
Average Consolidated Balance Sheet And Net Interest Analysis
Transitional Basel III and Pro forma Fully Phased-In Basel III Common Equity Tier 1 Capital Ratios – 2014 Periods
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A)
Financial Review
Consolidated Financial Highlights
Executive Summary
Consolidated Income Statement Review
Consolidated Balance Sheet Review
Off-Balance Sheet Arrangements And Variable Interest Entities
Fair Value Measurements
Business Segments Review
Critical Accounting Estimates and Judgments
Status Of Qualified Defined Benefit Pension Plan
Recourse And Repurchase Obligations
Risk Management
Internal Controls And Disclosure Controls And Procedures
Glossary Of Terms
Cautionary Statement Regarding Forward-Looking Information
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
Item 1A. RiskFactors
Item 2. Unregistered Sales Of Equity Securities And Use Of Proceeds
Item 6. Exhibits
Exhibit Index
Corporate Information
Signature
Cross-Reference Index to First Quarter 2015 Form 10-Q (continued)
MD&A TABLE REFERENCE
Table
Description
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40
41
42
43
44
45
46
47
48
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS TABLE REFERENCE
50
51
52
53
54
55
56
57
58
59
60
61
62
63
64
65
66
67
68
69
70
71
72
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
93
94
95
96
97
98
99
100
101
102
103
104
105
106
107
108
109
110
111
112
113
114
115
116
117
118
119
FINANCIAL REVIEW
This Financial Review, including the Consolidated Financial Highlights, should be read together with our unaudited Consolidated Financial Statements and unaudited Statistical Information included elsewhere in this Report and with Items 6, 7, 8 and 9A of our 2014 Annual Report on Form 10-K (2014 Form 10-K). We have reclassified certain prior period amounts to conform with the current period presentation, which we believe is more meaningful to readers of our consolidated financial statements. For information regarding certain business, regulatory and legal risks, see the following sections as they appear in this Report and in our 2014 Form 10-K: the Risk Management and Recourse And Repurchase Obligations sections of the Financial Review portion of this Report and of Item 7 of our 2014 Form 10-K, respectively; Item 1A Risk Factors included in our 2014 Form 10-K; and the Legal Proceedings and Commitments and Guarantees Notes of the Notes To Consolidated Financial Statements included in the respective report. Also, see the Cautionary Statement Regarding Forward-Looking Information section in this Financial Review and the Critical Accounting Estimates And Judgments section in this Financial Review and in our 2014 Form 10-K for certain other factors that could cause actual results or future events to differ, perhaps materially, from historical performance and from those anticipated in the forward-looking statements included in this Report. See Note 17 Segment Reporting in the Notes To Consolidated Financial Statements included in Part I, Item 1 of this Report for a reconciliation of total business segment earnings to total PNC consolidated net income as reported on a GAAP basis.
Table 1: Consolidated Financial Highlights
Dollars in millions, except per share data
Unaudited
Financial Results (a)
Revenue
Net interest income
Noninterest income
Total revenue
Noninterest expense
Pretax, pre-provision earnings (b)
Provision for credit losses
Income before income taxes and noncontrolling interests
Net income
Less:
Net income (loss) attributable to noncontrolling interests
Preferred stock dividends and discount accretion and redemptions
Net income attributable to common shareholders
Dividends and undistributed earnings allocated to nonvested restricted shares
Impact of BlackRock earnings per share dilution
Net income attributable to diluted common shares
Diluted earnings per common share
Cash dividends declared per common share
Performance Ratios
Net interest margin (c)
Noninterest income to total revenue
Efficiency
Return on:
Average common shareholders’ equity
Average assets
See page 49 for a glossary of certain terms used in this Report.
The PNC Financial Services Group, Inc. – Form 10-Q 1
Table 1: Consolidated Financial Highlights (Continued) (a)
Balance Sheet Data (dollars in millions, except per share data)
Assets
Loans
Allowance for loan and lease losses
Interest-earning deposits with banks (b)
Investment securities
Loans held for sale
Goodwill
Mortgage servicing rights
Equity investments (c)
Other assets
Noninterest-bearing deposits
Interest-bearing deposits
Total deposits
Transaction deposits
Borrowed funds
Total shareholders’ equity
Common shareholders’ equity
Accumulated other comprehensive income
Book value per common share
Common shares outstanding (millions)
Loans to deposits
Client Investment Assets (billions)
Discretionary client assets under management
Nondiscretionary client assets under administration
Total client assets under administration
Brokerage account client assets
Total
Capital Ratios
Transitional Basel III (d) (e)
Common equity Tier 1
Tier 1 risk-based
Total capital risk-based
Leverage
Pro forma Fully Phased-In Basel III (e)
Common shareholders’ equity to assets
Asset Quality
Nonperforming loans to total loans
Nonperforming assets to total loans, OREO and foreclosed assets
Nonperforming assets to total assets
Net charge-offs to average loans (for the three months ended) (annualized)
Allowance for loan and lease losses to total loans
Allowance for loan and lease losses to nonperforming loans (f)
Accruing loans past due 90 days or more (in millions)
2 The PNC Financial Services Group, Inc. – Form 10-Q
EXECUTIVE SUMMARY
The PNC Financial Services Group, Inc. (PNC) is one of the largest diversified financial services companies in the United States and is headquartered in Pittsburgh, Pennsylvania.
We have businesses engaged in retail banking, corporate and institutional banking, asset management and residential mortgage banking, providing many of our products and services nationally, as well as other products and services in our primary geographic markets located in Pennsylvania, Ohio, New Jersey, Michigan, Illinois, Maryland, Indiana, North Carolina, Florida, Kentucky, Washington, D.C., Delaware, Virginia, Alabama, Missouri, Georgia, Wisconsin and South Carolina. We also provide certain products and services internationally.
Key Strategic Goals
At PNC we manage our company for the long term. We are focused on the fundamentals of growing customers, loans, deposits and fee revenue and improving profitability, while investing for the future and managing risk, expenses and capital. We continue to invest in our products, markets and brand, and embrace our corporate responsibility to the communities where we do business.
We strive to expand and deepen customer relationships by offering a broad range of deposit, fee-based and credit products and services. We are focused on delivering those products and services where, when and how our customers choose with the goal of offering insight that addresses their specific needs. Our approach is concentrated on organically growing and deepening client relationships that meet our risk/return measures. Our strategies for growing fee income across our lines of business are focused on achieving deeper market penetration and cross selling our diverse product mix.
Our strategic priorities are designed to enhance value over the long term. A key priority is to drive growth in acquired and underpenetrated geographic markets, including in the Southeast. In addition, we are seeking to attract more of the investable assets of new and existing clients. PNC is focused on transforming our retail banking business to a more customer-centric and sustainable model while lowering delivery costs as customer banking preferences evolve. We are also working to build a stronger residential mortgage banking business with the goal of becoming the provider of choice for our customers. Additionally, we continue to focus on expense management while investing in technology and business infrastructure and streamlining our processes.
Our capital priorities are to support client growth and business investment, maintain appropriate capital in light of economic uncertainty and the Basel III framework and return excess capital to shareholders, in accordance with the capital plan included in our 2015 Comprehensive Capital Analysis and
Review (CCAR) submission to the Board of Governors of the Federal Reserve System (Federal Reserve). New regulatory short-term liquidity standards became effective for PNC and PNC Bank, National Association (PNC Bank) beginning January 1, 2015. For more detail, see the Balance Sheet, Liquidity and Capital Highlights portion of this Executive Summary, the Capital portion of the Consolidated Balance Sheet Review section and the Liquidity Risk Management portion of the Risk Management section of this Financial Review and the Supervision and Regulation section in Item 1 Business of our 2014 Form 10-K.
PNC faces a variety of risks that may impact various aspects of our risk profile from time to time. The extent of such impacts may vary depending on factors such as the current economic, political and regulatory environment, merger and acquisition activity and operational challenges. Many of these risks and our risk management strategies are described in more detail in our 2014 Form 10-K and elsewhere in this Report.
Recent Market and Industry Developments
There have been numerous legislative and regulatory developments and significant changes in the competitive landscape of our industry over the last several years. The United States and other governments have undertaken major reform of the regulation of the financial services industry, including engaging in new efforts to impose requirements designed to strengthen the stability of the financial system and protect consumers and investors. The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), enacted in July 2010, mandates the most wide-ranging overhaul of financial industry regulation in decades. Many parts of the law are now in effect, and others are now in the implementation stage, which is likely to continue for several years. We expect to face additional regulation of our industry as a result of Dodd-Frank as well as other current and future initiatives intended to enhance the regulation of financial services companies, the stability of the financial system, the protection of consumers and investors, and the liquidity and solvency of financial institutions and markets. We also expect the scrutiny from our supervisors in the examination process and the enforcement of laws and regulations on both the federal and state levels to remain at elevated levels. Compliance with new regulations will increase our costs and reduce our revenue. Some new regulations may limit our ability to pursue certain desirable business opportunities.
On March 11, 2015, the Federal Reserve announced the results of its 2015 CCAR exercise. As we announced on that date, the Federal Reserve accepted the capital plan that PNC submitted in January 2015 and did not object to the capital actions included in that plan. See the Capital portion of the Consolidated Balance Sheet Review section of this Financial Review. Of the 30 other bank holding companies participating in 2015 CCAR, the Federal Reserve announced that it did not
The PNC Financial Services Group, Inc. – Form 10-Q 3
object to the capital plans of 27 other bank holding companies, provided a conditional non-objection to the capital plan of one bank holding company based on qualitative grounds and objected to the capital plans of two other bank holding companies also for qualitative reasons.
For additional information concerning recent legislative and regulatory developments, as well as certain governmental, legislative and regulatory inquiries and investigations that may affect PNC, please see the Supervision and Regulation section of Item 1 Business, Item 1A Risk Factors, and Note 21 Legal Proceedings and Note 22 Commitments and Guarantees in the Notes To Consolidated Financial Statements in Item 8 of our 2014 Form 10-K, as well as Note 15 Legal Proceedings and Note 16 Commitments and Guarantees in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report.
Key Factors Affecting Financial Performance
Our financial performance is substantially affected by a number of external factors outside of our control, including the following:
General economic conditions, including the continuity, speed and stamina of the current U.S. economic expansion in general and on our customers in particular,
The monetary policy actions and statements of the Federal Reserve and the Federal Open Market Committee (FOMC),
The level of, and direction, timing and magnitude of movement in, interest rates and the shape of the interest rate yield curve,
The functioning and other performance of, and availability of liquidity in, the capital and other financial markets,
Loan demand, utilization of credit commitments and standby letters of credit, and asset quality,
Customer demand for non-loan products and services,
Changes in the competitive and regulatory landscape and in counterparty creditworthiness and performance as the financial services industry restructures in the current environment,
The impact of the extensive reforms enacted in the Dodd-Frank legislation and other legislative, regulatory and administrative initiatives and actions, including those outlined elsewhere in this Report, in our 2014 Form 10-K and in our other SEC filings, and
The impact of market credit spreads on asset valuations.
In addition, our success will depend upon, among other things:
Focused execution of strategic priorities for organic customer growth opportunities,
Further success in growing profitability through the acquisition and retention of customers and deepening relationships,
Driving growth in acquired and underpenetrated geographic markets, including our Southeast markets,
Our ability to effectively manage PNC’s balance sheet and generate net interest income,
Revenue growth from fee income and our ability to provide innovative and valued products to our customers,
Our ability to utilize technology to develop and deliver products and services to our customers and protect PNC’s systems and customer information,
Our ability to bolster our critical infrastructure and streamline our core processes,
Our ability to manage and implement strategic business objectives within the changing regulatory environment,
A sustained focus on expense management,
Managing our credit risk in our portfolio,
Managing the non-strategic assets portfolio and impaired assets,
Continuing to maintain and grow our deposit base as a low-cost funding source,
Prudent risk, liquidity and capital management related to our efforts to manage risk to acceptable levels and to meet evolving regulatory capital, capital planning, stress testing and liquidity standards,
Actions we take within the capital and other financial markets,
The impact of legal and regulatory-related contingencies, and
The appropriateness of reserves needed for critical accounting estimates and related contingencies.
For additional information, please see the Cautionary Statement Regarding Forward-Looking Information section in this Financial Review and Item 1A Risk Factors in our 2014 Form 10-K.
Income Statement Highlights
Net income for the first quarter of 2015 was $1.0 billion, or $1.75 per diluted common share, compared to $1.1 billion, or $1.82 per diluted common share for the first quarter of 2014. Net income decreased $56 million in the comparison, as a 4% increase in noninterest expense and a 1% decrease in revenue were partially offset by lower provision for credit losses. Lower revenue in the comparison reflected a 6% decline in net interest income, which was partially offset by a 5% increase in noninterest income. For additional detail, see the Consolidated Income Statement Review section in this Financial Review.
4 The PNC Financial Services Group, Inc. – Form 10-Q
Net interest income of $2.1 billion for the first quarter of 2015 decreased 6% compared with the first quarter of 2014, primarily driven by lower loan yields and a reduction in purchase accounting accretion, partially offset by commercial and commercial real estate loan growth.
Net interest margin decreased to 2.82% for the first quarter of 2015 compared to 3.26% for the first quarter of 2014. The decline was principally due to the impact of balance sheet management activities related to regulatory short-term liquidity standards, lower loan yields and lower benefit from purchase accounting accretion.
Noninterest income of $1.7 billion for the first quarter of 2015 increased 5% compared to the first quarter of 2014, due to strong client fee income growth and higher net securities gains, partially offset by the impact of a gain on sale of Visa Class B common shares in the prior year quarter.
The provision for credit losses decreased to $54 million for the first quarter of 2015 compared to $94 million for the first quarter of 2014 reflecting overall credit quality improvement.
Noninterest expense of $2.3 billion for the first quarter of 2015 increased 4% compared with the first quarter of 2014, primarily related to PNC’s investments in technology and business infrastructure in support of its strategic priorities and higher personnel expense, partially offset by lower legal and residential mortgage compliance costs.
Credit Quality Highlights
Overall credit quality for the first quarter of 2015 improved modestly compared with the fourth quarter of 2014. For additional detail, see the Credit Risk Management portion of the Risk Management section of this Financial Review.
Nonperforming assets decreased $.1 billion, or 4%, to $2.8 billion at March 31, 2015 compared to December 31, 2014. Nonperforming assets to total assets were 0.78% at March 31, 2015, compared to 0.83% at December 31, 2014.
Overall loan delinquencies of $1.8 billion at March 31, 2015 decreased $.2 billion, or 10%, compared with December 31, 2014.
The allowance for loan and lease losses was 1.61% of total loans and 137% of nonperforming loans at March 31, 2015, compared with 1.63% and 133% at December 31, 2014, respectively.
Net charge-offs of $103 million for the first quarter of 2015 were down 45% compared to net charge-offs of $186 million for the first quarter of 2014. Annualized net charge-offs were 0.20% of average loans in the first quarter of 2015 and 0.38% of average loans in the first quarter of 2014.
Balance Sheet, Liquidity and Capital Highlights
Total loans decreased by $.1 billion to $205 billion at March 31, 2015 compared to December 31, 2014, as loan activity declined from higher fourth quarter levels.
Total commercial lending increased by $1.3 billion, or 1%, as a result of increases in commercial and commercial real estate loans.
Total consumer lending decreased $1.4 billion, or 2%, due to declines in home equity, automobile, education and credit card loans. Of the decline in consumer lending, $.3 billion, or 21% of the decline, related to non-strategic loans.
Investment securities increased by $4.9 billion, or 9%, during the first quarter to $61 billion at March 31, 2015, primarily funded by deposit growth.
Total deposits increased by $4.3 billion, or 2%, to $237 billion at March 31, 2015 compared with December 31, 2014, driven by higher retail deposits.
PNC’s well-positioned balance sheet remained core funded with a loans to deposits ratio of 87% at March 31, 2015.
PNC maintained a strong liquidity position.
New regulatory short-term liquidity standards became effective for PNC and PNC Bank as advanced approaches banking organizations beginning January 1, 2015, with a minimum phased-in Liquidity Coverage Ratio requirement of 80% in 2015, calculated as of month end.
The Liquidity Coverage Ratio at March 31, 2015 exceeded 100% for both PNC and PNC Bank.
PNC maintained a strong capital position.
The Transitional Basel III common equity Tier 1 capital ratio was 10.5% at March 31, 2015 and 10.9% at December 31, 2014, calculated using the regulatory capital methodologies applicable to PNC during 2015 and 2014, respectively.
Pro forma fully phased-in Basel III common equity Tier 1 capital ratio was an estimated 10.0% at March 31, 2015 and 10.0% at December 31, 2014 based on the standardized approach rules. See the Capital discussion and Table 18 in the Consolidated Balance Sheet Review section of this Financial Review and the December 31, 2014 capital ratio tables in the Statistical Information (Unaudited) section of this Report for more detail.
PNC returned capital to shareholders.
In the first quarter of 2015, in accordance with PNC’s 2014 capital plan and under the share repurchase authorization in effect during that period, we repurchased 4.4 million shares of common stock on the open market, with an
The PNC Financial Services Group, Inc. – Form 10-Q 5
average price of $89.48 per share and an aggregate repurchase price of $.4 billion.
These first quarter 2015 repurchases completed PNC’s common stock repurchase program for the four quarter period that began in second quarter 2014 with total repurchases of 17.3 million common shares for $1.5 billion.
In connection with the 2015 CCAR, PNC submitted its 2015 capital plan, as approved by its Board of Directors, to the Federal Reserve in January 2015. As we announced on March 11, 2015, the Federal Reserve accepted the capital plan and did not object to our proposed capital actions, which included the new share repurchase programs and dividend increase discussed below.
In March 2015, PNC announced new share repurchase programs of up to $2.875 billion for the five quarter period beginning in the second quarter of 2015. See the Capital portion of the Consolidated Balance Sheet review of this Financial Review for more detail on these share repurchase programs.
In April 2015, the Board of Directors raised the quarterly dividend on common stock to 51 cents per share, an increase of 3 cents per share, or 6 percent, effective with the May dividend.
On May 4, 2015, we redeemed $500 million of PNC’s Fixed-to-Floating Rate Non-Cumulative Perpetual Preferred Stock, Series K, as well as all Depositary Shares representing interests therein. Each Depositary Share represented a 1/10 interest in a share of the Series K Preferred Stock. All 50,000 shares of Series K Preferred Stock, as well as all 500,000 Depositary Shares representing interests therein, were redeemed. The redemption price was $10,000 per share of Series K Preferred Stock equivalent to $1,000 per Depositary Share, plus declared and unpaid dividends to but excluding the redemption date.
Our Consolidated Income Statement and Consolidated Balance Sheet Review sections of this Item 7 describe in greater detail the various items that impacted our results during the first three months of 2015 and 2014 and balances at March 31, 2015 and December 31, 2014, respectively.
Our ability to take certain capital actions, including plans to pay or increase common stock dividends or to repurchase shares under current or future programs, is subject to the results of the supervisory assessment of capital adequacy undertaken by the Federal Reserve as part of the CCAR process.
See the Capital portion of the Consolidated Balance Sheet Review and the Liquidity Risk Management portion of the Risk Management section of this Financial Review for more detail on our 2015 capital and liquidity actions.
Average Consolidated Balance Sheet Highlights
Table 2: Summarized Average Balance Sheet
Three months ended March 31
Dollars in millions
Interest-earning assets
Interest-earning deposits with banks
Other
Total interest-earning assets
Noninterest-earning assets
Total average assets
Average liabilities and equity
Interest-bearing liabilities
Total interest-bearing liabilities
Other liabilities
Equity
Total average liabilities and equity
Average balances are generally indicative of underlying business trends apart from the impact of acquisitions and divestitures, while various seasonal and other factors can impact period-end balances. The Consolidated Balance Sheet Review section of this Financial Review provides information on changes in selected Consolidated Balance Sheet categories at March 31, 2015 compared with December 31, 2014. Total assets were $351.0 billion at March 31, 2015 compared with $345.1 billion at December 31, 2014.
Average investment securities declined in the first three months of 2015 compared with the first three months of 2014, due to a decrease in average residential mortgage-backed securities. Total investment securities comprised 19% of average interest-earning assets for the first quarter of 2015 and 21% for the first quarter of 2014.
6 The PNC Financial Services Group, Inc. – Form 10-Q
Average total loans increased in the first quarter of 2015 compared to the prior year quarter, driven by increases in average commercial loans of $8.3 billion and average commercial real estate loans of $2.3 billion, which were due to growth primarily in Corporate Banking, Real Estate and Business Credit in our Corporate & Institutional Banking segment. Average consumer loans decreased $1.6 billion.
Average loans represented 68% of average interest-earning assets for the first quarter of 2015 and 71% of average interest-earning assets for the first quarter of 2014.
Average interest-earning deposits with banks, which are primarily maintained with the Federal Reserve Bank, increased in the first quarter of 2015 compared to first quarter 2014, reflecting higher balances maintained on deposit with the Federal Reserve Bank in part due to regulatory short-term liquidity standards phased in starting January 1, 2015.
The increase in average noninterest-earning assets for the first three months of 2015 compared to the first three months of 2014 was driven primarily by higher accounts receivable from trade date securities sales and available-for-sale securities valuations, both of which are included in noninterest-earning assets for average balance sheet purposes, and an increase in trading assets, primarily net derivatives.
Average total deposits increased $14.7 billion in the first quarter of 2015 compared with the prior year quarter, primarily due to an increase of $15.0 billion in average transaction deposits, which grew to $199.3 billion for the first quarter of 2015. Growth in both our Retail Banking and Corporate & Institutional Banking segments drove the increase in average
transaction deposits. These increases were partially offset by a decrease of $2.0 billion in average retail certificates of deposit attributable to run-off of maturing accounts.
Average total deposits represented 67% of average total assets for the first quarter of 2015 and 68% for the first quarter of 2014.
The increase in average borrowed funds in the current year first quarter compared with the prior year first quarter was primarily due to increases in average Federal Home Loan Bank (FHLB) borrowings and average bank notes and senior debt, partially offset by a decline in average federal funds purchased and repurchase agreements. The Liquidity Risk Management portion of the Risk Management section of this Financial Review includes additional information regarding our sources and uses of borrowed funds.
Business Segment Highlights
The Business Segments Review section of this Financial Review includes further analysis of our business segment results over the first three months of 2015 and 2014 including presentation differences from Note 17 Segment Reporting in our Notes To Consolidated Financial Statements in Part I, Item 1 of this Report. Note 17 Segment Reporting presents results of businesses for the first three months of 2015 and 2014.
We provide a reconciliation of total business segment earnings to PNC total consolidated net income as reported on a GAAP basis in Note 17 Segment Reporting in our Notes To Consolidated Financial Statements of this Report.
Table 3: Results Of Businesses – Summary (a)
(Unaudited)
Retail Banking
Corporate & Institutional Banking
Asset Management Group
Residential Mortgage Banking
BlackRock
Non-Strategic Assets Portfolio
Total business segments
Other (c) (d) (e)
The PNC Financial Services Group, Inc. – Form 10-Q 7
CONSOLIDATED INCOME STATEMENTREVIEW
Our Consolidated Income Statement is presented in Part I, Item 1 of this Report.
Net income for the first three months of 2015 was $1.0 billion, a decrease of 5% compared with $1.1 billion for the first three months of 2014. The decrease was driven by a 4% increase in noninterest expense and a 1% decrease in revenue, partially offset by lower provision for credit losses. Lower revenue in the comparison reflected a 6% decline in net interest income, which was partially offset by a 5% increase in noninterest income.
Net Interest Income
Table 4: Net Interest Income and Net Interest Margin
Net interest margin
Changes in net interest income and margin result from the interaction of the volume and composition of interest-earning assets and related yields, interest-bearing liabilities and related rates paid, and noninterest-bearing sources of funding. See the Statistical Information (Unaudited) – Average Consolidated Balance Sheet And Net Interest Analysis section of this Report and the discussion of purchase accounting accretion on purchased impaired loans in the Consolidated Balance Sheet Review section of this Financial Review for additional information.
Net interest income decreased by $123 million, or 6%, in the first quarter of 2015 compared with the first quarter of 2014 reflecting the ongoing low rate environment. Lower loan yields and a reduction in purchase accounting accretion were partially offset by commercial and commercial real estate loan growth. The decline in net interest income also included the impact from the second quarter 2014 correction to reclassify certain commercial facility fees from net interest income to noninterest income.
Net interest margin decreased in the comparison to the prior year quarter, driven by a 43 basis point decline in the yield on total interest-earning assets, which was principally due to the impact of balance sheet management activities related to regulatory short-term liquidity standards, lower loan yields and lower benefit from purchase accounting accretion. The decline also included the impact of the second quarter 2014 correction to reclassify certain commercial facility fees.
In the second quarter of 2015, we expect net interest income to remain stable compared with the first quarter of 2015.
For full year 2015, we expect purchase accounting accretion to be down approximately $225 million compared to 2014. Further, full year revenues are expected to remain under pressure as the delay in expected interest rate increases will make growing core net interest income (net interest income exclusive of purchase accounting accretion) that much more difficult.
Noninterest Income
Table 5: Noninterest Income
Asset management
Consumer services
Corporate services
Residential mortgage
Service charges on deposits
Net gains on sales of securities
Net other-than-temporary impairments
Total noninterest income
Noninterest income increased during the first quarter of 2015 compared to first quarter of 2014, reflecting strong client fee income growth and higher net securities gains, partially offset by the impact of a gain on sale of Visa Class B common shares in the prior year quarter. Noninterest income as a percentage of total revenue was 44% in the first quarter of 2015, up from 42% in the first quarter of 2014.
Higher asset management revenue in the first three months of 2015 was driven by increased earnings from our BlackRock investment, as well as stronger average equity markets and positive net flows, after adjustments for cyclical client activities. Discretionary client assets under management grew to $136 billion at March 31, 2015 compared with $130 billion at March 31, 2014.
Consumer service fees increased in the first quarter of 2015 compared to the prior year quarter primarily due to higher customer-initiated transaction volumes.
Corporate services revenue increased in the first quarter of 2015 compared to the first quarter of 2014, principally due to the impact of the second quarter 2014 correction to reclassify certain commercial facility fees from net interest income to noninterest income, an increase in treasury management fees and higher net hedging gains on commercial mortgage servicing rights, partially offset by lower mergers and acquisition advisory fees.
8 The PNC Financial Services Group, Inc. – Form 10-Q
Residential mortgage fee revenue increased slightly in the first three months of 2015 compared to the prior year quarter, as higher net hedging gains on residential mortgage servicing rights were substantially offset by lower servicing fee revenue.
Service charges on deposits increased in the first quarter of 2015 compared to the prior year quarter, benefitting from changes in product offerings and higher customer-related activity.
Other noninterest income declined in the first quarter of 2015 compared to the prior year quarter primarily due to the impact of the first quarter 2014 gain on sale of 1 million Visa Class B common shares partially offset by higher customer-related trading revenue. As of March 31, 2015, we held approximately 7 million Visa Class B common shares with a fair value of approximately $740 million and a recorded investment of approximately $77 million.
Other noninterest income typically fluctuates from period to period depending on the nature and magnitude of transactions completed. Further details regarding our customer-related trading activities are included in the Market Risk Management – Customer-Related Trading Risk portion of the Risk Management section of this Financial Review. Further details regarding private and other equity investments are included in the Market Risk Management – Equity And Other Investment Risk section, and further details regarding gains or losses related to our equity investment in BlackRock are included in the Business Segments Review section.
In the second quarter of 2015, we expect the fee income categories of noninterest income (asset management, consumer services, corporate services, residential mortgage and service charges on deposits) to be up low single digits, on a percentage basis, compared to the first quarter of 2015, reflecting our continued focus on our strategic priorities.
Provision For Credit Losses
The provision for credit losses totaled $54 million for the first quarter of 2015 compared with $94 million for the first quarter of 2014. The decline in provision reflected overall credit quality improvement since the first quarter of 2014.
We expect our provision for credit losses in the second quarter of 2015 to be between $50 million and $100 million.
The Credit Risk Management portion of the Risk Management section of this Financial Review includes additional information regarding factors impacting the provision for credit losses.
Noninterest Expense
Noninterest expense increased $85 million, or 4%, to $2.3 billion for the first quarter of 2015 compared with first quarter 2014, primarily related to PNC’s investments in technology and business infrastructure in support of its strategic priorities and higher personnel expense, partially offset by lower legal and residential mortgage compliance costs.
In the first quarter of 2015 we have captured savings of more than 30 percent of our 2015 continuous improvement savings goal of $400 million, and we expect to achieve the full-year goal. We intend to fund our business and technology investments with the cost savings.
In the second quarter of 2015, we expect noninterest expense to be up low single digits, on a percentage basis, compared to the first quarter of 2015, due to the expected impact of seasonality as second quarter expenses typically increase compared to the first quarter.
For full year 2015, we expect noninterest expense to be stable compared to 2014.
Effective Income Tax Rate
The effective income tax rate was 24.4% in the first quarter of 2015 compared with 25.3% in the first quarter of 2014. The effective tax rate is generally lower than the statutory rate primarily due to tax credits PNC receives from our investments in low income housing and new markets investments, as well as earnings in other tax exempt investments.
We expect our 2015 effective tax rate to be approximately 25%.
The PNC Financial Services Group, Inc. – Form 10-Q 9
CONSOLIDATED BALANCE SHEETREVIEW
Table 6: Summarized Balance Sheet Data
March 31
2015
December 31
2014
Other intangible assets
Other, net
Total assets
Liabilities
Deposits
Total liabilities
Noncontrolling interests
Total equity
Total liabilities and equity
The summarized balance sheet data above is based upon our Consolidated Balance Sheet in Part 1, Item 1 of this Report.
The increase in total assets was primarily due to higher investment securities balances and an increase in other assets partially offset by lower deposit balances maintained with the Federal Reserve Bank. The increase in investment securities was primarily funded by deposit growth while other assets increased due to accounts receivable from trade date securities sales. The increase in liabilities was largely due to growth in deposits and a rise in other liabilities due to accounts payable from trade date securities purchased, while borrowed funds remained relatively stable. An analysis of changes in selected balance sheet categories follows.
Outstanding loan balances of $204.7 billion at March 31, 2015 and $204.8 billion at December 31, 2014 were net of unearned income, net deferred loan fees, unamortized discounts and premiums, and purchase discounts and premiums totaling $1.6 billion at March 31, 2015 and $1.7 billion at December 31, 2014, respectively. The balances include purchased impaired loans but do not include future accretable net interest (i.e., the difference between the undiscounted expected cash flows and the carrying value of the loan) on those loans.
10 The PNC Financial Services Group, Inc. – Form 10-Q
Table 7: Details Of Loans
Commercial lending
Commercial
Retail/wholesale trade
Manufacturing
Service providers
Real estate related (a)
Financial services
Health care
Other industries
Total commercial
Commercial real estate
Real estate projects (b)
Commercial mortgage
Total commercial real estate
Equipment lease financing
Total commercial lending (c)
Consumer lending
Home equity
Lines of credit
Installment
Total home equity
Residential real estate
Residential construction
Total residential real estate
Credit card
Other consumer
Education
Automobile
Total consumer lending
Total loans
The slight decline in loans was driven by a decrease in total consumer lending resulting from lower home equity, automobile, education and credit card loans, offset by an increase in total commercial lending driven by commercial real estate projects.
Loans represented 58% of total assets at March 31, 2015 and 59% at December 31, 2014. Commercial lending represented 63% of the loan portfolio at both March 31, 2015 and December 31, 2014. Consumer lending represented 37% of the loan portfolio at both March 31, 2015 and December 31, 2014.
Commercial real estate loans represented 12% of total loans at March 31, 2015 and 11% of total loans at December 31, 2014 and represented 7% of total assets at both March 31, 2015 and December 31, 2014. See the Credit Risk Management portion of the Risk Management section of this Financial Review for additional information regarding our loan portfolio.
Total loans above include purchased impaired loans of $4.7 billion, or 2% of total loans, at March 31, 2015, and $4.9 billion, or 2% of total loans, at December 31, 2014.
Our loan portfolio continued to be diversified among numerous industries, types of businesses and consumers across our principal geographic markets.
The PNC Financial Services Group, Inc. – Form 10-Q 11
Allowance for Loan and Lease Losses (ALLL)
Information regarding our higher risk loans and ALLL is included in the Credit Risk Management portion of the Risk Management section of this Financial Review and Note 1 Accounting Policies, Note 3 Asset Quality and Note 5 Allowances for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit in our Notes To Consolidated Financial Statements included in Part 1, Item 1 of this Report.
Purchase Accounting Accretion and Valuation of Purchased Impaired Loans
Information related to purchase accounting accretion and accretable yield for the first three months of 2015 and 2014 follows. Additional information on our policies for ALLL for purchased impaired loans is provided in Note 1 Accounting Policies in the Notes To Consolidated Financial Statements of this Report. A description of our purchased impaired loan accounting and loan data is included in Note 4 Purchased Loans in the Notes To Consolidated Financial Statements of this Report.
Table 8: Accretion – Purchased Impaired Loans
Accretion on purchased impaired loans
Scheduled accretion
Reversal of contractual interest on impaired loans
Scheduled accretion net of contractual interest
Excess cash recoveries (a)
Table 9: Purchased Impaired Loans – Accretable Yield
January 1
Excess cash recoveries
Net reclassification to accretable from non-accretable and other activity (a)
March 31 (b)
Information related to the valuation of purchased impaired loans at March 31, 2015 and December 31, 2014 follows.
Table 10: Valuation of Purchased Impaired Loans
Commercial and commercial real estate loans:
Outstanding balance (a)
Recorded investment
Allowance for loan losses
Net investment/Carrying value
Consumer and residential mortgage loans:
Total purchased impaired loans:
12 The PNC Financial Services Group, Inc. – Form 10-Q
At March 31, 2015, our largest individual purchased impaired loan had a recorded investment of $9 million. We currently expect to collect total cash flows of $5.3 billion on purchased impaired loans, representing the $3.8 billion net investment at March 31, 2015 and the accretable net interest of $1.5 billion shown in Table 9.
Weighted Average Life of the Purchased Impaired Portfolios
The table below provides the weighted average life (WAL) for each of the purchased impaired portfolios as of March 31, 2015.
Table 11: Weighted Average Life of the Purchased Impaired Portfolios
As of March 31, 2015
Consumer (b)
Purchased Impaired Loans – Accretable Difference Sensitivity Analysis
The following table provides a sensitivity analysis on the Total Purchased Impaired Loans portfolio. The analysis reflects hypothetical changes in key drivers for expected cash flows over the life of the loans under declining and improving conditions at a point in time. Any unusual significant economic events or changes, as well as other variables not considered below (e.g., natural or widespread disasters), could result in impacts outside of the ranges represented below. Additionally, commercial and commercial real estate loan settlements or sales proceeds can vary widely from appraised values due to a number of factors including, but not limited to, special use considerations, liquidity premiums and improvements/deterioration in other income sources.
Table 12: Accretable Difference Sensitivity – Total Purchased Impaired Loans
March 31,
Declining
Scenario (a)
Improving
Scenario (b)
Expected cash flows
Accretable difference
The present value impact of declining cash flows is primarily reflected as an immediate impairment charge to the provision for credit losses, resulting in an increase to the allowance for loan and lease losses. The present value impact of increased cash flows is first recognized as a reversal of the allowance with any additional cash flow increases reflected as an increase in accretable yield over the life of the loan.
Commitment to extend credit are comprised of the following:
Table 13: Commitments to Extend Credit (a)
Total commercial lending (b)
Home equity lines of credit
Standby bond purchase agreements totaled $1.1 billion at March 31, 2015 and $1.1 billion at December 31, 2014 and are included in the preceding table, primarily within the Total commercial lending category.
In addition to the credit commitments set forth in the table above, our net outstanding standby letters of credit totaled $9.8 billion at March 31, 2015 and $10.0 billion at December 31, 2014. Standby letters of credit commit us to make payments on behalf of our customers if specified future events occur.
Information regarding our commitments to extend credit and our allowance for unfunded loan commitments and letters of credit is included in Note 1 Accounting Policies, Note 5 Allowances for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit and Note 16 Commitments and Guarantees in the Notes To Consolidated Financial Statements in Part 1, Item 1 of this Report.
The PNC Financial Services Group, Inc. – Form 10-Q 13
INVESTMENT SECURITIES
The following table presents the distribution of our investment securities portfolio. We have included credit ratings information because we believe that the information is an indicator of the degree of credit risk to which we are exposed. Changes in credit ratings classifications could indicate increased or decreased credit risk and could be accompanied by a reduction or increase in the fair value of our investment securities portfolio. For those securities, where during our quarterly security-level impairment assessments we determined losses represented other-than-temporary impairment (OTTI), we have recorded cumulative credit losses of $1.2 billion in earnings and accordingly have reduced the amortized cost of our securities. See Table 71 in Note 6 Investment Securities in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report for more detail. The majority of these cumulative impairment charges related to non-agency residential mortgage-backed and asset-backed securities rated BB or lower.
Table 14: Investment Securities
Ratings (a)
AAA/
AA
BB
and
Lower
No
Rating
U.S. Treasury and government agencies
Agency residential mortgage-backed
Non-agency residential mortgage-backed
Agency commercial mortgage-backed
Non-agency commercial mortgage-backed (b)
Asset-backed (c)
State and municipal
Other debt
Corporate stock and other
Total investment securities (d)
Investment securities represented 17% of total assets at March 31, 2015 and 16% at December 31, 2014.
We evaluate our investment securities portfolio in light of changing market conditions and other factors and, where appropriate, take steps to improve our overall positioning. We consider the portfolio to be well-diversified and of high quality. At March 31, 2015, 87% of the securities in the portfolio were rated AAA/AA, with U.S. Treasury and government agencies, agency residential mortgage-backed and agency commercial mortgage-backed securities collectively representing 62% of the portfolio.
The investment securities portfolio includes both available for sale and held to maturity securities. Securities classified as available for sale are carried at fair value with net unrealized gains and losses, representing the difference between amortized cost and fair value, included in Shareholders’ equity as Accumulated other comprehensive income or loss, net of tax, on our Consolidated Balance Sheet. Securities classified as held to maturity are carried at amortized cost. As of March 31, 2015, the amortized cost and fair value of available for sale securities totaled $46.4 billion and $47.6 billion, respectively, compared to an amortized cost and fair value as
of December 31, 2014 of $43.2 billion and $44.2 billion, respectively. The amortized cost and fair value of held to maturity securities were $13.2 billion and $13.6 billion, respectively, at March 31, 2015, compared to $11.6 billion and $12.0 billion, respectively, at December 31, 2014.
The fair value of investment securities is impacted by interest rates, credit spreads, market volatility and liquidity conditions. The fair value of investment securities generally decreases when interest rates increase and vice versa. In addition, the fair value generally decreases when credit spreads widen and vice versa. Net unrealized gains in the total investment securities portfolio increased to $1.6 billion at March 31, 2015 from $1.5 billion at December 31, 2014 primarily due to the impact of market interest rates and credit spreads. The comparable amounts for the securities available for sale portfolio were both $1.1 billion.
Unrealized gains and losses on available for sale debt securities do not impact liquidity. However these gains and losses do affect capital under the regulatory capital rules. Also, a change in the securities’ credit ratings could impact the liquidity of the securities and may be indicative of a change in credit quality, which could affect our risk-weighted
14 The PNC Financial Services Group, Inc. – Form 10-Q
assets and, therefore, our risk-based regulatory capital ratios under the regulatory capital rules. In addition, the amount representing the credit-related portion of OTTI on securities would reduce our earnings and regulatory capital ratios.
The duration of investment securities was 2.1 years at March 31, 2015. We estimate that, at March 31, 2015, the effective duration of investment securities was 2.3 years for an immediate 50 basis points parallel increase in interest rates and 2.0 years for an immediate 50 basis points parallel decrease in interest rates. Comparable amounts at December 31, 2014 for the effective duration of investment securities were 2.2 years and 2.1 years, respectively.
At least quarterly, we conduct a comprehensive security-level impairment assessment on all securities. For securities in an unrealized loss position, we determine whether the loss represents OTTI. For debt securities that we neither intend to sell nor believe we will be required to sell prior to expected recovery, we recognize the credit portion of OTTI charges in current earnings and include the noncredit portion of OTTI in Net unrealized gains (losses) on OTTI securities on our Consolidated Statement of Comprehensive Income and net of tax in Accumulated other comprehensive income (loss) on our Consolidated Balance Sheet. During the first quarters of 2015 and 2014 we recognized OTTI credit losses of $1 million and $2 million, respectively.
If economic conditions, including housing values, were to deteriorate from current levels, and if market volatility and illiquidity were to deteriorate from current levels, or if market interest rates were to increase or credit spreads were to widen appreciably, the valuation of our investment securities portfolio would likely be adversely affected and we could incur additional OTTI credit losses that would impact our Consolidated Income Statement.
Additional information regarding our investment securities is included in Note 6 Investment Securities and Note 7 Fair Value in the Notes To Consolidated Financial Statements included in Part I, Item 1 of this Report.
Loans Held for Sale
Table 15: Loans Held For Sale
Commercial mortgages at fair value
Commercial mortgages at lower of cost or fair value
Total commercial mortgages
Residential mortgages at fair value
Residential mortgages at lower of cost or fair value
Total residential mortgages
As of September 1, 2014, we have elected to apply the fair value option to commercial mortgage loans held for sale to agencies. This election applies to all new commercial mortgage loans held for sale originated for sale to the agencies effective on or after September 1, 2014. The election of fair value option aligns the accounting for the commercial mortgages with the related commitments to sell the loans.
We sold $1.0 billion of commercial mortgage loans to agencies during the first three months of 2015 compared to $439 million during the first three months of 2014. Total gains of $15 million were recognized on the valuation and sale of commercial mortgage loans held for sale, net of hedges, during the first three months of 2015, and $7 million during the first three months of 2014. These amounts are included in Other noninterest income on our Consolidated Income Statement.
Residential mortgage loan origination volume was $2.6 billion during the first three months of 2015 compared to $1.9 billion during the first three months of 2014. The majority of such loans were originated under agency or Federal Housing Administration (FHA) standards. We sold $1.9 billion of loans and recognized loan sales revenue of $104 million during the first three months of 2015. The comparable amounts for the first three months of 2014 were $2.1 billion and $107 million.
Interest income on loans held for sale was $23 million during both the first three months of 2015 and 2014. These amounts are included in Other interest income on our Consolidated Income Statement.
Additional information regarding our loan sale and servicing activities is included in Note 2 Loan Sale and Servicing Activities and Variable Interest Entities and Note 7 Fair Value in our Notes To Consolidated Financial Statements included in Part 1, Item 1 of this Report.
Goodwill and Intangible Assets
Goodwill and intangible assets of $10.9 billion remained relatively flat at March 31, 2015. See additional information regarding our goodwill and intangible assets in Note 8 Goodwill and Intangible Assets included in the Notes To Consolidated Financial Statements in Part 1, Item 1 of this Report.
The PNC Financial Services Group, Inc. – Form 10-Q 15
Funding Sources
Table 16: Details Of Funding Sources
Money market
Demand
Retail certificates of deposit
Savings
Time deposits in foreign offices and other time deposits
Federal funds purchased and repurchase agreements
Federal Home Loan Bank borrowings
Bank notes and senior debt
Subordinated debt
Commercial paper
Total borrowed funds
Total funding sources
See the Liquidity Risk Management portion of the Risk Management section of this Financial Review for additional information regarding our 2015 capital and liquidity activities.
Total deposits increased $4.3 billion at March 31, 2015 compared with December 31, 2014 due to strong growth in money market, savings and demand, partially offset by lower other time deposits. Interest-bearing deposits represented 68% of total deposits at both March 31, 2015 and December 31, 2014. Total borrowed funds increased $61 million since December 31, 2014 as higher Federal Home Loan Bank borrowings and issuances of bank notes and senior debt were partially offset by a decline in federal funds purchased and repurchase agreements and commercial paper issuances.
Capital
Table 17: Shareholders’ Equity
Shareholders’ equity
Preferred stock (a)
Common stock
Capital surplus – preferred stock
Capital surplus – common stock and other
Retained earnings
Common stock held in treasury at cost
16 The PNC Financial Services Group, Inc. – Form 10-Q
We manage our funding and capital positions by making adjustments to our balance sheet size and composition, issuing debt, equity or other capital instruments, executing treasury stock transactions and capital redemptions, managing dividend policies and retaining earnings.
The increase in total shareholders’ equity compared to December 31, 2014 reflected an increase in retained earnings, partially offset by share repurchases of $.4 billion under PNC’s common stock repurchase program in effect through the first quarter of 2015. The increase in retained earnings was driven by net income of $1.0 billion, reduced by $319 million of common and preferred dividends declared. Accumulated other comprehensive income increased due to the impact of market interest rates and credit spreads on securities available for sale and derivatives that are part of cash flow hedging strategies. Common shares outstanding were 520 million at March 31, 2015 and 523 million at December 31, 2014.
Our 2007 common stock repurchase program authorization permitted us to purchase up to 25 million shares of PNC common stock on the open market or in privately negotiated transactions. Under such authorization, PNC repurchased 4.4 million common shares for $.4 billion during the first quarter of 2015 and completed its common stock repurchase programs for the four quarter period that began in second quarter 2014 with total repurchases of 17 million common shares for $1.5 billion. In the first quarter of 2015, PNC’s Board of Directors approved both the termination of the 2007 authorization, effective as of March 31, 2015, and the establishment of a new stock repurchase program authorization in the amount of 100 million shares of PNC common stock, effective April 1, 2015. The extent and timing of share repurchases under this authorization will depend on a number of factors including, among others, market and general economic conditions, economic and regulatory capital
considerations, alternative uses of capital, the potential impact on our credit ratings, contractual and regulatory limitations, and the results of future supervisory assessments of capital adequacy and capital planning processes undertaken by the Federal Reserve as part of the CCAR process. In connection with the 2015 CCAR, PNC submitted its 2015 capital plan, as approved by its Board of Directors, to the Federal Reserve in January 2015. In March 2015, the Federal Reserve accepted the capital plan and did not object to our proposed capital actions and PNC announced new share repurchase programs of up to $2.875 billion for the five quarter period beginning in the second quarter of 2015. These programs include repurchases of up to $375 million over the five quarter period related to stock issuances under employee benefit-related programs. Under the “de minimis” safe harbor of the Federal Reserve’s capital plan rule, PNC may make limited repurchases of common stock or other capital distributions in amounts that exceed the amounts included in its most recently approved capital plan, provided that, among other things, such distributions do not exceed, in the aggregate, 1% of PNC’s Tier 1 capital and the Federal Reserve does not object to the additional repurchases or distributions. Under the Federal Reserve’s capital plan rule, a bank holding company must resubmit a new capital plan prior to the annual submission date if, among other things, there has been or will be a material change in the bank holding company’s risk profile, financial condition, or corporate structure since its last capital plan submission. See the Supervision and Regulation section of Item 1 Business of our 2014 Form 10-K for further information concerning the CCAR process and the factors the Federal Reserve takes into consideration in its evaluation of capital plans and the Balance Sheet, Liquidity and Capital Highlights portion of the Executive Summary section of this Financial Review for the impact of the Federal Reserve’s current supervisory assessment of the capital adequacy program.
The PNC Financial Services Group, Inc. – Form 10-Q 17
Table 18: Basel III Capital
Transitional
Basel III (a)
Pro forma FullyPhased-In Basel III
(b)(c)
Common equity Tier 1 capital
Common stock plus related surplus, net of treasury stock
Accumulated other comprehensive income for securities currently and previously held as available for sale
Accumulated other comprehensive income for pension and other postretirement plans
Goodwill, net of associated deferred tax liabilities
Other disallowed intangibles, net of deferred tax liabilities
Other adjustments/(deductions)
Total common equity Tier 1 capital before threshold deductions
Total threshold deductions
Additional Tier 1 capital
Preferred stock plus related surplus
Trust preferred capital securities
Noncontrolling interests (d)
Tier 1 capital
Additional Tier 2 capital
Qualifying subordinated debt
Allowance for loan and lease losses included in Tier 2 capital
Total Basel III capital
Risk-weighted assets
Basel III standardized approach risk-weighted assets (e)
Estimated Basel III advanced approaches risk-weighted assets (f)
Average quarterly adjusted total assets
Supplementary leverage exposure (g)
Basel III risk-based capital and leverage ratios
Tier 1
Leverage (m)
Supplementary leverage ratio (n)
18 The PNC Financial Services Group, Inc. – Form 10-Q
The Basel II framework, which was adopted by the Basel Committee on Banking Supervision in 2004, seeks to provide more risk-sensitive regulatory capital calculations and promote enhanced risk management practices among large, internationally active banking organizations. The U.S. banking agencies initially adopted rules to implement the Basel II capital framework in 2004. In July 2013, the U.S. banking agencies adopted final rules (referred to as the advanced approaches) that modified the Basel II framework effective January 1, 2014. See the Supervision and Regulation section in Item 1 Business and Item 1A Risk Factors of our 2014 Form 10-K for additional information. Prior to fully implementing the advanced approaches to calculate risk-weighted assets, PNC and PNC Bank must successfully complete a “parallel run” qualification phase. Both PNC and PNC Bank entered this parallel run phase on January 1, 2013. Although the minimum parallel run qualification period is four quarters, the parallel run period for PNC and PNC Bank, now in its third year, is consistent with the experience of other U.S. advanced approaches banks that have all had multi-year parallel run periods. After PNC exits parallel run, its regulatory risk-based capital ratio for each measure (e.g., Common equity Tier 1 capital ratio) will be the lower of the ratios as calculated under the standardized approach and the advanced approaches.
As a result of the staggered effective dates of the final U.S. Basel III regulatory capital rules (Basel III rules), as well as the fact that PNC remains in the parallel run qualification phase for the advanced approaches, PNC’s regulatory risk-based ratios in 2015 will be calculated using the standardized approach, effective January 1, 2015, for determining risk-weighted assets, and the definitions of, and deductions from, regulatory capital under the Basel III rules (as such definitions and deductions are phased-in for 2015). We refer to the capital ratios calculated using the phased-in Basel III provisions in effect for 2015 and, for the risk-based ratios, standardized approach risk-weighted assets as the 2015 Transitional Basel III ratios. Under the standardized approach for determining credit risk-weighted assets, exposures are generally assigned a pre-defined risk weight. Exposures to high volatility commercial real estate, past due exposures, equity exposures and securitization exposures are generally subject to higher risk weights than other types of exposures.
Under the Basel III rules adopted by the U.S. banking agencies, significant common stock investments in unconsolidated financial institutions, mortgage servicing rights and deferred tax assets must be deducted from capital (subject to a phase-in schedule) to the extent they individually exceed 10%, or in the aggregate exceed 15%, of the institution’s adjusted common equity Tier 1 capital. Also, Basel III regulatory capital includes (subject to a phase-in schedule) accumulated other comprehensive income related to securities currently and previously held as available for sale, as well as pension and other postretirement plans.
Federal banking regulators have stated that they expect the largest U.S. bank holding companies, including PNC, to have a level of regulatory capital well in excess of the regulatory minimum and have required the largest U.S. bank holding companies, including PNC, to have a capital buffer sufficient to withstand losses and allow them to meet the credit needs of their customers through estimated stress scenarios. We seek to manage our capital consistent with these regulatory principles, and believe that our March 31, 2015 capital levels were aligned with them.
At March 31, 2015, PNC and PNC Bank, our sole bank subsidiary, were both considered “well capitalized,” based on applicable U.S. regulatory capital ratio requirements. To qualify as “well capitalized” during 2015, PNC and PNC Bank must have Transitional Basel III capital ratios of at least 6.5% for Common equity Tier 1 capital, 8% for Tier 1 risk-based and 10% for Total risk-based, and PNC Bank is required to have a Transitional Basel III leverage ratio of at least 5%.
The access to and cost of funding for new business initiatives, the ability to undertake new business initiatives including acquisitions, the ability to engage in expanded business activities, the ability to pay dividends or repurchase shares or other capital instruments, the level of deposit insurance costs, and the level and nature of regulatory oversight depend, in large part, on a financial institution’s capital strength.
We provide additional information regarding regulatory capital requirements and some of their potential impacts on PNC in the Supervision and Regulation section of Item 1 Business, Item 1A Risk Factors and Note 20 Regulatory Matters in the Notes To Consolidated Financial Statements in Item 8 of our 2014 Form 10-K.
The PNC Financial Services Group, Inc. – Form 10-Q 19
OFF-BALANCE SHEETARRANGEMENTS AND VARIABLE INTEREST ENTITIES
We engage in a variety of activities that involve unconsolidated entities or that are otherwise not reflected in our Consolidated Balance Sheet that are generally referred to as “off-balance sheet arrangements.” Additional information on these types of activities is included in our 2014 Form 10-K and in the following sections of this Report:
Commitments, including contractual obligations and other commitments, included within the Risk Management section of this Financial Review,
Note 2 Loan Sale and Servicing Activities and Variable Interest Entities in the Notes To Consolidated Financial Statements,
Note 9 Capital Securities of a Subsidiary Trust and Perpetual Trust Securities in the Notes To Consolidated Financial Statements, and
Note 16 Commitments and Guarantees in the Notes To Consolidated Financial Statements.
PNC consolidates variable interest entities (VIEs) when we are deemed to be the primary beneficiary. The primary beneficiary of a VIE is determined to be the party that meets both of the following criteria: (i) has the power to make decisions that most significantly affect the economic performance of the VIE and (ii) has the obligation to absorb losses or the right to receive benefits that in either case could potentially be significant to the VIE.
A summary of VIEs, including those that we have consolidated and those in which we hold variable interests but have not consolidated into our financial statements, as of March 31, 2015 and December 31, 2014 is included in Note 2 of this Report.
Trust Preferred Securities
We are subject to certain restrictions, including restrictions on dividend payments, in connection with $206 million in principal amount of an outstanding junior subordinated debenture associated with $200 million of trust preferred securities that were issued by PNC Capital Trust C, a subsidiary statutory trust (both amounts as of March 31, 2015). Generally, if there is (i) an event of default under the debenture, (ii) PNC elects to defer interest on the debenture, (iii) PNC exercises its right to defer payments on the related trust preferred security issued by the statutory trust or (iv) there is a default under PNC’s guarantee of such payment obligations, as specified in the applicable governing documents, then PNC would be subject during the period of such default or deferral to restrictions on dividends and other provisions protecting the status of the debenture holders similar to or in some ways more restrictive than those potentially imposed under the Exchange Agreement with PNC Preferred Funding Trust II. See Note 12 Capital Securities of Subsidiary Trusts and Perpetual Trust Securities in the Notes To Consolidated Financial Statements in Item 8 of our 2014 Form 10-K for information on contractual limitations on dividend payments resulting from securities issued by PNC Preferred Funding Trust I and PNC Preferred Funding Trust II.
20 The PNC Financial Services Group, Inc. – Form 10-Q
FAIR VALUE MEASUREMENTS
In addition to the following, see Note 7 Fair Value in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report for further information regarding fair value.
The following table summarizes the assets and liabilities measured at fair value at March 31, 2015 and December 31, 2014, respectively, and the portions of such assets and liabilities that are classified within Level 3 of the valuation hierarchy. Level 3 assets and liabilities are those where the fair value is estimated using significant unobservable inputs.
Table 19: Fair Value Measurements – Summary
Total assets at fair value as a percentage of consolidated assets
Level 3 assets as a percentage of total assets at fair value
Level 3 assets as a percentage of consolidated assets
Total liabilities at fair value as a percentage of consolidated liabilities
Level 3 liabilities as a percentage of total liabilities at fair value
Level 3 liabilities as a percentage of consolidated liabilities
The majority of assets recorded at fair value are included in the securities available for sale portfolio. The majority of Level 3 assets represent non-agency residential mortgage-backed securities in the securities available for sale portfolio, equity investments and mortgage servicing rights.
An instrument’s categorization within the hierarchy is based on the lowest level of input that is significant to the fair value measurement. Changes from one quarter to the next related to the observability of inputs to a fair value measurement may result in a reclassification (transfer) of assets or liabilities between hierarchy levels. PNC’s policy is to recognize transfers in and transfers out as of the end of the reporting period. For additional information regarding the transfers of assets or liabilities between hierarchy levels, see Note 7 Fair Value in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report.
BUSINESS SEGMENTS REVIEW
We have six reportable business segments:
Business segment results, including inter-segment revenues, and a description of each business are included in Note 17 Segment Reporting included in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report. Certain amounts included in this Financial Review differ from those amounts shown in Note 17 primarily due to the presentation in this Financial Review of business net interest revenue on a taxable-equivalent basis. Note 17 presents results of businesses for the first three months of 2015 and 2014.
Net interest income in business segment results reflects PNC’s internal funds transfer pricing methodology. Assets receive a funding charge and liabilities and capital receive a funding
credit based on a transfer pricing methodology that incorporates product repricing characteristics, tenor and other factors. In the first quarter of 2015, enhancements were made to PNC’s funds transfer pricing methodology primarily for costs related to the new regulatory short-term liquidity standards. The enhancements incorporate an additional charge assigned to assets, including for unfunded loan commitments. Conversely, a higher transfer pricing credit has been assigned to those deposits that are accorded higher value under Liquidity Coverage Ratio rules for liquidity purposes. Please see the Supervision and Regulation section in Item 1 and the Liquidity Risk Management section in Item 7 of our 2014 Form 10-K for more information about the ratio. These adjustments apply to business segment results prospectively beginning with the first quarter of 2015. Excluding any changes in business volumes, the estimated impacts of this change to net interest income for Retail Banking and Corporate & Institutional Banking were approximately an increase of $55 million and a decrease of $60 million, respectively, for the first quarter of 2015. The impacts to the other business segments were not significant. Prior periods have not been adjusted due to the impracticability of estimating the impact of the change for prior periods.
The PNC Financial Services Group, Inc. – Form 10-Q 21
Table 20: Retail Banking Table
Dollars in millions, except as noted
Income Statement
Brokerage
Pretax earnings
Income taxes
Earnings
Average Balance Sheet
Consumer
Indirect auto
Indirect other
Credit cards
Total consumer
Commercial and commercial real estate
Floor plan
Goodwill and other intangible assets
Noninterest-bearing demand
Interest-bearing demand
Total transaction deposits
Certificates of deposit
Return on average assets
Other Information (a)
Credit-related statistics:
Commercial nonperforming assets
Consumer nonperforming assets
Total nonperforming assets (b)
Purchased impaired loans (c)
Commercial lending net charge-offs
Credit card lending net charge-offs
Consumer lending (excluding credit card) net charge-offs
Total net charge-offs
Commercial lending annualized net charge-off ratio
Credit card lending annualized net charge-off ratio
Consumer lending (excluding credit card) annualized net charge-off ratio
Total annualized net charge-off ratio
Other Information (Continued) (a)
Home equity portfolio credit statistics: (d)
% of first lien positions at origination (f)
Weighted-average loan-to-value ratios (LTVs) (e) (f)
Weighted-average updated FICO scores (g)
Net charge-off ratio
Delinquency data – % of total loans: (h)
Loans 30 – 59 days past due
Loans 60 – 89 days past due
Accruing loans past due
Nonperforming loans
Other statistics:
ATMs
Branches (i)
Brokerage account client assets (in billions) (j)
Customer-related statistics (average):
Non-teller deposit transactions (k)
Digital consumer customers (l)
Retail Banking earned $202 million in the first quarter of 2015 compared with earnings of $158 million for the same period a year ago. The increase in earnings was driven by lower provision for credit losses and increased net interest income offset by higher expenses and lower noninterest income. Noninterest income declined as a result of the sale of Visa Class B common shares recognized in the first quarter of 2014.
Retail Banking continues to enhance the customer experience with refinements to product offerings that drive product value for consumers and small businesses. We are focused on growing customer share of wallet through the sale of liquidity, banking, and investment products.
Retail Banking also continued to serve more customers through cost effective channels that meet their evolving preferences for convenience.
In the first quarter of 2015, approximately 50% of consumer customers used non-teller channels for the
22 The PNC Financial Services Group, Inc. – Form 10-Q
majority of their transactions compared with 43% for the same period in 2014.
Deposit transactions via ATM and mobile channels increased to 40% of total deposit transactions in the first quarter of 2015 compared with 31% for the same period a year ago.
As part of PNC’s retail branch transformation strategy, we continue to evolve our network. In the first quarter of 2015 we converted 127 branches to the new universal branch format and 40 branches were closed or consolidated. In support of our transformation efforts, we increased our ATM network by more than 9% since the first quarter of 2014.
Retail Banking’s primary geographic footprint extends across 17 states and Washington, D.C. Our retail branch network covers nearly half the U.S. population, with 2,660 branches and 8,754 ATMs.
Total revenue for the first three months of 2015 increased $32 million compared to the same period a year ago, which included a $58 million increase in net interest income. In addition to the benefit from the enhancements to funds transfer pricing methodology in the first quarter of 2015, net interest income increased slightly, as growth in deposit balances was mostly offset by lower yields on loans and lower purchase accounting accretion on loans and deposits.
Noninterest income decreased $26 million, or 5%, compared to the first quarter of 2014, reflecting the impact of the $62 million gain on sales of Visa Class B common shares in the first quarter of 2014. Excluding this gain, noninterest income increased as a result of strong customer-related fee income growth, primarily resulting from increases in customer-initiated transactions, changes in product offerings, and increased brokerage and merchant processing revenue.
Provision for credit losses and net charge-offs in the first quarter of 2015 declined by $96 million and $46 million, respectively, in the comparison to the prior year quarter. Provision for credit losses decreased due to improved credit metrics. Lower net charge-offs were driven by improved credit quality in both consumer and commercial portfolios.
Noninterest expense increased $58 million in the first three months of 2015 compared to the same period in 2014. Increases in technology investments, compensation, marketing, and customer transaction-related costs were offset by reduced branch network expenses as a result of transaction migration to lower cost digital and ATM channels.
Growing core checking deposits is key to Retail Banking’s growth and to providing a source of low-cost funding and liquidity to PNC. The deposit product strategy of Retail Banking is to remain disciplined on pricing, target specific products and markets for growth, and focus on the retention and growth of customer balances. In the first quarter of 2015,
average total deposits increased $6.0 billion, or 4%, compared with the same period in 2014.
Average transaction deposits grew $7.0 billion, or 7%, and average savings deposit balances grew $1.6 billion, or 14%, compared to the first quarter in 2014 as a result of organic deposit growth. Compared with the same period a year ago, average demand deposits increased $3.4 billion, or 6%, to $58.2 billion and average money market deposits increased $3.6 billion, or 7%.
Total average certificates of deposit decreased $2.6 billion, or 13%, compared to the same period in 2014. The decline in average certificates of deposit was due to the expected run-off of maturing accounts.
Retail Banking continued to focus on a relationship-based lending strategy that targets specific products and markets for growth, small businesses, and auto dealerships. In the first quarter of 2015, average total loans declined $2.1 billion, compared to the same period a year ago, driven by a decline in home equity loans and declines from run-off of non-strategic portions of the portfolios.
Average home equity loans decreased $1.2 billion, or 4%, compared to the first three months of 2014. The overall portfolio declines resulted from reduced refinance activity. Retail Banking’s home equity loan portfolio is relationship based, with 97% of the portfolio attributable to borrowers in our primary geographic footprint.
Average auto dealer floor plan loans declined $160 million, or 7%, in the first quarter of 2015, compared to the same period in 2014, primarily resulting from lower dealer line utilization.
Average indirect auto loans increased $293 million, or 3%, compared to the first three months 2014. The increase was primarily due to growth in newer footprint indirect auto markets.
Average credit card balances increased $173 million, or 4%, over the same period in 2014 as a result of efforts to increase credit card share of wallet through organic growth.
Average residential mortgage balances increased $87 million, or 13%, compared to the first three months of 2014. The increase was due to the transfer of $198 million in CRA mortgage loans from the Residential Mortgage Banking business segment.
In the first quarter of 2015, average loan balances for the remainder of the portfolio declined a net $1.3 billion, compared to the same period a year ago, driven by declines in the education portfolio of $921 million and commercial & commercial real estate of $397 million. The discontinued government guaranteed education loan and indirect other portfolios are primarily run-off portfolios.
Nonperforming assets declined $57 million, or 5%, over the same period in 2014. The decrease was driven by declines in both commercial and consumer non-performing loans.
The PNC Financial Services Group, Inc. – Form 10-Q 23
Table 21: Corporate & Institutional Banking Table
Corporate service fees
Provision for credit losses (benefit)
Total commercial lending
Commercial Loan Servicing Portfolio – Serviced For PNC and Others (in billions)
Beginning of period
Acquisitions/additions
Repayments/transfers
End of period
Other Information
Consolidated revenue from: (a)
Treasury Management (b)
Capital Markets (c)
Commercial mortgage banking activities
Commercial mortgage loans held for sale (d)
Commercial mortgage loan servicingincome (e)
Commercial mortgage servicing rights valuation, net of economic hedge (f)
Average Loans (by C&IB business)
Corporate Banking
Real Estate
Business Credit
Equipment Finance
Total average loans
Total loans (g)
Net carrying amount of commercial mortgage servicing rights (g)
Nonperforming assets (g) (h)
Purchased impaired loans (g) (i)
Net charge-offs (recoveries)
Corporate & Institutional Banking earned $482 million in the first quarter of 2015 compared with earnings of $523 million for the same period a year ago. The decrease in earnings was due to lower net interest income, an increase in the provision for credit losses and an increase in noninterest expense, partially offset by higher noninterest income. We continue to focus on building client relationships where the risk-return profile is attractive, including the Southeast.
Net interest income decreased $79 million in the first three months of 2015 compared to the first three months of 2014. The decline was due to the impact of first quarter 2015 enhancements to funds transfer pricing methodology, continued spread compression on loans, and lower purchase accounting accretion, partially offset by the impact of higher average loans and deposits. Decreased net interest income in the comparison also reflected the impact from the second quarter 2014 correction to reclassify certain commercial facility usage fees from net interest income to corporate service fees.
Corporate service fees increased $42 million in the first quarter of 2015 compared to the first quarter of 2014. This increase was primarily due to the impact of the second quarter 2014 correction to reclassify certain commercial facility fees from net interest income to corporate service fees, an increase in treasury management fees and higher net hedging gains on commercial mortgage servicing rights, partially offset by lower mergers and acquisition advisory fees.
Other noninterest income increased $23 million in the first quarter of 2015 compared to the first quarter of 2014. This increase was driven by increased securities underwriting activity, higher revenue associated with credit valuations for customer-related derivatives activities and related derivatives sales and higher multifamily loans originated for sale to agencies, partially offset by lower gains on asset sales.
The provision for credit losses was $17 million for the first three months of 2015 compared with a benefit of $13 million
24 The PNC Financial Services Group, Inc. – Form 10-Q
for the first three months of 2014 reflecting the impact of portfolio growth and slower credit quality improvement.
Noninterest expense increased $26 million in the first quarter of 2015 compared to the prior year period, primarily driven by investments in technology and infrastructure.
Average loans increased $11.6 billion, or 11%, for the first quarter of 2015 compared to the prior year quarter, reflecting strong growth in Corporate Banking, Real Estate, Business Credit and Equipment Finance:
Corporate Banking business provides lending, treasury management and capital markets-related products and services to mid-sized and large corporations, government and not-for-profit entities. Average loans for this business increased $6.0 billion, or 11%, in the first quarter of 2015 compared with the first quarter of 2014, primarily due to an increase in loan commitments from specialty lending businesses and higher utilization.
PNC Real Estate provides banking, financing and servicing solutions for commercial real estate clients across the country. Average loans for this business increased $3.9 billion, or 15%, in the first quarter of 2015 compared with the first quarter of 2014 due to increased originations and higher utilization.
PNC Business Credit provides asset-based lending. The loan portfolio is relatively high yielding, with acceptable risk as the loans are mainly secured by short-term assets. Average loans for this business increased $1.7 billion, or 13%, in the first three months of 2015 compared with the first three months of 2014 due to new originations, increasing deal sizes and higher utilization.
PNC Equipment Finance provides equipment financing solutions for clients throughout the U.S. and Canada. Average equipment finance loans and operating leases were $11.8 billion in the first quarter of 2015, an increase of $.9 billion, or 8%, compared with the first quarter of 2014.
Period-end loan balances increased by 9%, or $9.5 billion, at March 31, 2015 compared to March 31, 2014 primarily due to growth in our Corporate Banking, Real Estate and Business Credit businesses.
Loan commitments increased 8%, or $15.2 billion, to $213.7 billion at March 31, 2015 compared to March 31, 2014, primarily due to growth in our Corporate Banking, Real Estate and Business Credit businesses.
Average deposits for the first quarter of 2015 increased $7.6 billion, or 11%, compared with the first quarter of 2014 as a result of business growth and inflows into demand and money market deposits.
The commercial loan servicing portfolio increased $39 billion, or 11%, compared with March 31, 2014, as servicing additions exceeded portfolio run-off.
Nonperforming assets declined 34% from March 31, 2014 due to continued improving credit quality.
Product Revenue
In addition to credit and deposit products for commercial customers, Corporate & Institutional Banking offers other services, including treasury management, capital markets-related products and services, and commercial mortgage banking activities, for customers of all our business segments. On a consolidated basis, the revenue from these other services is included in net interest income, corporate service fees and other noninterest income. From a segment perspective, the majority of the revenue and expense related to these services is reflected in the Corporate & Institutional Banking segment results and the remainder is reflected in the results of other businesses. The Other Information section in Table 21 in the Corporate & Institutional Banking portion of this Business Segments Review section includes the consolidated revenue to PNC for these services. A discussion of the consolidated revenue from these services follows.
Treasury management revenue, comprised of fees and net interest income from customer deposit balances, increased $8 million in the comparison of first quarter 2015 to first quarter 2014, driven by growth in our commercial card, wholesale lockbox, and PINACLE® and other deposit-related services.
Capital markets revenue includes merger and acquisition advisory fees, loan syndications, derivatives, foreign exchange, asset-backed finance revenue and fixed income and equity capital markets advisory activities. Revenue from capital markets-related products and services increased $23 million in the first three months of 2015 compared with the first three months of 2014. The increase in the comparison was driven by increased securities underwriting activity and higher revenue associated with credit valuations for customer-related derivatives activities and related derivatives sales, partially offset by lower mergers and acquisition advisory fees.
Commercial mortgage banking activities include revenue derived from commercial mortgage servicing (including net interest income and noninterest income) and revenue derived from commercial mortgage loans held for sale and related hedges. Revenue from total commercial mortgage banking activities increased $13 million in the first quarter of 2015 compared with the first quarter of 2014. The increase in the comparison was mainly due to higher multifamily loans originated for sale to agencies and higher net hedging gains on commercial mortgage servicing rights.
The PNC Financial Services Group, Inc. – Form 10-Q 25
Table 22: Asset Management Group Table
CDs/IRAs/savings deposits
Total nonperforming assets (a) (b)
Purchased impaired loans (a) (c)
Client Assets Under Administration (a) (d) (in billions)
Personal
Institutional
Asset Type
Fixed Income
Liquidity/Other
Asset Management Group earned $37 million in both the first quarter of 2015 and the first quarter of 2014. Client assets under administration were $265 billion as of March 31, 2015 compared to $255 billion as of March 31, 2014. Earnings remained consistent with the prior year as increased noninterest income was offset by higher noninterest expense from strategic growth and higher technology expenses.
The core growth strategies of the business include increasing sales sourced from other PNC lines of business, maximizing front line productivity and optimizing market presence including additions to staff in high opportunity markets. Wealth Management and Hawthorn have over 100 offices operating in 7 out of the 10 most affluent states in the U.S. with a majority co-located with retail banking branches. The businesses’ strategies primarily focus on growing client assets under management through expanding relationships directly and through cross-selling from PNC’s other lines of business.
Institutional Asset Management provides advisory, custody, and retirement administration services to institutional clients primarily within our banking footprint. The business also offers PNC proprietary mutual funds. Institutional Asset Management is strengthening its partnership with the Corporate Bank to drive growth and is focused on building retirement capabilities and expanding product solutions for all customers.
Client assets under administration increased $10 billion compared to a year ago. Discretionary client assets under management at March 31, 2015 increased $6 billion compared with March 31, 2014, driven by higher equity markets, new sales, and positive net flows, after adjustments for cyclical client activities.
Total revenue for the first quarter of 2015 increased $11 million, or 4%, compared to the first quarter of 2014, primarily relating to higher noninterest income due to stronger average equity markets and positive net flows, after adjustments for cyclical client activities.
Noninterest expense increased $11 million, or 6%, in the first three months of 2015 compared to the prior year period, which was primarily attributable to higher compensation costs from strategic growth and higher technology expenses. Over the last 12 months, total full-time headcount has increased by approximately 95 positions, or 3%. Asset Management Group remains focused on disciplined expense management as it invests in strategic growth opportunities.
Average deposits and average transaction deposits increased $1.1 billion, or 12%, in the first quarter of 2015 compared to the prior year first quarter. Average loan balances increased $.3 billion, or 5%, in the comparison due to continued growth in the consumer loan portfolio.
26 The PNC Financial Services Group, Inc. – Form 10-Q
Table 23: Residential Mortgage Banking Table
Loan servicing revenue
Servicing fees
Mortgage servicing rights valuation, net of economic hedge
Loan sales revenue
Pretax earnings (loss)
Income taxes (benefit)
Earnings (loss)
Portfolio loans
Mortgage servicing rights (MSR)
Borrowings and other liabilities
Residential Mortgage Servicing Portfolio – Serviced for Third Parties (in billions)
Acquisitions
Additions
Servicing portfolio – third-party statistics: (a)
Fixed rate
Adjustable rate/balloon
Weighted-average interest rate
MSR asset value (in billions)
MSR capitalization value (in basis points)
Weighted-average servicing fee (in basis points)
Residential Mortgage Repurchase Reserve
(Benefit)/ Provision
Losses – loan repurchases
End of Period
Loan origination volume (in billions)
Loan sale margin percentage
Percentage of originations represented by:
Purchase volume (b)
Refinance volume
Total nonperforming assets (a) (c)
Residential Mortgage Banking earned $28 million in the first three months of 2015 compared to a $4 million loss in the first three months of 2014. Earnings increased from the prior year primarily as a result of lower noninterest expense and higher net hedging gains on residential mortgage servicing rights, partially offset by lower servicing fees and net interest income.
The strategic focus of the business is the acquisition of new customers through a retail loan officer sales force with an emphasis on home purchase transactions. Our strategy involves competing on the basis of superior service to new and existing customers in serving their home purchase and refinancing needs. A key consideration in pursuing this approach is the cross-sell opportunity, especially in the bank footprint markets.
Residential Mortgage Banking overview:
Total loan originations increased $.7 billion for the first three months of 2015 compared to the first three months of 2014. Loans continue to be originated primarily through direct channels under Federal National Mortgage Association (FNMA), Federal Home Loan Mortgage Corporation (FHLMC) and Federal Housing Administration (FHA)/Department of Veterans Affairs agency guidelines. Refinancings were 69% of originations for the first three months of 2015 and 63% in the first three months of 2014. During 2015, 18% of loan originations were under the original or revised Home Affordable Refinance Program (HARP or HARP 2).
Investors having purchased mortgage loans may request PNC to indemnify them against losses on certain loans or to repurchase loans that they believe do not comply with applicable contractual loan origination covenants and representations and warranties we have made. The liability for estimated losses on repurchase and indemnification claims for the Residential Mortgage Banking business segment increased slightly to $106 million at March 31, 2015 compared to March 31, 2014. See the Recourse And Repurchase Obligations section of this Financial Review and Note 16 Commitments and Guarantees in the Notes To Consolidated Financial Statements of this Report for additional information.
Residential mortgage loans serviced for others declined slightly at March 31, 2015 compared to March 31, 2014 as payoffs slightly outpaced new loan origination volume and acquisitions.
Noninterest income increased $11 million in the first quarter of 2015 compared to the prior year quarter, primarily due to higher net hedging gains on residential mortgage servicing rights, partially offset by lower servicing revenue. Loan sales revenue
The PNC Financial Services Group, Inc. – Form 10-Q 27
declined slightly in the comparison, as higher loan sales revenue on increased loan originations was more than offset by the impact of the first quarter 2014 $19 million benefit from the release of reserves for residential mortgage repurchase obligations.
Net interest income declined $10 million in the comparison of the first three months of 2015 to the prior year period, primarily due to lower average portfolio loans, which declined $.8 billion, or 37%, in the comparison.
Noninterest expense declined $52 million, or 24%, in the first quarter of 2015 compared to the first quarter of 2014 due to lower legal accruals.
Table 24: BlackRock Table
Information related to our equity investment in BlackRock follows:
Business segment earnings (a)
PNC’s economic interest in BlackRock (b)
Carrying value of PNC’s investment in BlackRock (c)
Market value of PNC’s investment in BlackRock (d)
In addition, at March 31, 2015, we held approximately 1.3 million shares of BlackRock Series C Preferred Stock valued at $384 million, which are available to fund our obligation in connection with certain BlackRock long-term incentive plan (LTIP) programs.
We account for the BlackRock Series C Preferred Stock at fair value, which offsets the impact of marking-to-market the obligation to deliver these shares to BlackRock. The fair value amount of the BlackRock Series C Preferred Stock is included on our Consolidated Balance Sheet in the caption Other assets. Additional information regarding the valuation of the BlackRock Series C Preferred Stock is included in Note 7 Fair Value in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report and in Note 7 Fair Value in the Notes To Consolidated Financial Statements in Item 8 of our 2014 Form 10-K.
Our 2014 Form 10-K includes additional information about our investment in BlackRock.
28 The PNC Financial Services Group, Inc. – Form 10-Q
Table 25: Non-Strategic Assets Portfolio Table
Commercial Lending:
Commercial/Commercial real estate
Lease financing
Consumer Lending:
Total portfolio loans
Other assets (a)
Deposits and other liabilities
Nonperforming assets (b) (c)
Purchased impaired loans (b) (d)
Net charge-offs
Annualized net charge-off ratio
Loans (b)
Commercial Lending
Consumer Lending
This business segment consists of non-strategic assets primarily obtained through acquisitions of other companies. The business activity of this segment is to manage the wind-down of the portfolios while maximizing the value and mitigating risk.
Non-Strategic Assets Portfolio had earnings of $81 million in the first three months of 2015 compared with $110 million in the first three months of 2014. Earnings decreased year-over-year due to lower net interest income and a reduced benefit from the provision for credit losses.
Non-Strategic Assets Portfolio overview:
Net interest income declined $30 million, or 21%, in the first three months of 2015 compared with the first three months of 2014, resulting from lower purchase accounting accretion and the impact of the declining average balance of the loan portfolio.
Noninterest income increased slightly in the first quarter of 2015 compared to the prior year quarter, due to lower provision for estimated losses on repurchase obligations on home equity loans and lines.
Provision for credit losses was a benefit in both the first quarter of 2015 and 2014, reflecting continued improvements in credit quality.
Noninterest expense declined slightly in the first three months of 2015 compared with the first three months of 2014, as lower costs of managing and servicing the loan portfolios was mostly offset by higher residential OREO expense.
Average portfolio loans declined $1.7 billion, or 17%, in the first quarter of 2015 compared to the prior year quarter, due to customer payment activity and portfolio management activities to reduce under-performing assets.
CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS
Note 1 Accounting Policies in Item 8 of our 2014 Form 10-K and in the Notes To Consolidated Financial Statements included in Part I, Item 1 of this Report describe the most significant accounting policies that we use to prepare our consolidated financial statements. Certain of these policies require us to make estimates or economic assumptions that may prove inaccurate or be subject to variations that may significantly affect our reported results and financial position for the period or in future periods.
We must use estimates, assumptions and judgments when assets and liabilities are required to be recorded at, or adjusted to reflect, fair value.
The PNC Financial Services Group, Inc. – Form 10-Q 29
Assets and liabilities carried at fair value inherently result in a higher degree of financial statement volatility. Fair values and the information used to record valuation adjustments for certain assets and liabilities are based on either quoted market prices or are provided by independent third-party sources, including appraisers and valuation specialists, when available. When such third-party information is not available, we estimate fair value primarily by using discounted cash flow and other financial modeling techniques. Changes in underlying factors, assumptions or estimates could materially impact our future financial condition and results of operations.
We discuss the following critical accounting policies and judgments under this same heading in Item 7 of our 2014 Form 10-K:
Allowances for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit
Estimated Cash Flows on Purchased Impaired Loans
Lease Residuals
Revenue Recognition
Residential and Commercial Mortgage Servicing Rights
Income Taxes
Recently Issued Accounting Standards
We provide additional information about many of these items in the Notes To Consolidated Financial Statements included in Part I, Item l of this Report.
In May 2014, the Financial Accounting Standard Board (“FASB”) issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). This ASU clarifies the principles for recognizing revenue and replaces nearly all existing revenue recognition guidance in U.S. GAAP with one accounting model. The core principle of the guidance is that an entity should recognize revenue to depict the satisfaction of a performance obligation by transfer of promised goods or services to customers. The ASU also requires additional qualitative and quantitative disclosures relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The ASU is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. The requirements within the ASU should be applied retrospectively to each prior period presented (with several practical expedients for certain completed contracts) or retrospectively with the cumulative effect of initially applying the ASU recognized at the date of initial application. Recently, the FASB has proposed delaying the effective date by one year to annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The proposal is subject to the FASB’s due process and will
include a period for public comments. We are currently evaluating the impact of this ASU on our results of operations and financial position.
In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. All legal entities are subject to re-evaluation under this ASU, including investment companies and certain other entities measured in a manner consistent with ASC 946 Financial Services – Investment Companies which were previously excluded. The ASU will change the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. Specifically, the ASU modifies the evaluation of whether limited partnerships and similar legal entities are variable interest entities (VIEs) or voting interest entities; eliminates the presumption that a general partner should consolidate a limited partnership; potentially changes the consolidation conclusions of reporting entities that are involved with VIEs, in particular those that have fee arrangements and related party arrangements, and provides a scope exception for reporting entities with interests held in certain money market funds. The ASU is effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2015 and may be applied through a retrospective or modified retrospective approach. We are currently evaluating the impact of this ASU on our results of operations and financial position.
Recently Adopted Accounting Standards
See Note 1 Accounting Policies in the Notes To Consolidated Financial Statements included in Part I, Item I of this Report regarding the impact of new accounting pronouncements adopted in the first quarter of 2015.
STATUS OF QUALIFIED DEFINEDBENEFIT PENSION PLAN
We have a noncontributory, qualified defined benefit pension plan (plan or pension plan) covering eligible employees. Benefits are determined using a cash balance formula where earnings credits are applied as a percentage of eligible compensation. We calculate the expense associated with the pension plan and the assumptions and methods that we use include a policy of reflecting plan assets at their fair market value. On an annual basis, we review the actuarial assumptions related to the pension plan.
We currently estimate pretax pension expense of $9 million in 2015 compared with pretax income of $7 million in 2014. This year-over-year expected increase in expense reflects the effects of the lower expected return on asset assumption, improved mortality, and the lower discount rate required to be used in 2015. These factors are partially offset by the favorable impact of the increase in plan assets at December 31, 2014 and the assumed return on a $200 million voluntary contribution to the plan made in February 2015.
30 The PNC Financial Services Group, Inc. – Form 10-Q
The table below reflects the estimated effects on pension expense of certain changes in annual assumptions, using 2015 estimated expense as a baseline.
Table 26: Pension Expense – Sensitivity Analysis
EstimatedIncrease/(Decrease)to 2015
Pension
Expense
(In millions)
.5% decrease in discount rate
.5% decrease in expected long-term return on assets
.5% increase in compensation rate
We provide additional information on our pension plan in Note 13 Employee Benefit Plans in the Notes To Consolidated Financial Statements in Item 8 of our 2014 Form 10-K.
RECOURSE AND REPURCHASEOBLIGATIONS
As discussed in Note 2 Loan Sale and Servicing Activities and Variable Interest Entities in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report, PNC has sold commercial mortgage, residential mortgage and home equity loans/lines of credit directly or indirectly through securitization and loan sale transactions in which we have continuing involvement. One form of continuing involvement includes certain recourse and loan repurchase obligations associated with the transferred assets.
Commercial Mortgage Loan Recourse Obligations
We originate and service certain multi-family commercial mortgage loans which are sold to FNMA under FNMA’s Delegated Underwriting and Servicing (DUS) program. We participated in a similar program with the FHLMC. Our exposure and activity associated with these recourse obligations are reported in the Corporate & Institutional Banking segment. For more information regarding our Commercial Mortgage Loan Recourse Obligations, see the Recourse and Repurchase Obligations section of Note 16 Commitments and Guarantees included in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report.
Residential Mortgage Repurchase Obligations
While residential mortgage loans are sold on a non-recourse basis, we assume certain loan repurchase obligations associated with mortgage loans we have sold to investors. These loan repurchase obligations primarily relate to situations where PNC is alleged to have breached certain origination covenants and representations and warranties made to purchasers of the loans in the respective purchase and sale agreements. Residential mortgage loans covered by these
loan repurchase obligations include first and second-lien mortgage loans we have sold through Agency securitizations, Non-Agency securitizations, and loan sale transactions. As discussed in Note 2 in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report, Agency securitizations consist of mortgage loan sale transactions with FNMA, FHLMC and the Government National Mortgage Association (GNMA), while Non-Agency securitizations consist of mortgage loan sale transactions with private investors. Mortgage loan sale transactions that are not part of a securitization may involve FNMA, FHLMC or private investors. Our historical exposure and activity associated with Agency securitization repurchase obligations has primarily been related to transactions with FNMA and FHLMC, as indemnification and repurchase losses associated with FHA and VA-insured and uninsured loans pooled in GNMA securitizations historically have been minimal. In addition to indemnification and repurchase risk, we face other risks of loss with respect to our participation in these programs, some of which are described in Note 15 Legal Proceedings in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report with respect to governmental inquiries related to FHA-insured loans. Repurchase obligation activity associated with residential mortgages is reported in the Residential Mortgage Banking segment.
Origination and sale of residential mortgages is an ongoing business activity and, accordingly, management continually assesses the need to recognize indemnification and repurchase liabilities pursuant to the associated investor sale agreements. We establish indemnification and repurchase liabilities for estimated losses on sold first and second-lien mortgages for which indemnification is expected to be provided or for loans that are expected to be repurchased. For the first and second-lien mortgage sold portfolio, we have established an indemnification and repurchase liability pursuant to investor sale agreements based on claims made and our estimate of future claims on a loan by loan basis. To estimate the mortgage repurchase liability arising from breaches of representations and warranties, we consider the following factors: (i) borrower performance in our historically sold portfolio (both actual and estimated future defaults); (ii) the level of outstanding unresolved repurchase claims; (iii) estimated probable future repurchase claims, considering information about expected investor behaviors, delinquent and liquidated loans, resolved and unresolved mortgage insurance rescission notices and our historical experience with claim rescissions; (iv) the potential ability to cure the defects identified in the repurchase claims (“rescission rate”) and (v) the estimated severity of loss upon repurchase of the loan or collateral, make-whole settlement or indemnification.
We previously reached agreements with both FNMA and FHLMC to resolve their repurchase claims with respect to loans sold between 2000 and 2008. Thus, our repurchase obligations involve Agency securitizations and other loan
The PNC Financial Services Group, Inc. – Form 10-Q 31
sales with FNMA and FHLMC subsequent to 2008 only, as well as Agency securitizations with GNMA and Non-Agency securitizations and other loan sales with private investors. The unpaid principal balance of loans associated with our exposure to repurchase obligations totaled $67.6 billion at March 31, 2015, of which $1.4 billion was 90 days or more delinquent. The comparative amounts were $68.3 billion and $1.5 billion, respectively, at December 31, 2014.
We believe our indemnification and repurchase liability appropriately reflects the estimated probable losses on indemnification and repurchase claims for all residential mortgage loans sold and outstanding as of March 31, 2015 and December 31, 2014. In making these estimates we consider the losses that we expect to incur over the life of the sold loans. See Note 16 Commitments and Guarantees in this Report for additional information on residential mortgage repurchase obligations.
Home Equity Repurchase Obligations
PNC’s repurchase obligations include obligations with respect to certain brokered home equity loans/lines of credit that were sold to a limited number of private investors in the financial services industry by National City prior to our acquisition of National City. PNC is no longer engaged in the brokered home equity lending business, and our exposure under these loan repurchase obligations is limited to repurchases of the loans sold in these transactions. Repurchase activity associated with brokered home equity loans/lines of credit is reported in the Non-Strategic Assets Portfolio segment.
For more information regarding our Home Equity Repurchase Obligations, see the Recourse and Repurchase Obligations section under Item 7 of our 2014 Form 10-K and Note 16 Commitments and Guarantees included in this Report.
RISKMANAGEMENT
PNC encounters risk as part of the normal course of operating our business. Accordingly, we design risk management processes to help manage these risks.
The Risk Management section included in Item 7 of our 2014 Form 10-K describes our enterprise risk management framework including risk appetite and strategy, risk culture, risk organization and governance, risk identification and quantification, risk control and limits, and risk monitoring and reporting. Additionally, our 2014 Form 10-K provides an analysis of our key areas of risk, which include but are not limited to credit, operational, compliance, model, liquidity and market. Our use of financial derivatives as part of our overall asset and liability risk management process is also addressed within the Risk Management section.
The following information updates our 2014 Form 10-K risk management disclosures.
Credit Risk Management
As more fully discussed in the Credit Risk Management portion of the Risk Management section in our 2014 Form 10-K, credit risk represents the possibility that a customer, counterparty or issuer may not perform in accordance with contractual terms. Credit risk is inherent in the financial services business and results from extending credit to customers, purchasing securities, and entering into financial derivative transactions and certain guarantee contracts. Credit risk is one of our most significant risks. Our processes for managing credit risk are embedded in PNC’s risk culture and in our decision-making processes using a systematic approach whereby credit risks and related exposures are identified and assessed, managed through specific policies and processes, measured and evaluated against our risk appetite and credit concentration limits, and reported, along with specific mitigation activities, to management and the Board through our governance structure.
Asset Quality Overview
Asset quality trends improved during the first three months of 2015.
Nonperforming assets at March 31, 2015 decreased $126 million compared with December 31, 2014 as a result of improvements in both consumer and commercial nonperforming loans. Consumer lending nonperforming loans decreased $54 million, commercial real estate nonperforming loans declined $41 million and commercial nonperforming loans decreased $10 million. Nonperforming assets were 0.78% of total assets at March 31, 2015 compared with 0.83% at December 31, 2014.
Overall loan delinquencies of $1.8 billion decreased $196 million, or 10%, from year-end 2014 levels. The reduction was due in large part to a reduction in accruing government insured residential real estate loans past due 90 days or more of $85 million, the majority of which we took possession of and conveyed the real estate, or are in the process of conveyance and claim resolution.
Net charge-offs were $103 million in the first quarter of 2015, down 45% from net charge-offs in the same quarter of 2014 of $186 million, due primarily to improved overall credit quality.
Provision for credit losses in the first quarter of 2015 decreased to $54 million compared with $94 million in the first quarter of 2014. The smaller provision is attributed to improved overall credit quality, including lower consumer loan delinquencies, and the increasing value of residential real estate which resulted in greater expected cash flows from our purchased impaired loans.
The level of ALLL remained at $3.3 billion at both March 31, 2015 and December 31, 2014.
32 The PNC Financial Services Group, Inc. – Form 10-Q
Nonperforming Assets and Loan Delinquencies
Nonperforming Assets, including OREO and Foreclosed Assets
Nonperforming assets include nonperforming loans and leases for which ultimate collectability of the full amount of contractual principal and interest is not probable and include nonperforming troubled debt restructurings (TDRs), OREO and foreclosed assets. Loans held for sale, certain government insured or guaranteed loans, purchased impaired loans and loans accounted for under the fair value option are excluded from nonperforming loans. Additional information regarding our nonperforming loans and nonaccrual policies is included in Note 1 Accounting Policies in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report. A summary of the major categories of nonperforming assets are presented in Table 27. See Note 3 Asset Quality in the Notes To Consolidated Financial Statements of this Report for further detail of nonperforming asset categories.
Table 27: Nonperforming Assets By Type
Consumer lending (a)
Total nonperforming loans (b) (c)
OREO and foreclosed assets
Total nonperforming assets
Amount of TDRs included in nonperforming loans
Percentage of total nonperforming loans
Allowance for loan and lease losses to total nonperforming loans (d)
Table 28: Change in Nonperforming Assets
New nonperforming assets
Charge-offs and valuation adjustments
Principal activity, including paydowns and payoffs
Asset sales and transfers to loans held for sale
Returned to performing status
Nonperforming assets decreased $126 million at March 31, 2015 compared to December 31, 2014, as a result of improvements in both consumer and commercial lending. Consumer lending nonperforming loans decreased $54 million, commercial real estate nonperforming loans declined $41 million and commercial nonperforming loans decreased $10 million. As of March 31, 2015, approximately 91% of total nonperforming loans were secured by collateral which lessens reserve requirements and is expected to reduce credit losses in the event of default. As of March 31, 2015, commercial lending nonperforming loans were carried at approximately 64% of their unpaid principal balance, due to charge-offs recorded to date, before consideration of the ALLL. See Note 3 Asset Quality in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report for additional information on these loans.
Within consumer nonperforming loans, residential real estate TDRs comprise 63% of total residential real estate nonperforming loans at March 31, 2015, up from 60% at December 31, 2014. Home equity TDRs comprise 53% of home equity nonperforming loans at March 31, 2015, down from 54% at December 31, 2014. TDRs generally remain in nonperforming status until a borrower has made at least six consecutive months of both principal and interest payments under the modified terms or ultimate resolution occurs. Loans where borrowers have been discharged from personal liability through Chapter 7 bankruptcy and have not formally reaffirmed their loan obligations to PNC and loans to borrowers not currently obligated to make both principal and interest payments under the restructured terms are not returned to accrual status.
At March 31, 2015, our largest nonperforming asset was $35 million in the Real Estate, Rental and Leasing Industry and our average nonperforming loans associated with commercial lending were under $1 million. All of the ten largest outstanding nonperforming assets are from the commercial lending portfolio and represent 21% and 4% of total commercial lending nonperforming loans and total nonperforming assets, respectively, as of March 31, 2015.
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Purchased impaired loans are considered performing, even if contractually past due (or if we do not expect to receive payment in full based on the original contractual terms), as we accrete interest income over the expected life of the loans. Total nonperforming loans and assets in the tables above are significantly lower than they would have been due to this accounting treatment for purchased impaired loans. This treatment also results in a lower ratio of nonperforming loans to total loans and a higher ratio of ALLL to nonperforming loans. See Note 4 Purchased Loans in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report, as well as the Credit Risk Management portion of the Risk Management section in our 2014 Form 10-K for additional information, including the accounting treatment, on these loans.
Table 29: OREO and Foreclosed Assets
Other real estate owned (OREO):
Residential properties
Residential development properties
Commercial properties
Total OREO
Foreclosed and other assets
Total OREO and foreclosed assets
Total OREO and foreclosed assets decreased $21 million during the first three months of 2015 and is 13% of total nonperforming assets at March 31, 2015. As of both March 31, 2015 and December 31, 2014, 62% of our OREO and foreclosed assets were comprised of residential related properties.
Loan Delinquencies
We regularly monitor the level of loan delinquencies and believe these levels may be a key indicator of loan portfolio asset quality. Measurement of delinquency status is based on the contractual terms of each loan. Loans that are 30 days or more past due in terms of payment are considered delinquent. Loan delinquencies exclude loans held for sale and purchased impaired loans, but include government insured or guaranteed loans and loans accounted for under the fair value option.
Table 30: Accruing Loans Past Due (a) (b)
Early stage loan delinquencies
Accruing loans past due 30 to 59 days
Accruing loans past due 60 to 89 days
Late stage loan delinquencies
Accruing loans past due 90 days or more
Total early stage loan delinquencies (accruing loans past due 30 to 89 days) decreased $79 million at March 31, 2015 compared to December 31, 2014, driven by reductions in both consumer and commercial lending early stage delinquencies due to improved credit quality.
Accruing loans past due 90 days or more decreased $117 million, or 11%, at March 31, 2015 compared to December 31, 2014 due to a decline in government insured residential real estate loans of $85 million, the majority of
which we took possession of and conveyed the real estate, or are in the process of conveyance and claim resolution. Accruing loans past due 90 days or more are referred to as late stage loan delinquencies. These loans are not included in nonperforming loans and continue to accrue interest because they are well secured by collateral, and/or are in the process of collection, are managed in homogenous portfolios with specified charge-off timeframes adhering to regulatory guidelines, or are certain government insured or guaranteed loans.
34 The PNC Financial Services Group, Inc. – Form 10-Q
On a regular basis our Special Asset Committee closely monitors loans, primarily commercial loans, that are not included in the nonperforming or accruing past due categories and for which we are uncertain about the borrower’s ability to comply with existing repayment terms. These loans totaled $.2 billion at both March 31, 2015 and December 31, 2014.
See Note 1 Accounting Policies and Note 3 Asset Quality in the Notes To Consolidated Financial Statements of this Report for additional information regarding our nonperforming loan and nonaccrual policies and further information on loan delinquencies.
Home Equity Loan Portfolio
Our home equity loan portfolio totaled $34.1 billion as of March 31, 2015, or 17% of the total loan portfolio. Of that total, $19.9 billion, or 58%, was outstanding under primarily variable-rate home equity lines of credit and $14.1 billion, or 42%, consisted of closed-end home equity installment loans. Approximately 6% of the home equity portfolio was purchased credit impaired and 3% of the home equity portfolio was on nonperforming status as of March 31, 2015.
As of March 31, 2015, we are in an originated first lien position for approximately 52% of the total outstanding portfolio and, where originated as a second lien, we currently hold or service the first lien position for an additional 2% of the portfolio. The remaining 46% of the portfolio was secured by second liens where we do not hold the first lien position. The credit performance of the majority of the home equity portfolio where we are in, hold or service the first lien position, is superior to the portion of the portfolio where we hold the second lien position but do not hold the first lien.
Generally, our variable-rate home equity lines of credit have either a seven or ten year draw period, followed by a 20-year amortization term. During the draw period, we have home equity lines of credit where borrowers pay either interest or principal and interest. We view home equity lines of credit where borrowers are paying principal and interest under the draw period as less risky than those where the borrowers are paying interest only, as these borrowers have a demonstrated ability to make some level of principal and interest payments. The risk associated with the borrower’s ability to satisfy the loan terms upon the draw period ending is considered in establishing our ALLL. Based upon outstanding balances at March 31, 2015, the following table presents the periods when home equity lines of credit draw periods are scheduled to end.
Table 31: Home Equity Lines of Credit – Draw Period End Dates
Remainder of 2015
2016
2017
2018
2019
2020 and thereafter
Total (a) (b)
Based upon outstanding balances, and excluding purchased impaired loans, at March 31, 2015, for home equity lines of credit for which the borrower can no longer draw (e.g., draw period has ended or borrowing privileges have been terminated), approximately 3% were 30-89 days past due and approximately 5% were 90 days or more past due. Generally, when a borrower becomes 60 days past due, we terminate borrowing privileges and those privileges are not subsequently reinstated. At that point, we continue our collection/recovery processes, which may include loan modification resulting in a loan that is classified as a TDR.
See the Credit Risk Management portion of the Risk Management section in our 2014 Form 10-K for more information on our home equity loan portfolio.
Loan Modifications and Troubled Debt Restructurings
Consumer Loan Modifications
We modify loans under government and PNC-developed programs based upon our commitment to help eligible homeowners and borrowers avoid foreclosure, where appropriate. Initially, a borrower is evaluated for a modification under a government program. If a borrower does not qualify under a government program, the borrower is then evaluated under a PNC program. Our programs utilize both temporary and permanent modifications and typically reduce the interest rate, extend the term and/or defer principal. Loans that are either temporarily or permanently modified under programs involving a change to loan terms are generally classified as TDRs. Further, loans that have certain types of payment plans and trial payment arrangements which do not include a contractual change to loan terms may be classified as TDRs. Additional detail on TDRs is discussed below as well as in Note 3 Asset Quality in our 2014 Form 10-K.
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A temporary modification, with a term between 3 and 24 months, involves a change in original loan terms for a period of time and reverts to a calculated exit rate for the remaining term of the loan as of a specific date. A permanent modification, with a term greater than 24 months, is a modification in which the terms of the original loan are changed. Permanent modification programs primarily include the government-created Home Affordable Modification Program (HAMP) and PNC-developed HAMP-like modification programs. These programs first require a reduction of the interest rate followed by an extension of term and, if appropriate, deferral of principal payments.
We also monitor the success rates and delinquency status of our loan modification programs to assess their effectiveness in serving our customers’ needs while mitigating credit losses. Table 32 provides the number of accounts and unpaid principal balance of modified consumer real estate related loans at the end of each year presented and Table 33 provides the number of accounts and unpaid principal balance of modified loans that were 60 days or more past due as of six months, nine months, twelve months and fifteen months after the modification date.
Table 32: Consumer Real Estate Related Loan Modifications
Temporary Modifications
Permanent Modifications
Residential Mortgages
Non-Prime Mortgages
Residential Construction
Total Consumer Real Estate Related Loan Modifications
36 The PNC Financial Services Group, Inc. – Form 10-Q
Table 33: Consumer Real Estate Related Loan Modifications Re-Default by Vintage (a) (b)
March 31, 2015
Home Equity
Third Quarter 2014
Second Quarter 2014
First Quarter 2014
Fourth Quarter 2013
Third Quarter 2013
In addition to temporary loan modifications, we may make available to a borrower a payment plan or a HAMP trial payment period. Under a payment plan or a HAMP trial payment period, there is no change to the loan’s contractual terms so the borrower remains legally responsible for payment of the loan under its original terms.
Payment plans may include extensions, re-ages and/or forbearance plans. All payment plans bring an account current once certain requirements are achieved and are primarily intended to demonstrate a borrower’s renewed willingness and ability to re-pay. Due to the short term nature of the payment plan, there is a minimal impact to the ALLL.
The PNC Financial Services Group, Inc. – Form 10-Q 37
Under a HAMP trial payment period, we establish an alternate payment, generally at an amount less than the contractual payment amount, for the borrower during this short time period. This allows a borrower to demonstrate successful payment performance before permanently restructuring the loan into a HAMP modification. Subsequent to successful borrower performance under the trial payment period, we will capitalize the original contractual amount past due, to include accrued interest and fees receivable, and restructure the loan’s contractual terms, along with bringing the restructured account current. As the borrower is often already delinquent at the time of participation in the HAMP trial payment period, generally enrollment in the program does not significantly increase the ALLL. If the trial payment period is unsuccessful, the loan will be evaluated for further action based upon our existing policies.
Commercial Loan Modifications and Payment Plans
Modifications of terms for commercial loans are based on individual facts and circumstances. Commercial loan modifications may involve reduction of the interest rate, extension of the loan term and/or forgiveness of principal. Modified commercial loans are usually already nonperforming prior to modification. We evaluate these modifications for TDR classification based upon whether we granted a concession to a borrower experiencing financial difficulties. Additional detail on TDRs is discussed below as well as in Note 3 Asset Quality in our 2014 Form 10-K.
We have established certain commercial loan modification and payment programs for small business loans, Small Business Administration loans, and investment real estate loans. As of March 31, 2015 and December 31, 2014, $30 million and $34 million, respectively, in loan balances were covered under these modification and payment plan programs. Of these loan balances, $11 million and $12 million have been determined to be TDRs as of March 31, 2015 and December 31, 2014, respectively.
Troubled Debt Restructurings
A TDR is a loan whose terms have been restructured in a manner that grants a concession to a borrower experiencing financial difficulties. TDRs result from our loss mitigation activities and include rate reductions, principal forgiveness, postponement/reduction of scheduled amortization and extensions, which are intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Additionally, TDRs also result from borrowers that have been discharged from personal liability through Chapter 7
bankruptcy and have not formally reaffirmed their loan obligations to PNC. For the three months ended March 31, 2015, $232 million of Consumer loans held for sale, loans accounted for under the fair value option and pooled purchased impaired loans, as well as certain government insured or guaranteed loans, were excluded from the TDR population. The comparable amount for the three months ended March 31, 2014 was $302 million.
Table 34: Summary of Troubled Debt Restructurings (a)
Consumer lending:
Real estate-related
Total TDRs
Nonperforming
Accruing
Total TDRs decreased $53 million, or 2%, during the first quarter of 2015. Nonperforming TDRs were approximately 55% of total nonperforming loans, and 52% of total TDRs.
TDRs that are performing, including credit card loans, are excluded from nonperforming loans. These TDRs remained flat during the first quarter of 2015 at $1.2 billion. Generally, the accruing category is comprised of loans where borrowers have been performing under the restructured terms for at least six consecutive months. Loans where borrowers have been discharged from personal liability through Chapter 7 bankruptcy and have not formally reaffirmed their loan obligations to PNC and loans to borrowers not currently obligated to make both principal and interest payments under the restructured terms are not returned to accrual status.
See Note 3 Asset Quality and the Credit Risk Management portion of the Risk Management section in our 2014 Form 10-K for additional information on loan modifications and TDRs.
38 The PNC Financial Services Group, Inc. – Form 10-Q
We recorded $103 million in net charge-offs for the first three months of 2015, compared to $186 million in the first three months of 2014. Commercial lending net charge-offs decreased from $31 million in the first three months of 2014 to $1 million in the first three months of 2015. Consumer lending net charge-offs decreased from $155 million in the first three months of 2014 to $102 million in the first three months of 2015.
Table 35: Loan Charge-Offs And Recoveries
Three months endedMarch 31
Total net charge-offs are lower than they would have been otherwise due to the accounting treatment for purchased impaired loans. This treatment also results in a lower ratio of net charge-offs to average loans. See Note 4 Purchased Loans in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report for additional information on net charge-offs related to these loans.
We maintain an ALLL to absorb losses from the loan and lease portfolio and determine this allowance based on quarterly assessments of the estimated probable credit losses incurred in the loan and lease portfolio. Our total ALLL of $3.3 billion at March 31, 2015 consisted of $1.6 billion and $1.7 billion established for the commercial lending and consumer lending categories, respectively. We maintain the
ALLL at a level that we believe to be appropriate to absorb estimated probable credit losses incurred in the loan and lease portfolio as of the balance sheet date. The reserve calculation and determination process is dependent on the use of key assumptions. Key reserve assumptions and estimation processes react to and are influenced by observed changes in loan and lease portfolio performance experience, the financial strength of the borrower, and economic conditions. Key reserve assumptions are periodically updated.
We establish specific allowances for loans considered impaired using methods prescribed by GAAP. All impaired loans are subject to individual analysis, except leases and large groups of smaller-balance homogeneous loans which may include, but are not limited to, credit card, residential real estate secured and consumer installment loans. Specific allowances for individual loans (including commercial and consumer TDRs) are determined based on an analysis of the present value of expected future cash flows from the loans discounted at their effective interest rate, observable market price or the fair value of the underlying collateral.
Reserves allocated to non-impaired commercial loan classes are based on PD and LGD credit risk ratings.
Our commercial pool reserve methodology is sensitive to changes in key risk parameters such as PD and LGD. The results of these parameters are then applied to the loan balance and unfunded loan commitments and letters of credit to determine the amount of the respective reserves. Our PDs and LGDs are primarily determined using internal commercial loan loss data. This internal data is supplemented with third-party data and management judgment, as deemed necessary. We continue to evaluate and enhance our use of internal commercial loss data and will periodically update our PDs and LGDs as well as consider third-party data, regulatory guidance and management judgment.
The majority of the commercial portfolio is secured by collateral, including loans to asset-based lending customers, which generally demonstrate lower LGD compared to loans not secured by collateral. Additionally, guarantees on loans greater than $1 million and owner guarantees for small business loans do not significantly impact our ALLL.
Allocations to non-impaired consumer loan classes are primarily based upon a roll-rate model which uses statistical relationships, calculated from historical data that estimate the movement of loan outstandings through the various stages of delinquency and ultimately charge-off.
A portion of the ALLL is related to qualitative and measurement factors. These factors may include, but are not limited to, the following:
Industry concentrations and conditions,
Recent credit quality trends,
Recent loss experience in particular portfolios,
The PNC Financial Services Group, Inc. – Form 10-Q 39
Recent macro-economic factors,
Model imprecision,
Changes in lending policies and procedures,
Timing of available information, including the performance of first lien positions, and
Limitations of available historical data.
Purchased impaired loans are initially recorded at fair value and applicable accounting guidance prohibits the carry over or creation of valuation allowances at acquisition. Because the initial fair values of these loans already reflect a credit component, additional reserves are established when performance is expected to be worse than our expectations as of the acquisition date. At March 31, 2015, we had established reserves of $.9 billion for purchased impaired loans. In addition, loans (purchased impaired and non-impaired) acquired after January 1, 2009 were recorded at fair value. No allowance for loan losses was carried over and no allowance was created at the date of acquisition. See Note 4 Purchased Loans in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report for additional information.
In determining the appropriateness of the ALLL, we make specific allocations to impaired loans and allocations to portfolios of commercial and consumer loans. We also allocate reserves to provide coverage for probable losses incurred in the portfolio at the balance sheet date based upon current market conditions, which may not be reflected in historical loss data. Commercial lending is the largest category of credits and is sensitive to changes in assumptions and judgments underlying the determination of the ALLL. We have allocated approximately $1.6 billion, or 48%, of the ALLL at March 31, 2015 to the commercial lending category. Consumer lending allocations are made based on historical loss experience adjusted for recent activity. Approximately $1.7 billion, or 52%, of the ALLL at March 31, 2015 has been allocated to these consumer lending categories.
In addition to the ALLL, we maintain an allowance for unfunded loan commitments and letters of credit. We report this allowance as a liability on our Consolidated Balance Sheet. We maintain the allowance for unfunded loan commitments and letters of credit at a level we believe is appropriate to absorb estimated probable losses on these unfunded credit facilities. We determine this amount using estimates of the probability of the ultimate funding and losses related to those credit exposures. Other than the estimation of the probability of funding, this methodology is very similar to the one we use for determining our ALLL.
We refer you to Note 1 Accounting Policies and Note 3 Asset Quality in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report and in our 2014 Form 10-K for further information on certain key asset quality indicators that we use to evaluate our portfolios and establish the allowances.
Table 36: Allowance for Loan and Lease Losses
Net change in allowance for unfunded loan commitments and letters of credit
Total allowance for loan and lease losses to total loans
Consumer lending net charge-offs
The provision for credit losses totaled $54 million for the first three months of 2015 compared to $94 million for the first three months of 2014. The primary driver of the decrease to the provision was improved overall credit quality, including lower consumer loan delinquencies, and the increasing value of residential real estate which resulted in greater expected cash flows for our purchased impaired loans. For the first three months of 2015, the provision for commercial lending credit losses decreased by $20 million, or 111%, from the first three months of 2014. The provision for consumer lending credit losses also decreased $20 million, or 26%, from the first three months of 2014.
At March 31, 2015, total ALLL to total nonperforming loans was 137%. The comparable amount for December 31, 2014 was 133%. These ratios are 88% and 85%, respectively, when excluding the $1.2 billion of ALLL at both March 31, 2015 and December 31, 2014 allocated to consumer loans and lines of credit not secured by residential real estate and purchased impaired loans. We have excluded consumer loans and lines of credit not secured by real estate as they are charged off after 120 to 180 days past due and not placed on nonperforming status. Additionally, we have excluded purchased impaired loans as they are considered performing regardless of their delinquency status as interest is accreted in accordance with ASC 310-30 based on the recorded investment balance. See Table 27 within this Credit Risk Management section for additional information.
The ALLL balance increases or decreases across periods in relation to fluctuating risk factors, including asset quality trends, net charge-offs and changes in aggregate portfolio balances. During the first three months of 2015, improving
40 The PNC Financial Services Group, Inc. – Form 10-Q
asset quality trends, including, but not limited to, delinquency status and improving economic conditions, as well as reduced net charge-offs and overall portfolio growth combined to result in the ALLL remaining essentially flat at March 31, 2015 compared to December 31, 2014.
See Note 1 Accounting Policies and Note 4 Purchased Loans in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report regarding changes in the ALLL and in the allowance for unfunded loan commitments and letters of credit.
Liquidity Risk Management
Liquidity risk, including our liquidity monitoring measures and tools, is described in further detail in the Liquidity Risk Management section of our 2014 Form 10-K.
PNC also monitors its liquidity by reference to the LCR, a regulatory minimum liquidity requirement designed to ensure that covered banking organizations maintain an adequate level of liquidity to meet net liquidity needs over the course of a 30-day stress scenario. The LCR is calculated by dividing the amount of an institution’s high quality, unencumbered liquid assets (HQLA), as defined and calculated in accordance with the haircuts and limitations of the LCR rules, by its estimated net cash outflow, with net cash outflows determined by applying assumed outflow factors in the LCR rules. The resulting quotient is expressed as a percentage. For PNC and PNC Bank, the LCR became effective January 1, 2015. The minimum required LCR will be phased-in over a period of years. For 2015, PNC and PNC Bank are required to calculate the LCR on a month-end basis and the minimum LCR that PNC and PNC Bank are required to maintain is 80 percent. Effective July 1, 2016, PNC and PNC Bank must begin calculating their respective LCR ratios on a daily basis.
As of March 31, 2015, the LCR for PNC and PNC Bank exceeded 100 percent. The March 31, 2015 LCR calculation and the underlying components are based on PNC’s current interpretation and understanding of the final LCR rules and are subject to, among other things, further regulatory guidance.
We provide additional information regarding regulatory liquidity requirements and their potential impact on PNC in the Supervision and Regulation section of Item 1 Business and Item 1A Risk Factors of our 2014 Form 10-K.
Bank Level Liquidity – Uses
At the bank level, primary contractual obligations include funding loan commitments, satisfying deposit withdrawal requests and maturities and debt service related to bank borrowings. As of March 31, 2015, there were approximately $8.7 billion of bank borrowings with contractual maturities of less than one year. We also maintain adequate bank liquidity to meet future potential loan demand and provide for other business needs, as necessary.
Bank Level Liquidity – Sources
Our largest source of bank liquidity on a consolidated basis is the deposit base generated by our retail and commercial banking businesses. Total deposits increased to $236.5 billion at March 31, 2015 from $232.2 billion at December 31, 2014, driven by higher retail deposits. Assets determined by PNC to be liquid (liquid assets) and unused borrowing capacity from a number of sources are also available to maintain our liquidity position. Borrowed funds come from a diverse mix of short-term and long-term funding sources.
At March 31, 2015, our liquid assets consisted of short-term investments (Federal funds sold, resale agreements, trading securities and interest-earning deposits with banks) totaling $35.2 billion and securities available for sale totaling $47.6 billion. The level of liquid assets fluctuates over time based on many factors, including market conditions, loan and deposit growth and balance sheet management activities. Of our total liquid assets of $82.8 billion, we had $4.0 billion of securities available for sale and trading securities pledged as collateral to secure public and trust deposits, repurchase agreements and for other purposes. In addition to the liquid assets we pledged, $6.5 billion of securities held to maturity were also pledged as collateral for these purposes.
In addition to the customer deposit base, which has historically provided the single largest source of relatively stable and low-cost funding, the bank also obtains liquidity through the issuance of traditional forms of funding including long-term debt (senior notes and subordinated debt and FHLB advances) and short-term borrowings (Federal funds purchased, securities sold under repurchase agreements, commercial paper issuances and other short-term borrowings).
The PNC Financial Services Group, Inc. – Form 10-Q 41
Under its 2014 bank note program, PNC Bank may from time to time offer up to $25 billion aggregate principal amount at any one time outstanding of its unsecured senior and subordinated notes due more than nine months from their date of issue (in the case of senior notes) and due five years or more from their date of issue (in the case of subordinated notes). The $25 billion of notes authorized to be issued and outstanding at any one time includes notes issued by PNC Bank prior to January 16, 2014 under the 2004 bank note program and those notes PNC Bank has assumed through the acquisition of other banks, in each case for so long as such notes remain outstanding. The terms of the new program do not affect any of the bank notes issued prior to January 16, 2014. At March 31, 2015, PNC Bank had $18.4 billion of notes outstanding under this program. The following table details all issuances during 2015:
Table 37: PNC Bank Bank Notes Issued During 2015
February 6, 2015
February 23, 2015
Total senior and subordinated debt of PNC Bank increased to $20.0 billion at March 31, 2015 from $17.5 billion at December 31, 2014 due to the following activity in the period.
Table 38: PNC Bank Senior and Subordinated Debt
Issuances
PNC Bank is a member of the FHLB-Pittsburgh and, as such, has access to advances from FHLB-Pittsburgh secured generally by residential mortgage loans, other mortgage-related loans and commercial mortgage-backed securities. At March 31, 2015, our unused secured borrowing capacity was $16.3 billion with FHLB-Pittsburgh. Total FHLB borrowings increased to $21.2 billion at March 31, 2015 from $20.0 billion at December 31, 2014 due to the following activity in the period.
Table 39: FHLB Borrowings
The FHLB-Pittsburgh also periodically provides standby letters of credit on behalf of PNC Bank to secure certain public deposits. PNC Bank began using standby letters of credit issued by the FHLB-Pittsburgh for these purposes in response to the regulatory liquidity standards finalized during 2014. If the FHLB-Pittsburgh is required to make payment for a beneficiary’s draw, the payment amount is converted into a collateralized advance to PNC Bank. At both March 31, 2015 and December 31, 2014, standby letters of credit issued on our behalf by the FHLB-Pittsburgh totaled $6.2 billion.
PNC Bank has the ability to offer up to $10.0 billion of its commercial paper to provide additional liquidity. As of March 31, 2015, there was $4.4 billion outstanding under this program.
PNC Bank can also borrow from the Federal Reserve Bank discount window to meet short-term liquidity requirements. The Federal Reserve Bank, however, is not viewed as the primary means of funding our routine business activities, but rather as a potential source of liquidity in a stressed environment or during a market disruption. These potential borrowings are secured by commercial loans. At March 31, 2015, our unused secured borrowing capacity was $16.0 billion with the Federal Reserve Bank.
Parent Company Liquidity
As of March 31, 2015, available parent company liquidity totaled $6.2 billion. Parent company liquidity is primarily held in short-term investments, the terms of which provide for the availability of cash in 31 days or less. Investments with longer durations may also be acquired, but if so, the related maturities are aligned with scheduled cash needs, such as the maturity of parent company debt obligations.
Parent Company Liquidity – Uses
The parent company’s contractual obligations consist primarily of debt service related to parent company borrowings and funding non-bank affiliates. As of March 31,
42 The PNC Financial Services Group, Inc. – Form 10-Q
2015, there were approximately $1.1 billion of parent company borrowings with contractual maturities of less than one year. Additionally, the parent company maintains adequate liquidity to fund discretionary activities such as paying dividends to PNC shareholders, share repurchases, and acquisitions.
See Balance Sheet, Liquidity and Capital Highlights in the Executive Summary section of this Financial Review for information on our 2015 capital plan that was accepted by the Federal Reserve. Our capital plan included a recommendation to increase the quarterly common stock dividend in the second quarter of 2015 and the ability to redeem the Series K Preferred Stock, as further described below, and also included share repurchase programs of up to $2.875 billion for the five quarter period beginning in the second quarter of 2015. See the Capital portion of the Consolidated Balance Sheet Review in this Financial Review for more information on our share repurchase programs, including detail on our first quarter repurchase of 4.4 million common shares for $.4 billion.
On April 2, 2015, consistent with our 2015 capital plan, our Board of Directors approved an increase to PNC’s quarterly common stock dividend from 48 cents per common share to 51 cents per common share beginning with the May 5, 2015 dividend payment.
See the Supervision and Regulation section of Item 1 Business in our 2014 Form 10-K for additional information regarding the Federal Reserve’s CCAR process and the factors the Federal Reserve takes into consideration in evaluating capital plans, qualitative and quantitative liquidity risk management standards proposed by the U.S. banking agencies, and final rules issued by the Federal Reserve that make certain modifications to the Federal Reserve’s capital planning and stress testing rules.
See Table 37 for information on an affiliate purchase of notes issued by PNC Bank during 2015.
Parent Company Liquidity – Sources
The principal source of parent company liquidity is the dividends it receives from its subsidiary bank, which may be impacted by the following:
Bank-level capital needs,
Laws and regulations,
Corporate policies,
Contractual restrictions, and
Other factors.
There are statutory and regulatory limitations on the ability of national banks to pay dividends or make other capital distributions or to extend credit to the parent company or its non-bank subsidiaries. The amount available for dividend payments by PNC Bank to the parent company without prior regulatory approval was approximately $1.2 billion at March 31, 2015. See Note 20 Regulatory Matters in the Notes To Consolidated Financial Statements in Item 8 of our 2014 Form 10-K for a further discussion of these limitations. We provide additional information on certain contractual restrictions in Note 12 Capital Securities of a Subsidiary Trust and Perpetual Trust Securities in the Notes To Consolidated Financial Statements in Item 8 of our 2014 Form 10-K.
In addition to dividends from PNC Bank, other sources of parent company liquidity include cash and investments, as well as dividends and loan repayments from other subsidiaries and dividends or distributions from equity investments.
We can also generate liquidity for the parent company and PNC’s non-bank subsidiaries through the issuance of debt and equity securities, including certain capital instruments, in public or private markets and commercial paper. We have an effective shelf registration statement pursuant to which we can issue additional debt, equity and other capital instruments.
Total parent company senior and subordinated debt and hybrid capital instruments decreased to $8.7 billion at March 31, 2015 from $10.1 billion at December 31, 2014 due to the following activity in the period.
Table 40: Parent Company Senior and Subordinated Debt and Hybrid Capital Instruments
Maturities
The parent company has the ability to offer up to $5.0 billion of commercial paper to provide additional liquidity. As of March 31, 2015, there were no issuances outstanding under this program.
The PNC Financial Services Group, Inc. – Form 10-Q 43
Status of Credit Ratings
The cost and availability of short-term and long-term funding, as well as collateral requirements for certain derivative instruments, is influenced by PNC’s debt ratings.
In general, rating agencies base their ratings on many quantitative and qualitative factors, including capital adequacy, liquidity, asset quality, business mix, level and quality of earnings, and the current legislative and regulatory environment, including implied government support. In addition, rating agencies themselves have been subject to scrutiny arising from the most recent financial crisis and could make or be required to make substantial changes to their ratings policies and practices, particularly in response to legislative and regulatory changes. Potential changes in the legislative and regulatory environment and the timing of those changes could impact our ratings, which as noted above, could impact our liquidity and financial condition. A decrease, or potential decrease, in credit ratings could impact access to the capital markets and/or increase the cost of debt, and thereby adversely affect liquidity and financial condition.
On March 16, 2015, Moody’s Investors Service (Moody’s) published a new bank ratings methodology which is being implemented on a global basis and includes assessment of expected loss ratings on instruments ranging from bank deposits to preferred stock. On March 17, 2015, Moody’s announced rating actions related to this change in
methodology for various banking entities across the globe. As part of the announcement, several ratings for PNC and PNC Bank were placed under review for upgrade, including the subordinated debt and preferred stock ratings for PNC, and the long-term deposits rating for PNC Bank. In addition, two ratings for PNC Bank, the long-term senior unsecured and issuer rating (Senior debt), and the short-term notes and issuer rating, were placed under review for possible downgrade. In light of this change in methodology, PNC is reviewing options related to the two ratings under review for possible downgrade.
Table 41: Credit Ratings as of March 31, 2015 for PNC and PNC Bank
PNC
Senior debt
Preferred stock
PNC Bank
Long-term deposits
Short-term deposits
Short-term notes
Commitments
The following tables set forth contractual obligations and various other commitments as of March 31, 2015 representing required and potential cash outflows.
Table 42: Contractual Obligations
Remaining contractual maturities of time deposits (a)
Borrowed funds (a) (b)
Minimum annual rentals on noncancellable leases
Nonqualified pension and postretirement benefits
Purchase obligations (c)
Total contractual cash obligations
At March 31, 2015, we had unrecognized tax benefits of $83 million, which represents a reserve for tax positions that we have taken in our tax returns which ultimately may not be sustained upon examination by taxing authorities. Since the ultimate amount and timing of any future cash settlements cannot be predicted with reasonable certainty, this estimate has been excluded from the contractual obligations table. See Note 14 Income Taxes in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report for additional information.
Our contractual obligations totaled $82.0 billion at December 31, 2014. The decrease in the comparison is primarily attributable to the decline in time deposits. See Funding Sources in the Consolidated Balance Sheet Review section of this Financial Review for additional information regarding our funding sources.
44 The PNC Financial Services Group, Inc. – Form 10-Q
Table 43: Other Commitments (a)
Commitments to extend credit (b)
Net outstanding standby letters of credit (c)
Reinsurance agreements (d)
Standby bond purchase agreements
Other commitments (e)
Total commitments
Our total commitments were $156.0 billion at December 31, 2014. The decrease in the comparison is primarily due to the declining exposure on our commitments to extend credit and the decrease in reinsurance agreements driven by the programs being in run-off. See Note 16 Commitments and Guarantees in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report for additional information related to our commitments.
Market Risk Management
Market risk is the risk of a loss in earnings or economic value due to adverse movements in market factors such as interest rates, credit spreads, foreign exchange rates, commodity prices and equity prices. We are exposed to market risk primarily by our involvement in the following activities, among others:
Traditional banking activities of gathering deposits and extending loans,
Equity and other investments and activities whose economic values are directly impacted by market factors, and
Fixed income securities, derivatives and foreign exchange activities, as a result of customer activities and securities underwriting.
We have established enterprise-wide policies and methodologies to identify, measure, monitor and report market risk. Market Risk Management provides independent oversight by monitoring compliance with these limits and guidelines, and reporting significant risks in the business to the Risk Committee of the Board.
Market Risk Management – Interest Rate Risk
Interest rate risk results primarily from our traditional banking activities of gathering deposits and extending loans. Many factors, including economic and financial conditions, movements in interest rates and consumer preferences, affect the difference between the interest that we earn on assets and the interest that we pay on liabilities and the level of our noninterest-bearing funding sources. Due to the repricing term mismatches and embedded options inherent in certain of these products, changes in market interest rates not only affect expected near-term earnings, but also the economic values of these assets and liabilities.
Asset and Liability Management centrally manages interest rate risk as prescribed in our risk management policies, which are approved by management’s Asset and Liability Committee and the Risk Committee of the Board.
The PNC Financial Services Group, Inc. – Form 10-Q 45
Sensitivity results and market interest rate benchmarks for the first quarters of 2015 and 2014 follow:
Table 44: Interest Sensitivity Analysis
Net Interest Income Sensitivity Simulation (a)
Effect on net interest income in first year from gradual interest rate change over following 12 months of:
100 basis point increase
100 basis point decrease
Effect on net interest income in second year from gradual interest rate change over the preceding 12 months of:
Duration of Equity Model (a)
Base case duration of equity (in years)
Key Period-End Interest Rates
One-month LIBOR
Three-year swap
In addition to measuring the effect on net interest income assuming parallel changes in current interest rates, we routinely simulate the effects of a number of nonparallel interest rate environments. Table 45 reflects the percentage change in net interest income over the next two 12-month periods assuming (i) the PNC Economist’s most likely rate forecast, (ii) implied market forward rates and (iii) Yield Curve Slope Flattening (a 100 basis point yield curve slope flattening between 1-month and ten-year rates superimposed on current base rates) scenario.
Table 45: Net Interest Income Sensitivity to Alternative Rate Scenarios (First Quarter 2015)
First year sensitivity
Second year sensitivity
All changes in forecasted net interest income are relative to results in a base rate scenario where current market rates are assumed to remain unchanged over the forecast horizon.
When forecasting net interest income, we make assumptions about interest rates and the shape of the yield curve, the volume and characteristics of new business and the behavior of existing on- and off-balance sheet positions. These assumptions determine the future level of simulated net
interest income in the base interest rate scenario and the other interest rate scenarios presented in Tables 44 and 45 above. These simulations assume that as assets and liabilities mature, they are replaced or repriced at then current market rates. We also consider forward projections of purchase accounting accretion when forecasting net interest income.
The following graph presents the LIBOR/Swap yield curves for the base rate scenario and each of the alternate scenarios one year forward.
Table 46: Alternate Interest Rate Scenarios: One Year Forward
The first quarter 2015 interest sensitivity analyses indicate that our Consolidated Balance Sheet is positioned to benefit from an increase in interest rates and an upward sloping interest rate yield curve. We believe that we have the deposit funding base and balance sheet flexibility to adjust, where appropriate and permissible, to changing interest rates and market conditions.
Market Risk Management – Customer-Related Trading Risk
We engage in fixed income securities, derivatives and foreign exchange transactions to support our customers’ investing and hedging activities. These transactions, related hedges and the credit valuation adjustment (CVA) related to our customer derivatives portfolio are marked-to-market daily and reported as customer-related trading activities. We do not engage in proprietary trading of these products.
We use value-at-risk (VaR) as the primary means to measure and monitor market risk in customer-related trading activities. We calculate a diversified VaR at a 95% confidence interval. VaR is used to estimate the probability of portfolio losses based on the statistical analysis of historical market risk factors. A diversified VaR reflects empirical correlations across different asset classes.
During the first three months of 2015, our 95% VaR ranged between $1.5 million and $3.1 million, averaging $2.2 million. During the first three months of 2014, our 95% VaR ranged between $3.1 million and $3.9 million, averaging $3.5 million.
46 The PNC Financial Services Group, Inc. – Form 10-Q
To help ensure the integrity of the models used to calculate VaR for each portfolio and enterprise-wide, we use a process known as backtesting. The backtesting process consists of comparing actual observations of gains or losses against the VaR levels that were calculated at the close of the prior day. This assumes that market exposures remain constant throughout the day and that recent historical market variability is a good predictor of future variability. Our customer-related trading activity includes customer revenue and intraday hedging which helps to reduce losses, and may reduce the number of instances of actual losses exceeding the prior day VaR measure. There were two instances during the first three months of 2015 where actual losses exceeded the prior day VaR measure under our diversified VaR measure. In comparison, there were no such instances during the first three months of 2014. We use a 500 day look back period for backtesting and include customer-related revenue.
The following graph shows a comparison of enterprise-wide gains and losses against prior day diversified VaR for the period indicated.
Table 47: Enterprise-Wide Gains/Losses Versus Value-at-Risk
Customer-related trading revenue increased to $49 million for the first quarter of 2015 compared with $40 million for the first quarter of 2014. The increase was primarily attributable to improved derivative client sales and market interest rate changes impacting credit valuations for customer related derivatives activities, which were partially offset by reduced foreign exchange results.
Market Risk Management – Equity And Other Investment Risk
Equity investment risk is the risk of potential losses associated with investing in both private and public equity markets. PNC invests primarily in private equity markets. In addition to extending credit, taking deposits, securities underwriting and trading financial instruments, we make and manage direct investments in a variety of transactions, including management buyouts, recapitalizations, and growth financings in a variety of industries. We also have investments in affiliated and non-affiliated funds that make similar
investments in private equity and in debt and equity-oriented hedge funds. The economic and/or book value of these investments and other assets such as loan servicing rights are directly affected by changes in market factors.
The primary risk measurement for equity and other investments is economic capital. Economic capital is a common measure of risk for credit, market and operational risk. It is an estimate of the potential value depreciation over a one year horizon commensurate with solvency expectations of an institution rated single-A by the credit rating agencies. Given the illiquid nature of many of these types of investments, it can be a challenge to determine their fair values. See Note 7 Fair Value in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report and Note 7 Fair Value in Item 8 of our 2014 Form 10-K for additional information.
Various PNC business units manage our equity and other investment activities. Our businesses are responsible for making investment decisions within the approved policy limits and associated guidelines.
A summary of our equity investments follows:
Table 48: Equity Investments Summary
Tax credit investments
Private equity
Visa
PNC owned approximately 35 million common stock equivalent shares of BlackRock equity at March 31, 2015, accounted for under the equity method. The primary risk measurement, similar to other equity investments, is economic capital. The Business Segments Review section of this Financial Review includes additional information about BlackRock.
Tax Credit Investments
Included in our equity investments are direct tax credit investments and equity investments held by consolidated partnerships which totaled $2.4 billion at March 31, 2015 and $2.6 billion at December 31, 2014. These equity investment balances include unfunded commitments totaling $706 million and $717 million at March 31, 2015 and December 31, 2014, respectively. These unfunded commitments are included in Other Liabilities on our Consolidated Balance Sheet.
The PNC Financial Services Group, Inc. – Form 10-Q 47
Note 2 Loan Sale and Servicing Activities and Variable Interest Entities in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report has further information on Tax Credit Investments.
Private Equity
The private equity portfolio is an illiquid portfolio comprised of mezzanine and equity investments that vary by industry, stage and type of investment.
Private equity investments carried at estimated fair value totaled $1.6 billion at both March 31, 2015 and December 31, 2014. As of March 31, 2015, $1.2 billion was invested directly in a variety of companies and $.4 billion was invested indirectly through various private equity funds. Included in direct investments are investment activities of two private equity funds that are consolidated for financial reporting purposes. The noncontrolling interests of these funds totaled $183 million as of March 31, 2015. The interests held in indirect private equity funds are not redeemable, but PNC may receive distributions over the life of the partnership from liquidation of the underlying investments. See Item 1 Business – Supervision and Regulation and Item 1A Risk Factors included in our 2014 Form 10-K for discussion of the potential impacts of the Volcker Rule provisions of Dodd-Frank on our interests in and sponsorship of private funds covered by the Volcker Rule.
Our unfunded commitments related to private equity totaled $147 million at March 31, 2015 compared with $140 million at December 31, 2014.
At March 31, 2015, our investment in Visa Class B common shares totaled approximately 7 million shares and had a carrying value of $77 million. Based on the March 31, 2015 closing price of $65.41 for the Visa Class A common shares, the fair value of our total investment was approximately $740 million at the current conversion rate. The Visa Class B common shares that we own are transferable only under limited circumstances until they can be converted into shares of the publicly traded class of stock, which cannot happen until the settlement of all of the specified litigation.
Our 2014 Form 10-K includes information regarding the October 2007 Visa restructuring, our involvement with judgment and loss sharing agreements with Visa and certain other banks, the status of pending interchange litigation, the sales of portions of our Visa Class B common shares and the related swap agreements with the purchaser.
Other Investments
We also make investments in affiliated and non-affiliated funds with both traditional and alternative investment strategies. The economic values could be driven by either the fixed-income market or the equity markets, or both. At both March 31, 2015 and December 31, 2014, other investments totaled $155 million. Net gains related to these investments were not significant for the first three months of 2015 and 2014.
Given the nature of these investments, if market conditions affecting their valuation were to worsen, we could incur future losses.
Our unfunded commitments related to other investments at March 31, 2015 and December 31, 2014 were not significant.
Financial Derivatives
We use a variety of financial derivatives as part of the overall asset and liability risk management process to help manage exposure to market and credit risk inherent in our business activities. Substantially all such instruments are used to manage risk related to changes in interest rates. Interest rate swaps, interest rate caps and floors, swaptions, options, forwards and futures contracts are the primary instruments we use for interest rate risk management. We also enter into derivatives with customers to facilitate their risk management activities.
Financial derivatives involve, to varying degrees, market and credit risk. For interest rate swaps, options and futures contracts, only periodic cash payments and, with respect to options, premiums are exchanged. Therefore, cash requirements and exposure to credit risk are significantly less than the notional amount on these instruments.
Further information on our financial derivatives is presented in Note 1 Accounting Policies and Note 7 Fair Value in our Notes To Consolidated Financial Statements under Item 8 of our 2014 Form 10-K and in Note 7 Fair Value and Note 11 Financial Derivatives in the Notes To Consolidated Financial Statements in Part I, Item 1 of this Report, which is incorporated here by reference.
Not all elements of market and credit risk are addressed through the use of financial derivatives, and such instruments may be ineffective for their intended purposes due to unanticipated market changes, among other reasons.
48 The PNC Financial Services Group, Inc. – Form 10-Q
The following table summarizes the notional or contractual amounts and net fair value of financial derivatives at March 31, 2015 and December 31, 2014.
Table 49: Financial Derivatives Summary
Derivatives designated as hedging instruments under GAAP
Total derivatives designated as hedging instruments
Derivatives not designated as hedging instruments under GAAP
Total derivatives used for residential mortgage banking activities
Total derivatives used for commercial mortgage banking activities
Total derivatives used for customer-related activities
Total derivatives used for other risk management activities
Total derivatives not designated as hedging instruments
Total Derivatives
INTERNAL CONTROLS ANDDISCLOSURE CONTROLS AND PROCEDURES
As of March 31, 2015, we performed an evaluation under the supervision of and with the participation of our management, including the Chairman, President and Chief Executive Officer and the Executive Vice President and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures and of changes in our internal control over financial reporting.
Based on that evaluation, our Chairman, President and Chief Executive Officer and our Executive Vice President and Chief Financial Officer concluded that our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities and Exchange Act of 1934) were effective as of March 31, 2015, and that there has been no change in PNC’s internal control over financial reporting that occurred during the first quarter of 2015 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
GLOSSARY OFTERMS
Accretable net interest (Accretable yield) – The excess of cash flows expected to be collected on a purchased impaired loan over the carrying value of the loan. The accretable net interest is recognized into interest income over the remaining life of the loan using the constant effective yield method.
Adjusted average total assets – Primarily comprised of total average quarterly (or annual) assets plus (less) unrealized losses (gains) on investment securities, less goodwill and certain other intangible assets (net of eligible deferred taxes).
Annualized – Adjusted to reflect a full year of activity.
Basel III common equity Tier 1 capital – Common stock plus related surplus, net of treasury stock, plus retained earnings, plus accumulated other comprehensive income for securities currently and previously held as available for sale, plus accumulated other comprehensive income for pension and other post postretirement benefit plans, less goodwill, net of associated deferred tax liabilities, less other disallowed intangibles, net of deferred tax liabilities and plus/less other adjustments.
Basel III common equity Tier 1 capital ratio – Common equity Tier 1 capital divided by period-end risk-weighted assets (as applicable).
Basel III Tier 1 capital – Common equity Tier 1 capital, plus preferred stock, plus certain trust preferred capital securities, plus certain noncontrolling interests that are held by others and plus/ less other adjustments.
Basel III Tier 1 capital ratio – Tier 1 capital divided by period-end risk-weighted assets (as applicable).
Basel III Total capital – Tier 1 capital plus qualifying subordinated debt, plus certain trust preferred securities, plus, under the Basel III transitional rules and the standardized approach, the allowance for loan and lease losses included in Tier 2 capital and other.
Basel III Total capital ratio – Total capital divided by period-end risk-weighted assets (as applicable).
Basis point – One hundredth of a percentage point.
Carrying value of purchased impaired loans – The net value on the balance sheet which represents the recorded investment less any valuation allowance.
The PNC Financial Services Group, Inc. – Form 10-Q 49
Cash recoveries – Cash recoveries used in the context of purchased impaired loans represent cash payments for a single purchased impaired loan not included within a pool of loans from customers that exceeded the recorded investment of that loan.
Charge-off – Process of removing a loan or portion of a loan from our balance sheet because it is considered uncollectible. We also record a charge-off when a loan is transferred from portfolio holdings to held for sale by reducing the loan carrying amount to the fair value of the loan, if fair value is less than carrying amount.
Combined loan-to-value ratio (CLTV) – This is the aggregate principal balance(s) of the mortgages on a property divided by its appraised value or purchase price.
Common shareholders’ equity to total assets – Common shareholders’ equity divided by total assets. Common shareholders’ equity equals total shareholders’ equity less the liquidation value of preferred stock.
Core net interest income – Core net interest income is total net interest income less purchase accounting accretion.
Credit derivatives – Contractual agreements, primarily credit default swaps, that provide protection against a credit event of one or more referenced credits. The nature of a credit event is established by the protection buyer and protection seller at the inception of a transaction, and such events include bankruptcy, insolvency and failure to meet payment obligations when due. The buyer of the credit derivative pays a periodic fee in return for a payment by the protection seller upon the occurrence, if any, of a credit event.
Credit spread – The difference in yield between debt issues of similar maturity. The excess of yield attributable to credit spread is often used as a measure of relative creditworthiness, with a reduction in the credit spread reflecting an improvement in the borrower’s perceived creditworthiness.
Credit valuation adjustment (CVA) – Represents an adjustment to the fair value of our derivatives for our own and counterparties’ non-performance risk.
Derivatives – Financial contracts whose value is derived from changes in publicly traded securities, interest rates, currency exchange rates or market indices. Derivatives cover a wide assortment of financial contracts, including but not limited to forward contracts, futures, options and swaps.
Discretionary client assets under management – Assets over which we have sole or shared investment authority for our customers/clients. We do not include these assets on our Consolidated Balance Sheet.
Duration of equity – An estimate of the rate sensitivity of our economic value of equity. A negative duration of equity is associated with asset sensitivity (i.e., positioned for rising interest rates), while a positive value implies liability sensitivity (i.e., positioned for declining interest rates). For example, if the duration of equity is -1.5 years, the economic value of equity increases by 1.5% for each 100 basis point increase in interest rates.
Earning assets – Assets that generate income, which include: federal funds sold; resale agreements; trading securities; interest-earning deposits with banks; loans held for sale; loans; investment securities; and certain other assets.
Effective duration – A measurement, expressed in years, that, when multiplied by a change in interest rates, would approximate the percentage change in value of on- and off- balance sheet positions.
Efficiency – Noninterest expense divided by total revenue.
Enterprise risk management framework – An enterprise process designed to identify potential risks that may affect PNC, manage risk to be within our risk appetite and provide reasonable assurance regarding achievement of our objectives.
Fair value – The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
Fee income – When referring to the components of Noninterest income, we use the term fee income to refer to the following categories within Noninterest income: Asset management; Consumer services; Corporate services; Residential mortgage; and Service charges on deposits.
FICO score – A credit bureau-based industry standard score created by Fair Isaac Co. which predicts the likelihood of borrower default. We use FICO scores both in underwriting and assessing credit risk in our consumer lending portfolio. Lower FICO scores indicate likely higher risk of default, while higher FICO scores indicate likely lower risk of default. FICO scores are updated on a periodic basis.
Foreign exchange contracts – Contracts that provide for the future receipt and delivery of foreign currency at previously agreed-upon terms.
Funds transfer pricing – A management accounting methodology designed to recognize the net interest income effects of sources and uses of funds provided by the assets and liabilities of a business segment. We assign these balances LIBOR-based funding rates at origination that represent the interest cost for us to raise/invest funds with similar maturity and repricing structures.
50 The PNC Financial Services Group, Inc. – Form 10-Q
Futures and forward contracts – Contracts in which the buyer agrees to purchase and the seller agrees to deliver a specific financial instrument at a predetermined price or yield. May be settled either in cash or by delivery of the underlying financial instrument.
GAAP – Accounting principles generally accepted in the United States of America.
Home price index (HPI) – A broad measure of the movement of single-family house prices in the U.S.
Impaired loans – Loans are determined to be impaired when, based on current information and events, it is probable that all contractually required payments will not be collected. Impaired loans include commercial nonperforming loans and consumer and commercial TDRs, regardless of nonperforming status. Excluded from impaired loans are nonperforming leases, loans held for sale, loans accounted for under the fair value option, smaller balance homogenous type loans and purchased impaired loans.
Interest rate floors and caps – Interest rate protection instruments that involve payment from the protection seller to the protection buyer of an interest differential, which represents the difference between a short-term rate (e.g., three-month LIBOR) and an agreed-upon rate (the strike rate) applied to a notional principal amount.
Interest rate swap contracts – Contracts that are entered into primarily as an asset/liability management strategy to reduce interest rate risk. Interest rate swap contracts are exchanges of interest rate payments, such as fixed-rate payments for floating-rate payments, based on notional principal amounts.
Intrinsic value – The difference between the price, if any, required to be paid for stock issued pursuant to an equity compensation arrangement and the fair market value of the underlying stock.
Leverage ratio – Tier 1 capital divided by average quarterly adjusted total assets.
LIBOR – Acronym for London InterBank Offered Rate. LIBOR is the average interest rate charged when banks in the London wholesale money market (or interbank market) borrow unsecured funds from each other. LIBOR rates are used as a benchmark for interest rates on a global basis. PNC’s product set includes loans priced using LIBOR as a benchmark.
Loan-to-value ratio (LTV) – A calculation of a loan’s collateral coverage that is used both in underwriting and assessing credit risk in our lending portfolio. LTV is the sum total of loan obligations secured by collateral divided by the market value of that same collateral. Market values of the
collateral are based on an independent valuation of the collateral. For example, a LTV of less than 90% is better secured and has less credit risk than a LTV of greater than or equal to 90%.
Loss given default (LGD) – An estimate of loss, net of recovery based on collateral type, collateral value, loan exposure, and other factors. Each loan has its own LGD. The LGD risk rating measures the percentage of exposure of a specific credit obligation that we expect to lose if default occurs. LGD is net of recovery, through any means, including but not limited to the liquidation of collateral or deficiency judgments rendered from foreclosure or bankruptcy proceedings.
Net interest margin – Annualized taxable-equivalent net interest income divided by average earning assets.
Nonaccretable difference – Contractually required payments receivable on a purchased impaired loan in excess of the cash flows expected to be collected.
Nonaccrual loans– Loans for which we do not accrue interest income. Nonaccrual loans include nonperforming loans, in addition to loans accounted for under fair value option and loans accounted for as held for sale for which full collection of contractual principal and/or interest is not probable.
Nondiscretionary client assets under administration – Assets we hold for our customers/clients in a nondiscretionary, custodial capacity. We do not include these assets on our Consolidated Balance Sheet.
Nonperforming assets – Nonperforming assets include nonperforming loans and OREO and foreclosed assets, but exclude certain government insured or guaranteed loans for which we expect to collect substantially all principal and interest, loans held for sale, loans accounted for under the fair value option and purchased impaired loans. We do not accrue interest income on assets classified as nonperforming.
Nonperforming loans – Loans accounted for at amortized cost for which we do not accrue interest income. Nonperforming loans include loans to commercial, commercial real estate, equipment lease financing, home equity, residential real estate, credit card and other consumer customers as well as TDRs which have not returned to performing status. Nonperforming loans exclude certain government insured or guaranteed loans for which we expect to collect substantially all principal and interest, loans held for sale, loans accounted for under the fair value option and purchased impaired loans. Nonperforming loans exclude purchased impaired loans as we are currently accreting interest income over the expected life of the loans.
Notional amount – A number of currency units, shares, or other units specified in a derivative contract.
The PNC Financial Services Group, Inc. – Form 10-Q 51
Operating leverage – The period to period dollar or percentage change in total revenue (GAAP basis) less the dollar or percentage change in noninterest expense. A positive variance indicates that revenue growth exceeded expense growth (i.e., positive operating leverage) while a negative variance implies expense growth exceeded revenue growth (i.e., negative operating leverage).
Options – Contracts that grant the purchaser, for a premium payment, the right, but not the obligation, to either purchase or sell the associated financial instrument at a set price during a specified period or at a specified date in the future.
Other real estate owned (OREO) and foreclosed assets – Assets taken in settlement of troubled loans primarily through deed-in-lieu of foreclosure or foreclosure. Foreclosed assets include real and personal property, equity interests in corporations, partnerships, and limited liability companies. Excludes certain assets that have a government-guarantee which are classified as other receivables.
Other-than-temporary impairment (OTTI) – When the fair value of a security is less than its amortized cost basis, an assessment is performed to determine whether the impairment is other-than-temporary. If we intend to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, an other-than-temporary impairment is considered to have occurred. In such cases, an other-than-temporary impairment is recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. Further, if we do not expect to recover the entire amortized cost of the security, an other-than-temporary impairment is considered to have occurred. However for debt securities, if we do not intend to sell the security and it is not more likely than not that we will be required to sell the security before its recovery, the other-than-temporary loss is separated into (a) the amount representing the credit loss, and (b) the amount related to all other factors. The other-than-temporary impairment related to credit losses is recognized in earnings while the amount related to all other factors is recognized in other comprehensive income, net of tax.
Parent company liquidity coverage – Liquid assets divided by funding obligations within a two year period.
Pretax earnings – Income before income taxes and noncontrolling interests.
Pretax, pre-provision earnings – Total revenue less noninterest expense.
Primary client relationship – A corporate banking client relationship with annual revenue generation of $10,000 to $50,000 or more, and for Asset Management Group, a client relationship with annual revenue generation of $10,000 or more.
Probability of default (PD) – An internal risk rating that indicates the likelihood that a credit obligor will enter into default status.
Purchase accounting accretion – Accretion of the discounts and premiums on acquired assets and liabilities. The purchase accounting accretion is recognized in net interest income over the weighted-average life of the financial instruments using the constant effective yield method. Accretion for a single purchased impaired loan not included within a pool of loans includes any cash recoveries on that loan received in excess of the recorded investment.
Purchased impaired loans – Acquired loans (or pools of loans) determined to be credit impaired under FASB ASC 310-30 (AICPA SOP 03-3). Loans (or pools of loans) are determined to be impaired if there is evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected.
Recorded investment (purchased impaired loans) – The initial investment of a purchased impaired loan plus interest accretion and less any cash payments and writedowns to date. The recorded investment excludes any valuation allowance which is included in our allowance for loan and lease losses.
Recovery – Cash proceeds received on a loan that we had previously charged off. We credit the amount received to the allowance for loan and lease losses.
Residential development loans – Project-specific loans to commercial customers for the construction or development of residential real estate including land, single family homes, condominiums and other residential properties.
Return on average assets – Annualized net income divided by average assets.
Return on average capital – Annualized net income divided by average capital.
Return on average common shareholders’ equity – Annualized net income attributable to common shareholders divided by average common shareholders’ equity.
Risk – The potential that an event or series of events could occur that would threaten PNC’s ability to achieve its strategic objectives, thereby negatively affecting shareholder value or reputation.
Risk appetite – A dynamic, forward-looking view on the aggregate amount of risk PNC is willing and able to take in executing business strategy in light of the current business environment.
52 The PNC Financial Services Group, Inc. – Form 10-Q
Risk limits – Quantitative measures based on forward looking assumptions that allocate the firm’s aggregate risk appetite (e.g. measure of loss or negative events) to business lines, legal entities, specific risk categories, concentrations and as appropriate, other levels.
Risk profile – The risk profile is a point-in-time assessment of risk. The profile represents overall risk position in relation to the desired risk appetite. The determination of the risk profile’s position is based on qualitative and quantitative analysis of reported risk limits, metrics, operating guidelines and qualitative assessments.
Risk-weighted assets – Computed by the assignment of specific risk-weights (as defined by the Board of Governors of the Federal Reserve System) to assets and off-balance sheet instruments.
Securitization – The process of legally transforming financial assets into securities.
Servicing rights – An intangible asset or liability created by an obligation to service assets for others. Typical servicing rights include the right to receive a fee for collecting and forwarding payments on loans and related taxes and insurance premiums held in escrow.
Swaptions – Contracts that grant the purchaser, for a premium payment, the right, but not the obligation, to enter into an interest rate swap agreement during a specified period or at a specified date in the future.
Taxable-equivalent interest – The interest income earned on certain assets is completely or partially exempt from Federal income tax. As such, these tax-exempt instruments typically yield lower returns than taxable investments. To provide more meaningful comparisons of yields and margins for all interest-earning assets, we use interest income on a taxable-equivalent basis in calculating average yields and net interest margins by increasing the interest income earned on tax-exempt assets to make it fully equivalent to interest income earned on other taxable investments. This adjustment is not permitted under GAAP on the Consolidated Income Statement.
Total equity – Total shareholders’ equity plus noncontrolling interests.
Total return swap – A non-traditional swap where one party agrees to pay the other the “total return” of a defined underlying asset (e.g., a loan), usually in return for receiving a stream of LIBOR-based cash flows. The total returns of the asset, including interest and any default shortfall, are passed through to the counterparty. The counterparty is, therefore, assuming the credit and economic risk of the underlying asset.
Transaction deposits – The sum of interest-bearing money market deposits, interest-bearing demand deposits, and noninterest-bearing deposits.
Transitional Basel III common equity – Common equity calculated under Basel III using phased in definitions and deductions applicable to PNC for 2014.
Troubled debt restructuring (TDR) – A loan whose terms have been restructured in a manner that grants a concession to a borrower experiencing financial difficulties.
Value-at-risk (VaR)– A statistically-based measure of risk that describes the amount of potential loss which may be incurred due to adverse market movements. The measure is of the maximum loss which should not be exceeded on 95 out of 100 days for a 95% VaR.
Watchlist – A list of criticized loans, credit exposure or other assets compiled for internal monitoring purposes. We define criticized exposure for this purpose as exposure with an internal risk rating of other assets especially mentioned, substandard, doubtful or loss.
Yield curve – A graph showing the relationship between the yields on financial instruments or market indices of the same credit quality with different maturities. For example, a “normal” or “positive” yield curve exists when long-term bonds have higher yields than short-term bonds. A “flat” yield curve exists when yields are the same for short-term and long-term bonds. A “steep” yield curve exists when yields on long-term bonds are significantly higher than on short-term bonds. An “inverted” or “negative” yield curve exists when short-term bonds have higher yields than long-term bonds.
The PNC Financial Services Group, Inc. – Form 10-Q 53
CAUTIONARY STATEMENT REGARDINGFORWARD-LOOKING INFORMATION
We make statements in this Report, and we may from time to time make other statements, regarding our outlook for earnings, revenues, expenses, capital and liquidity levels and ratios, asset levels, asset quality, financial position, and other matters regarding or affecting PNC and its future business and operations that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Forward-looking statements are typically identified by words such as “believe,” “plan,” “expect,” “anticipate,” “see,” “look,” “intend,” “outlook,” “project,” “forecast,” “estimate,” “goal,” “will,” “should” and other similar words and expressions. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time.
Forward-looking statements speak only as of the date made. We do not assume any duty and do not undertake to update forward-looking statements. Actual results or future events could differ, possibly materially, from those anticipated in forward-looking statements, as well as from historical performance.
Our forward-looking statements are subject to the following principal risks and uncertainties.
Our businesses, financial results and balance sheet values are affected by business and economic conditions, including the following:
Changes in interest rates and valuations in debt, equity and other financial markets.
Disruptions in the U.S. and global financial markets.
The impact on financial markets and the economy of any changes in the credit ratings of U.S. Treasury obligations and other U.S. government-backed debt, as well as issues surrounding the levels of U.S. and European government debt and concerns regarding the creditworthiness of certain sovereign governments, supranationals and financial institutions in Europe.
Actions by the Federal Reserve, U.S. Treasury and other government agencies, including those that impact money supply and market interest rates.
Changes in customers’, suppliers’ and other counterparties’ performance and creditworthiness.
Slowing or reversal of the current U.S. economic expansion.
Continued residual effects of recessionary conditions and uneven spread of positive impacts of recovery on the economy and our counterparties, including adverse impacts on
levels of unemployment, loan utilization rates, delinquencies, defaults and counterparty ability to meet credit and other obligations.
Changes in customer preferences and behavior, whether due to changing business and economic conditions, legislative and regulatory initiatives, or other factors.
Our forward-looking financial statements are subject to the risk that economic and financial market conditions will be substantially different than we are currently expecting. These statements are based on our current view that the U.S. economic expansion will speed up to an above trend growth rate near 3.2 percent in 2015, boosted by lower oil/energy prices, and that short-term interest rates and bond yields will rise only slowly in the latter half of 2015. These forward-looking statements also do not, unless otherwise indicated, take into account the impact of potential legal and regulatory contingencies.
PNC’s ability to take certain capital actions, including paying dividends and any plans to increase common stock dividends, repurchase common stock under current or future programs, or issue or redeem preferred stock or other regulatory capital instruments, is subject to the review of such proposed actions by the Federal Reserve as part of PNC’s comprehensive capital plan for the applicable period in connection with the regulators’ Comprehensive Capital Analysis and Review (CCAR) process and to the acceptance of such capital plan and non-objection to such capital actions by the Federal Reserve.
PNC’s regulatory capital ratios in the future will depend on, among other things, the company’s financial performance, the scope and terms of final capital regulations then in effect (particularly those implementing the Basel Capital Accords), and management actions affecting the composition of PNC’s balance sheet. In addition, PNC’s ability to determine, evaluate and forecast regulatory capital ratios, and to take actions (such as capital distributions) based on actual or forecasted capital ratios, will be dependent at least in part on the development, validation and regulatory approval of related models.
Legal and regulatory developments could have an impact on our ability to operate our businesses, financial condition, results of operations, competitive position, reputation, or pursuit of attractive acquisition opportunities. Reputational impacts could affect matters such as business generation and retention, liquidity, funding, and ability to attract and retain management. These developments could include:
Changes resulting from legislative and regulatory reforms, including major reform of the regulatory oversight structure of the financial services industry and changes to laws and
54 The PNC Financial Services Group, Inc. – Form 10-Q
regulations involving tax, pension, bankruptcy, consumer protection, and other industry aspects, and changes in accounting policies and principles. We will be impacted by extensive reforms provided for in the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and otherwise growing out of the most recent financial crisis, the precise nature, extent and timing of which, and their impact on us, remains uncertain.
Changes to regulations governing bank capital and liquidity standards, including due to the Dodd-Frank Act and to Basel-related initiatives.
Unfavorable resolution of legal proceedings or other claims and regulatory and other governmental investigations or other inquiries. In addition to matters relating to PNC’s current and historical business and activities, such matters may include proceedings, claims, investigations, or inquiries relating to pre-acquisition business and activities of acquired companies, such as National City. These matters may result in monetary judgments or settlements or other remedies, including fines, penalties, restitution or alterations in our business practices, and in additional expenses and collateral costs, and may cause reputational harm to PNC.
Results of the regulatory examination and supervision process, including our failure to satisfy requirements of agreements with governmental agencies.
Impact on business and operating results of any costs associated with obtaining rights in intellectual property claimed by others and of adequacy of our intellectual property protection in general.
Business and operating results are affected by our ability to identify and effectively manage risks inherent in our businesses, including, where appropriate, through effective use of third-party insurance, derivatives, and capital management techniques, and to meet evolving regulatory capital and liquidity standards. In particular, our results currently depend on our ability to manage elevated levels of impaired assets.
Business and operating results also include impacts relating to our equity interest in BlackRock, Inc. and rely to a significant extent on information provided to us by BlackRock. Risks and uncertainties that could affect BlackRock are discussed in more detail by BlackRock in its SEC filings.
We grow our business in part by acquiring from time to time other financial services companies, financial services assets and related deposits and other liabilities. Acquisition risks and uncertainties include those presented by the nature of the business acquired, including in some cases those associated with our entry into new businesses or new geographic or other markets and risks resulting from our inexperience in those new areas, as well as risks and uncertainties related to the acquisition transactions themselves, regulatory issues, and the integration of the acquired businesses into PNC after closing.
Competition can have an impact on customer acquisition, growth and retention and on credit spreads and product pricing, which can affect market share, deposits and revenues. Industry restructuring in the current environment could also impact our business and financial performance through changes in counterparty creditworthiness and performance and in the competitive and regulatory landscape. Our ability to anticipate and respond to technological changes can also impact our ability to respond to customer needs and meet competitive demands.
Business and operating results can also be affected by widespread natural and other disasters, pandemics, dislocations, terrorist activities, cyberattacks or international hostilities through impacts on the economy and financial markets generally or on us or our counterparties specifically.
We provide greater detail regarding these as well as other factors in our 2014 Form 10-K and elsewhere in this Report, including in the Risk Factors and Risk Management sections and the Legal Proceedings and Commitments and Guarantees Notes of the Notes To Consolidated Financial Statements in such reports. Our forward-looking statements may also be subject to other risks and uncertainties, including those discussed elsewhere in this Report or in our other filings with the SEC.
The PNC Financial Services Group, Inc. – Form 10-Q 55
CONSOLIDATED INCOME STATEMENT
In millions, except per share data
Interest Income
Total interest income
Interest Expense
Total interest expense
Other-than-temporary impairments
Less: Noncredit portion of other-than-temporary impairments (a)
Personnel
Occupancy
Equipment
Marketing
Total noninterest expense
Less: Net income (loss) attributable to noncontrolling interests
Earnings Per Common Share
Basic
Diluted
Average Common Shares Outstanding
See accompanying Notes To Consolidated Financial Statements.
56 The PNC Financial Services Group, Inc. – Form 10-Q
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
In millions
Other comprehensive income (loss), before tax and net of reclassifications into Net income:
Net unrealized gains (losses) on non-OTTI securities
Net unrealized gains (losses) on OTTI securities
Net unrealized gains (losses) on cash flow hedge derivatives
Pension and other postretirement benefit plan adjustments
Other comprehensive income (loss), before tax and net of reclassifications into Net income
Income tax benefit (expense) related to items of other comprehensive income
Other comprehensive income (loss), after tax and net of reclassifications into Net income
Comprehensive income
Less: Comprehensive income (loss) attributable to noncontrolling interests
Comprehensive income attributable to PNC
The PNC Financial Services Group, Inc. – Form 10-Q 57
CONSOLIDATED BALANCE SHEET
In millions, except par value
Cash and due from banks (includes $6 and $6 for VIEs) (a)
Federal funds sold and resale agreements (includes $151 and $155 measured at fair value) (b)
Trading securities
Interest-earning deposits with banks (includes $6 and $6 for VIEs) (a)
Loans held for sale (includes $2,207 and $2,154 measured at fair value) (b)
Loans (includes $1,486 and $1,606 for VIEs) (a)(includes $1,001 and $1,034 measured at fair value) (b)
Allowance for loan and lease losses (includes $(46) and $(50) for VIEs) (a)
Net loans
Equity investments (includes $334 and $492 for VIEs) (a)
Other (includes $434 and $483 for VIEs) (a)(includes $418 and $412 measured at fair value) (b)
Noninterest-bearing
Interest-bearing
Other (includes $341 and $347 for VIEs) (a) (includes $238 and $273 measured at fair value) (b)
Allowance for unfunded loan commitments and letters of credit
Accrued expenses (includes $69 and $70 for VIEs) (a)
Other (includes $142 and $206 for VIEs) (a)
Preferred stock (c)
Common stock ($5 par value, authorized 800 shares, issued 541 shares)
Common stock held in treasury at cost: 21 and 18 shares
58 The PNC Financial Services Group, Inc. – Form 10-Q
CONSOLIDATED STATEMENT OF CASH FLOWS
Operating Activities
Adjustments to reconcile net income to net cash provided (used) by operating activities
Depreciation and amortization
Deferred income taxes
Changes in fair value of mortgage servicing rights
Gain on sales of Visa Class B common shares
Undistributed earnings of BlackRock
Excess tax benefits from share-based payment arrangements
Net change in
Trading securities and other short-term investments
Accrued expenses and other liabilities
Net cash provided (used) by operating activities
Investing Activities
Sales
Securities available for sale
Repayments/maturities
Securities held to maturity
Purchases
Federal funds sold and resale agreements
Net cash provided (used) by investing activities
(continued on following page)
The PNC Financial Services Group, Inc. – Form 10-Q 59
(continued from previous page)
Financing Activities
Other borrowed funds
Sales/issuances
Common and treasury stock
Acquisition of treasury stock
Preferred stock cash dividends paid
Common stock cash dividends paid
Net cash provided (used) by financing activities
Net Increase (Decrease) In Cash And Due From Banks
Cash and due from banks at beginning of period
Cash and due from banks at end of period
Supplemental Disclosures
Interest paid
Income taxes paid
Income taxes refunded
Non-cash Investing and Financing Items
Transfer from (to) loans to (from) loans held for sale, net
Transfer from loans to foreclosed assets
60 The PNC Financial Services Group, Inc. – Form 10-Q
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
BUSINESS
PNC is one of the largest diversified financial services companies in the United States and is headquartered in Pittsburgh, Pennsylvania.
PNC has businesses engaged in retail banking, corporate and institutional banking, asset management, and residential mortgage banking, providing many of its products and services nationally, as well as other products and services in PNC’s primary geographic markets located in Pennsylvania, Ohio, New Jersey, Michigan, Illinois, Maryland, Indiana, North Carolina, Florida, Kentucky, Washington, D.C., Delaware, Virginia, Alabama, Missouri, Georgia, Wisconsin and South Carolina. PNC also provides certain products and services internationally.
NOTE 1 ACCOUNTING POLICIES
Basis Of Financial Statement Presentation
Our consolidated financial statements include the accounts of the parent company and its subsidiaries, most of which are wholly-owned, and certain partnership interests and variable interest entities.
We prepared these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (GAAP). We have eliminated intercompany accounts and transactions. We have also reclassified certain prior year amounts to conform to the 2015 presentation, which did not have a material impact on our consolidated financial condition or results of operations. Additionally, we evaluate the materiality of identified errors in the financial statements using both an income statement and a balance sheet approach, based on relevant quantitative and qualitative factors. The consolidated financial statements include certain adjustments to correct immaterial errors related to previously reported periods. In addition, as disclosed in certain Notes to the Consolidated Financial Statements, we made adjustments to previously reported periods for immaterial errors.
In our opinion, the unaudited interim consolidated financial statements reflect all normal, recurring adjustments needed to present fairly our results for the interim periods. The results of operations for interim periods are not necessarily indicative of the results that may be expected for the full year or any other interim period.
When preparing these unaudited interim consolidated financial statements, we have assumed that you have read the audited consolidated financial statements included in our 2014 Annual Report on Form 10-K. Reference is made to Note 1 Accounting Policies in the 2014 Form 10-K for a detailed description of significant accounting policies. Included herein are policies that are required to be disclosed on an interim basis as well as policies where there has been a significant change within the first three months of 2015. These interim consolidated financial statements serve to update the 2014 Form 10-K and may not include all information and notes necessary to constitute a complete set of financial statements.
We have also considered the impact of subsequent events on these consolidated financial statements.
Use Of Estimates
We prepared these consolidated financial statements using financial information available at the time of preparation, which requires us to make estimates and assumptions that affect the amounts reported. Our most significant estimates pertain to our fair value measurements, allowances for loan and lease losses and unfunded loan commitments and letters of credit, and accretion on purchased impaired loans. Actual results may differ from the estimates and the differences may be material to the consolidated financial statements.
The PNC Financial Services Group, Inc. – Form 10-Q 61
Nonperforming Loans and Leases
The matrix below summarizes PNC’s policies for classifying certain loans as nonperforming loans and/or discontinuing the accrual of loan interest income.
Loans Classified as Nonperforming and Accounted for as Nonaccrual
• Loans that are 90 days or more past due.
• Loans rated substandard or worse due to the determination that full collection of principal and interest is not probable as demonstrated by the following conditions:
– The collection of principal or interest is 90 days or more past due unless the asset is well-secured and/or in the process of collection;
– Reasonable doubt exists as to the certainty of the borrower’s future debt service ability, according to the terms of the credit arrangement, regardless of whether 90 days have passed or not;
– The borrower has filed or will likely file for bankruptcy;
– The bank advances additional funds to cover principal or interest;
– We are in the process of liquidating a commercial borrower; or
– We are pursuing remedies under a guarantee.
Loans Excluded from Nonperforming Classification but Accounted for as Nonaccrual
• Loans accounted for under the fair value option when we determine that full collection of principal and interest is not probable.
• Loans accounted for at the lower of cost or market less costs to sell (Held for Sale) when we determine that full collection of principal and interest is not probable.
Loans Excluded from Nonperforming Classification and Nonaccrual Accounting
• Purchased impaired loans because interest income is accreted through the accounting model.
• Loans that are well secured and in the process of collection.
• Loans accounted for at amortized cost where full collection of contractual principal and interest is not deemed probable as demonstrated in the policies below:
– The loan is 90 days past due for home equity and installment loans, and 180 days past due for well secured residential real estate loans;
– The loan has been modified and classified as a troubled debt restructuring (TDR);
– Notification of bankruptcy has been received and the loan is 30 days or more past due;
– The bank holds a subordinate lien position in the loan and the first lien loan is seriously stressed (i.e., 90 days or more past due);
– Other loans within the same borrower relationship have been placed on nonaccrual or charge-offs have been taken on them;
– The bank has repossessed non-real estate collateral securing the loan; or
– The bank has charged-off the loan to the value of the collateral.
• Certain government insured loans where substantially all principal and interest is insured.
• Residential real estate loans that are well secured and in the process of collection.
• Unsecured consumer loans and lines of credit as permitted by regulatory guidance.
See Note 3 Asset Quality in this Report for additional detail on nonperforming assets and asset quality indicators for commercial and consumer loans.
62 The PNC Financial Services Group, Inc. – Form 10-Q
Commercial Loans
We generally charge off Commercial Lending (Commercial, Commercial Real Estate, and Equipment Lease Financing) nonperforming loans when we determine that a specific loan, or portion thereof, is uncollectible. This determination is based on the specific facts and circumstances of the individual loans. In making this determination, we consider the viability of the business or project as a going concern, the past due status when the asset is not well-secured, the expected cash flows to repay the loan, the value of the collateral, and the ability and willingness of any guarantors to perform.
Additionally, in general, for smaller dollar commercial loans of $1 million or less, a partial or full charge-off occurs at 120 days past due for term loans and 180 days past due for revolvers. Certain small business credit card balances that are placed on nonaccrual status when they become 90 days or more past due are charged-off at 180 days past due.
Consumer Loans
Home equity installment loans, home equity lines of credit, and residential real estate loans that are not well-secured and in the process of collection are charged-off at no later than 180 days past due. At that time, the basis in the loan is reduced to the fair value of the collateral less costs to sell. In addition to this policy, the bank recognizes a charge-off on a secured consumer loan when:
The bank holds a subordinate lien position in the loan and a foreclosure notice has been received on the first lien loan;
The bank holds a subordinate lien position in the loan which is 30 days or more past due with a combined loan to value ratio of greater than or equal to 110% and the first lien loan is seriously stressed (i.e., 90 days or more past due);
The loan is modified or otherwise restructured in a manner that results in the loan becoming collateral dependent;
Notification of bankruptcy has been received within the last 60 days and the loan is 60 days or more past due;
The borrower has been discharged from personal liability through Chapter 7 bankruptcy and has not formally reaffirmed his or her loan obligation to PNC; or
The collateral securing the loan has been repossessed and the value of the collateral is less than the recorded investment of the loan outstanding.
For loans that continue to meet any of the above policies, collateral values are updated annually and subsequent declines in collateral values are charged-off resulting in incremental provision for credit loss.
Accounting for Nonperforming Loans and Leases and Other Nonaccrual Loans
For accrual loans, interest income is accrued on a monthly basis and certain fees and costs are deferred upon origination
and recognized in income over the term of the loan utilizing an effective yield method. For nonaccrual loans, interest income accrual and deferred fee/cost amortization is discontinued. Additionally, the current year accrued and uncollected interest is reversed through Net interest income and prior year accrued and uncollected interest is charged-off. Nonaccrual loans may also be charged-off to reduce the basis to the fair value of collateral less costs to sell.
If payment is received on a nonaccrual loan, generally the payment is first applied to the recorded investment; payments are then applied to recover any charged-off amounts related to the loan. Finally, if both recorded investment and any charge-offs have been recovered, then the payment will be recorded as fee and interest income.
For TDRs, payments are applied based upon their contractual terms unless the related loan is deemed non-performing. TDRs are generally included in nonperforming and nonaccrual loans until returned to performing/accruing status through performance under restructured terms and other performance indicators for a reasonable period of time demonstrating that the bank expects to collect all of the loan’s remaining contractual principal and interest. TDRs resulting from 1) borrowers that have been discharged from personal liability through Chapter 7 bankruptcy and have not formally reaffirmed their loan obligations to PNC and 2) borrowers that are not currently obligated to make both principal and interest payments under the restructured terms are not returned to accrual status.
Other nonaccrual loans are generally not returned to accrual status until the borrower has performed in accordance with the contractual terms and other performance indicators for at least six months, the period of time which was determined to demonstrate the expected collection of the loan’s remaining contractual principal and interest. When a nonperforming loan is returned to accrual status, it is then considered a performing loan.
See Note 3 Asset Quality and Note 5 Allowances for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit in this Report and in our 2014 Form 10-K for additional TDR information.
Allowance for Loan and Lease Losses
We maintain the ALLL at a level that we believe to be appropriate to absorb estimated probable credit losses incurred in the loan and lease portfolios as of the balance sheet date. Our determination of the allowance is based on periodic evaluations of these loan and lease portfolios and other relevant factors. This critical estimate includes significant use of PNC’s own historical data and complex methods to interpret this data. These evaluations are inherently subjective, as they require material estimates and may be susceptible to significant change, and include, among others:
Probability of default (PD),
Loss given default (LGD),
The PNC Financial Services Group, Inc. – Form 10-Q 63
Outstanding balance of the loan,
Movement through delinquency stages,
Amounts and timing of expected future cash flows,
Value of collateral, which may be obtained from third parties, and
Qualitative factors, such as changes in current economic conditions, that may not be reflected in modeled results.
For all loans, except purchased impaired loans, the ALLL is the sum of three components: (i) asset specific/individual impaired reserves, (ii) quantitative (formulaic or pooled) reserves and (iii) qualitative (judgmental) reserves.
The reserve calculation and determination process is dependent on the use of key assumptions. Key reserve assumptions and estimation processes react to and are influenced by observed changes in loan portfolio performance experience, the financial strength of the borrower, and economic conditions. Key reserve assumptions are periodically updated.
Asset Specific/Individual Component
Nonperforming loans that are considered impaired under ASC 310 – Receivables, which include all commercial and consumer TDRs, are evaluated for a specific reserve. Specific reserve allocations are determined as follows:
For commercial nonperforming loans and commercial TDRs greater than or equal to a defined dollar threshold, specific reserves are based on an analysis of the present value of the loan’s expected future cash flows, the loan’s observable market price or the fair value of the collateral.
For commercial nonperforming loans and commercial TDRs below the defined dollar threshold, the individual loan’s loss given default (LGD) percentage is multiplied by the loan balance and the results are aggregated for purposes of measuring specific reserve impairment.
Consumer nonperforming loans are collectively reserved for unless classified as consumer TDRs. For consumer TDRs, specific reserves are determined through an analysis of the present value of the loan’s expected future cash flows, except for those instances where loans have been deemed collateral dependent, including loans where borrowers have been discharged from personal liability through Chapter 7 bankruptcy and have not formally reaffirmed their loan obligations to PNC. Once that determination has been made, those TDRs are charged down to the fair value of the collateral less costs to sell at each period end.
Commercial Lending Quantitative Component
The estimates of the quantitative component of ALLL for incurred losses within the commercial lending portfolio
segment are determined through statistical loss modeling utilizing PD, LGD and outstanding balance of the loan. Based upon loan risk ratings, we assign PDs and LGDs. Each of these statistical parameters is determined based on internal historical data and market data. PD is influenced by such factors as liquidity, industry, obligor financial structure, access to capital and cash flow. LGD is influenced by collateral type, original and/or updated loan-to-value ratio (LTV), facility structure and other factors.
Consumer Lending Quantitative Component
Quantitative estimates within the consumer lending portfolio segment are calculated primarily using a roll-rate model based on statistical relationships, calculated from historical data that estimate the movement of loan outstandings through the various stages of delinquency and ultimately charge-off over our loss emergence period.
Qualitative Component
While our reserve methodologies strive to reflect all relevant risk factors, there continues to be uncertainty associated with, but not limited to, potential imprecision in the estimation process due to the inherent time lag of obtaining information and normal variations between estimates and actual outcomes. We provide additional reserves that are designed to provide coverage for losses attributable to such risks. The ALLL also includes factors that may not be directly measured in the determination of specific or pooled reserves. Such qualitative factors may include:
Allowance for Purchased Non-Impaired Loans
ALLL for purchased non-impaired loans is determined based upon a comparison between the methodologies described above and the remaining acquisition date fair value discount that has yet to be accreted into interest income. After making the comparison, an ALLL is recorded for the amount greater than the discount, or no ALLL is recorded if the discount is greater.
Allowance for Purchased Impaired Loans
ALLL for purchased impaired loans is determined in accordance with ASC 310-30 by comparing the net present value of the cash flows expected to be collected to the recorded investment for a given loan (or pool of loans). In cases where the net present value of expected cash flows is lower than the recorded investment, ALLL is established.
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Cash flows expected to be collected represent management’s best estimate of the cash flows expected over the life of a loan (or pool of loans). For large balance commercial loans, cash flows are separately estimated at the loan level. For smaller balance pooled loans, pool cash flows are estimated using cash flow models. Pools were defined at acquisition based on the risk characteristics of the loan. Our cash flow models use loan data including, but not limited to, contractual loan balance, delinquency status of the loan, updated borrower FICO credit scores, geographic information, historical loss experience, and updated LTVs, as well as best estimates for changes in unemployment rates, home prices and other economic factors, to determine estimated cash flows.
See Note 4 Purchased Loans and Note 5 Allowances for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit for additional loan data and application of the policies disclosed herein.
Our credit risk management policies, procedures and practices are designed to promote sound lending standards and prudent credit risk management. We have policies, procedures and practices that address financial statement requirements, collateral review and appraisal requirements, advance rates based upon collateral types, appropriate levels of exposure, cross-border risk, lending to specialized industries or borrower type, guarantor requirements, and regulatory compliance.
Allowance for Unfunded Loan Commitments and Letters of Credit
We maintain the allowance for unfunded loan commitments and letters of credit at a level we believe is appropriate to absorb estimated probable credit losses on these unfunded credit facilities as of the balance sheet date. We determine the allowance based on periodic evaluations of the unfunded credit facilities, including an assessment of the probability of commitment usage, credit risk factors, and, solely for commercial lending, the terms and expiration dates of the unfunded credit facilities. Other than the estimation of the probability of funding, the reserve for unfunded loan commitments is estimated in a manner similar to the methodology used for determining reserves for funded exposures. The allowance for unfunded loan commitments and letters of credit is recorded as a liability on the Consolidated Balance Sheet. Net adjustments to the allowance for unfunded loan commitments and letters of credit are included in the provision for credit losses.
See Note 5 Allowances for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit for additional loan data and application of the policies disclosed herein.
Basic earnings per common share is calculated using the two-class method to determine income attributable to common
shareholders. Unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are considered participating securities under the two-class method. Income attributable to common shareholders is then divided by the weighted-average common shares outstanding for the period.
Diluted earnings per common share is calculated under the more dilutive of either the treasury method or the two-class method. For the diluted calculation, we increase the weighted-average number of shares of common stock outstanding by the assumed conversion of outstanding convertible preferred stock from the beginning of the year or date of issuance, if later, and the number of shares of common stock that would be issued assuming the exercise of stock options and warrants and the issuance of incentive shares using the treasury stock method. These adjustments to the weighted-average number of shares of common stock outstanding are made only when such adjustments will dilute earnings per common share. See Note 12 Earnings Per Share for additional information.
In August 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-14, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40):Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force). This ASU requires that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure when a) the loan has a government guarantee that is not separable from the loan before foreclosure; b) the creditor has the intent to convey the real estate to the guarantor and make a claim on the guarantee and the creditor has the ability to recover under that claim at the time of foreclosure; and c) any amount of the claim that is determined upon the basis of the real estate is fixed at the time of foreclosure. The receivable should be measured based on the loan balance (inclusive of principal and interest) that is expected to be recovered from the guarantor. This ASU is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The ASU may be adopted using either a prospective or modified retrospective transition method consistent with the method elected to adopt ASU 2014-04, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. We adopted this guidance as of January 1, 2015. Adoption of this ASU did not have a material effect on our results of operations or financial position.
In June 2014, the FASB issued ASU 2014-11, Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures. This ASU impacts the accounting for repurchase-to-maturity transactions and transfers executed contemporaneously with a repurchase
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agreement with the same counterparty (i.e., a repurchase financing) by requiring secured borrowing accounting. We adopted this accounting as of January 1, 2015 and will adopt the disclosure requirements in the second quarter of 2015. Adoption of this ASU did not have a material effect on our results of operations or financial position.
In January 2014, the FASB issued ASU 2014-04, Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. This ASU clarifies that an in substance repossession or foreclosure is considered to have occurred, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon a) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or b) the borrower conveying all interest in the residential real estate property to the creditor to satisfy the loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. We adopted this guidance as of January 1, 2015. Adoption of this ASU did not have a material effect on our results of operations or financial position.
NOTE 2 LOAN SALE AND SERVICINGACTIVITIES AND VARIABLE INTEREST ENTITIES
Loan Sale and Servicing Activities
As more fully described in Note 2 Loan Sale and Servicing Activities and Variable Interest Entities in our 2014 Form 10-K, we have transferred residential and commercial mortgage loans in securitization or sales transactions in which we have continuing involvement. Our continuing involvement generally consists of servicing, repurchasing previously transferred loans under certain conditions and loss share arrangements, and, in limited circumstances, holding of mortgage-backed securities issued by the securitization SPEs.
The following table provides certain financial information and cash flows associated with PNC’s loan sale and servicing activities:
Table 50: Certain Financial Information and Cash Flows Associated with Loan Sale and Servicing Activities
FINANCIAL INFORMATION – March 31, 2015
Servicing portfolio (c)
Carrying value of servicing assets (d)
Servicing advances (e)
Repurchase and recourse obligations (f)
Carrying value of mortgage-backed securities held (g)
FINANCIAL INFORMATION – December 31, 2014
CASH FLOWS – Three months ended March 31, 2015
Sales of loans (h)
Repurchases of previously transferred loans (i)
Servicing fees (j)
Servicing advances recovered/(funded), net
Cash flows on mortgage-backed securities held (g)
CASH FLOWS – Three months ended March 31, 2014
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The table below presents information about the principal balances of transferred loans that we service and are not recorded on our balance sheet.
Table 51: Principal Balance, Delinquent Loans, and Net Charge-offs Related to Serviced Loans
Total principal balance
Delinquent loans (c)
December 31, 2014
Three months ended March 31, 2015
Net charge-offs (d)
Three months ended March 31, 2014
Variable Interest Entities (VIEs)
As discussed in Note 2 Loan Sale and Servicing Activities and Variable Interest Entities in our 2014 Form 10-K, we are involved with various entities in the normal course of business that are deemed to be VIEs. The following provides a summary of VIEs, including those that we have consolidated and those in which we hold variable interests but have not consolidated into our financial statements as of March 31, 2015 and December 31, 2014, respectively. We have not provided additional financial support to these entities which we are not contractually required to provide.
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Table 52: Consolidated VIEs – Carrying Value (a) (b)
Credit Card and Other
Securitization Trusts
Cash and due from banks
Equity investments
Accrued expenses
Table 53: Non-Consolidated VIEs
Aggregate
Commercial Mortgage-Backed Securitizations (b)
Residential Mortgage-Backed Securitizations (b)
Tax Credit Investments and Other (c)
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Our involvement with VIEs is discussed in further detail in Note 2 Loan Sale and Servicing Activities and Variable Interest Entities in our 2014 Form 10-K.
NOTE 3 ASSET QUALITY
We closely monitor economic conditions and loan performance trends to manage and evaluate our exposure to credit risk. Trends in delinquency rates may be a key indicator, among other considerations, of credit risk within the loan portfolios. The measurement of delinquency status is based on the contractual terms of each loan. Loans that are 30 days or more past due in terms of payment are considered delinquent. Loan delinquencies exclude loans held for sale, purchased impaired loans, nonperforming loans and loans accounted for under the fair value option which are on nonaccrual status, but include government insured or guaranteed loans and accruing loans accounted for under the fair value option.
Nonperforming assets include nonperforming loans and leases, OREO and foreclosed assets, and nonperforming TDRs. Nonperforming loans are those loans accounted for at amortized cost whose credit quality has deteriorated to the extent that full collection of contractual principal and interest is not probable. Interest income is not recognized on these loans. Loans accounted for under the fair value option are reported as performing loans as these loans are accounted for at fair value. Accordingly, when nonaccrual criteria is met, interest income is not recognized on these loans. Additionally, certain government insured or guaranteed loans for which we expect to collect substantially all principal and interest are not reported as nonperforming loans and continue to accrue interest. Purchased impaired loans are excluded from nonperforming loans as we are currently accreting interest income over the expected life of the loans. See Note 4 Purchased Loans for further information.
See Note 1 Accounting Policies for additional delinquency, nonperforming, and charge-off information.
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The following tables display the delinquency status of our loans and our nonperforming assets at March 31, 2015 and December 31, 2014, respectively.
Table 54: Analysis of Loan Portfolio (a)
(d) (e)
Residential real estate (f)
Other consumer (g)
Percentage of total loans
At March 31, 2015, we pledged $19.7 billion of commercial loans to the Federal Reserve Bank (FRB) and $54.0 billion of residential real estate and other loans to the Federal Home Loan Bank (FHLB) as collateral for the contingent ability to borrow, if necessary. The comparable amounts at December 31, 2014 were $19.2 billion and $52.8 billion, respectively.
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In the normal course of business, we originate or purchase loan products with contractual characteristics that, when concentrated, may increase our exposure as a holder of those loan products. Possible product features that may create a concentration of credit risk would include a high original or updated LTV ratio, terms that may expose the borrower to future increases in repayments above increases in market interest rates, and interest-only loans, among others.
We originate interest-only loans to commercial borrowers. Such credit arrangements are usually designed to match borrower cash flow expectations (e.g., working capital lines, revolvers). These products are standard in the financial services industry and product features are considered during the underwriting process to mitigate the increased risk that the interest-only feature may result in borrowers not being able to make interest and principal payments when due. We do not believe that these product features create a concentration of credit risk.
Table 55: Nonperforming Assets
Other real estate owned (OREO)
Nonperforming loans also include certain loans whose terms have been restructured in a manner that grants a concession to a borrower experiencing financial difficulties. In accordance with applicable accounting guidance, these loans are considered TDRs. See Note 1 Accounting Policies and the TDR section of Note 3 in our 2014 Form 10-K for additional information. For the three months ended March 31, 2015, $232 million of Consumer loans held for sale, loans accounted for under the fair value option, pooled purchased impaired loans, as well as certain government insured or guaranteed loans which were evaluated for TDR consideration, are not classified as TDRs. The comparable amount for the three months ended March 31, 2014 was $302 million.
Total nonperforming loans in the nonperforming assets table above include TDRs of $1.3 billion at March 31, 2015 and $1.4 billion at December 31, 2014. TDRs that are performing, including all credit card TDR loans, totaled $1.2 billion at March 31, 2015 and December 31, 2014 and are excluded from nonperforming loans. These performing TDR loans, excluding credit cards which are not placed on nonaccrual status as permitted by regulatory guidance, have demonstrated a period of at least six months of consecutive performance under the restructured terms. Loans where borrowers have been discharged from personal liability through Chapter 7 bankruptcy and have not formally reaffirmed their loan obligations to PNC and loans to borrowers not currently obligated to make both principal and interest payments under the restructured terms are not returned to accrual status.
Additional Asset Quality Indicators
We have two overall portfolio segments – Commercial Lending and Consumer Lending. Each of these two segments is comprised of multiple loan classes. Classes are characterized by similarities in initial measurement, risk attributes and the manner in which we monitor and assess credit risk. The Commercial Lending segment is comprised of the commercial, commercial real estate, equipment lease financing, and commercial purchased impaired loan classes. The Consumer Lending segment is comprised of the home equity, residential real estate, credit card, other consumer, and consumer purchased impaired loan classes.
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Commercial Lending Asset Classes
Commercial Loan Class
For commercial loans, we monitor the performance of the borrower in a disciplined and regular manner based upon the level of credit risk inherent in the loan. To evaluate the level of credit risk, we assign an internal risk rating reflecting the borrower’s PD and LGD. This two-dimensional credit risk rating methodology provides granularity in the risk monitoring process on an ongoing basis. These ratings are reviewed and updated on a risk-adjusted basis, generally at least once per year. Additionally, no less frequently than on an annual basis, we review PD rates related to each rating grade based upon internal historical data. These rates are updated as needed and augmented by market data as deemed necessary. For small balance homogenous pools of commercial loans, mortgages and leases, we apply statistical modeling to assist in determining the probability of default within these pools. Further, on a periodic basis, we update our LGD estimates associated with each rating grade based upon historical data. The combination of the PD and LGD ratings assigned to a commercial loan, capturing both the combination of expectations of default and loss severity in event of default, reflects the relative estimated likelihood of loss for that loan at the reporting date. In general, loans with better PD and LGD tend to have a lower likelihood of loss compared to loans with worse PD and LGD. The loss amount also considers exposure at date of default, which we also periodically update based upon historical data.
Based upon the amount of the lending arrangement and our risk rating assessment, we follow a formal schedule of written periodic review. Quarterly, we conduct formal reviews of a market’s or business unit’s entire loan portfolio, focusing on those loans which we perceive to be of higher risk, based upon PDs and LGDs, or loans for which credit quality is weakening. If circumstances warrant, it is our practice to review any customer obligation and its level of credit risk more frequently. We attempt to proactively manage our loans by using various procedures that are customized to the risk of a given loan, including ongoing outreach, contact, and assessment of obligor financial conditions, collateral inspection and appraisal.
Commercial Real Estate Loan Class
We manage credit risk associated with our commercial real estate projects and commercial mortgage activities similar to commercial loans by analyzing PD and LGD. Additionally, risks connected with commercial real estate projects and commercial mortgage activities tend to be correlated to the loan structure and collateral location, project progress and business environment. As a result, these attributes are also monitored and utilized in assessing credit risk.
As with the commercial class, a formal schedule of periodic review is also performed to assess market/geographic risk and business unit/industry risk. Often as a result of these overviews, more in-depth reviews and increased scrutiny are placed on areas of higher risk, including adverse changes in risk ratings, deteriorating operating trends, and/or areas that concern management. These reviews are designed to assess risk and take actions to mitigate our exposure to such risks.
Equipment Lease Financing Loan Class
We manage credit risk associated with our equipment lease financing loan class similar to commercial loans by analyzing PD and LGD.
Based upon the dollar amount of the lease and of the level of credit risk, we follow a formal schedule of periodic review. Generally, this occurs quarterly, although we have established practices to review such credit risk more frequently if circumstances warrant. Our review process entails analysis of the following factors: equipment value/residual value, exposure levels, jurisdiction risk, industry risk, guarantor requirements, and regulatory compliance.
Commercial Purchased Impaired Loan Class
Estimates of the expected cash flows primarily determine the valuation of commercial purchased impaired loans. Commercial cash flow estimates are influenced by a number of credit related items, which include but are not limited to: estimated collateral value, receipt of additional collateral, secondary trading prices, circumstances of possible and/or ongoing liquidation, capital availability, business operations and payment patterns.
We attempt to proactively manage these factors by using various procedures that are customized to the risk of a given loan. These procedures include a review by our Special Asset Committee (SAC), ongoing outreach, contact, and assessment of obligor financial conditions, collateral inspection and appraisal.
See Note 4 Purchased Loans for additional information.
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Table 56: Commercial Lending Asset Quality Indicators (a)(b)
Pass
Rated
Purchased impaired loans
Consumer Lending Asset Classes
Home Equity and Residential Real Estate Loan Classes
We use several credit quality indicators, including delinquency information, nonperforming loan information, updated credit scores, originated and updated LTV ratios, and geography, to monitor and manage credit risk within the home equity and residential real estate loan classes. We evaluate mortgage loan performance by source originators and loan servicers. A summary of asset quality indicators follows:
Delinquency/Delinquency Rates: We monitor trending of delinquency/delinquency rates for home equity and residential real estate loans. See the Asset Quality section of this Note 3 for additional information.
Nonperforming Loans: We monitor trending of nonperforming loans for home equity and residential real estate loans. See the Asset Quality section of this Note 3 for additional information.
Credit Scores: We use a national third-party provider to update FICO credit scores for home equity loans and lines of credit and residential real estate loans at least quarterly. The updated scores are incorporated into a series of credit management reports, which are utilized to monitor the risk in the loan classes.
LTV (inclusive of combined loan-to-value (CLTV) for first and subordinate lien positions): At least annually, we update the property values of real estate collateral and calculate an
updated LTV ratio. For open-end credit lines secured by real estate in regions experiencing significant declines in property values, more frequent valuations may occur. We examine LTV migration and stratify LTV into categories to monitor the risk in the loan classes.
Historically, we used, and we continue to use, a combination of original LTV and updated LTV for internal risk management and reporting purposes (e.g., line management, loss mitigation strategies). In addition to the fact that estimated property values by their nature are estimates, given certain data limitations it is important to note that updated LTVs may be based upon management’s assumptions (e.g., if an updated LTV is not provided by the third-party service provider, home price index (HPI) changes will be incorporated in arriving at management’s estimate of updated LTV).
Geography: Geographic concentrations are monitored to evaluate and manage exposures. Loan purchase programs are sensitive to, and focused within, certain regions to manage geographic exposures and associated risks.
A combination of updated FICO scores, originated and updated LTV ratios and geographic location assigned to home equity loans and lines of credit and residential real estate loans is used to monitor the risk in the loan classes. Loans with higher FICO scores and lower LTVs tend to have a lower level of risk. Conversely, loans with lower FICO scores, higher LTVs, and in certain geographic locations tend to have a higher level of risk.
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Consumer Purchased Impaired Loan Class
Estimates of the expected cash flows primarily determine the valuation of consumer purchased impaired loans. Consumer cash flow estimates are influenced by a number of credit related items, which include, but are not limited to: estimated real estate values, payment patterns, updated FICO scores, the current economic environment, updated LTV ratios and the date of origination. These key factors are monitored to help ensure that concentrations of risk are managed and cash flows are maximized.
Table 57: Home Equity and Residential Real Estate Balances
Home equity and residential real estate loans – excluding purchased impaired loans (a)
Home equity and residential real estate loans – purchased impaired loans (b)
Government insured or guaranteed residential real estate mortgages (a)
Difference between outstanding balance and recorded investment in purchased impaired loans (c)
Total home equity and residential real estate loans (a)
Table 58: Home Equity and Residential Real Estate Asset Quality Indicators – Excluding Purchased Impaired Loans (a) (b)
Current estimated LTV ratios (c)
Greater than or equal to 125% and updated FICO scores:
Greater than 660
Less than or equal to 660 (d) (e)
Missing FICO
Greater than or equal to 100% to less than 125% and updated FICO scores:
Greater than or equal to 90% to less than 100% and updated FICO scores:
Less than or equal to 660
Less than 90% and updated FICO scores:
Total home equity and residential real estate loans
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Table 59: Home Equity and Residential Real Estate Asset Quality Indicators – Purchased Impaired Loans (a)
Current estimated LTV ratios (d)
Missing LTV and updated FICO scores:
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Credit Card and Other Consumer Loan Classes
Table 60: Credit Card and Other Consumer Loan Classes Asset Quality Indicators
FICO score greater than 719
650 to 719
620 to 649
Less than 620
No FICO score available or required (c)
Total loans using FICO credit metric
Consumer loans using other internal credit metrics (b)
Total loan balance
Weighted-average updated FICO score (d)
Troubled Debt Restructurings (TDRs)
See Note 3 Asset Quality in our 2014 Form 10-K for additional discussion on TDRs. We held specific reserves in the ALLL of $.3 billion and $.4 billion at March 31, 2015 and December 31, 2014, respectively, for the total TDR portfolio.
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Table 61: Summary of Troubled Debt Restructurings
Accruing (a)
Table 62 quantifies the number of loans that were classified as TDRs as well as the change in the recorded investments as a result of the TDR classification during the first three months of 2015 and 2014, respectively. Additionally, the table provides information about the types of TDR concessions. The Principal Forgiveness TDR category includes principal forgiveness and accrued interest forgiveness. These types of TDRs result in a write down of the recorded investment and a charge-off if such action has not already taken place. The Rate Reduction TDR category includes reduced interest rate and interest deferral. The TDRs within this category result in
reductions to future interest income. The Other TDR category primarily includes consumer borrowers that have been discharged from personal liability through Chapter 7 bankruptcy and have not formally reaffirmed their loan obligations to PNC, as well as postponement/reduction of scheduled amortization and contractual extensions for both consumer and commercial borrowers.
In some cases, there have been multiple concessions granted on one loan. This is most common within the commercial loan portfolio. When there have been multiple concessions granted in the commercial loan portfolio, the principal forgiveness concession was prioritized for purposes of determining the inclusion in Table 62. For example, if there is principal forgiveness in conjunction with lower interest rate and postponement of amortization, the type of concession will be reported as Principal Forgiveness. Second in priority would be rate reduction. For example, if there is an interest rate reduction in conjunction with postponement of amortization, the type of concession will be reported as a Rate Reduction. In the event that multiple concessions are granted on a consumer loan, concessions resulting from discharge from personal liability through Chapter 7 bankruptcy without formal affirmation of the loan obligations to PNC would be prioritized and included in the Other type of concession in the table below. After that, consumer loan concessions would follow the previously discussed priority of concessions for the commercial loan portfolio.
Table 62: Financial Impact and TDRs by Concession Type (a)
Pre-TDR
RecordedInvestment (b)
During the three months ended March 31, 2015
During the three months ended March 31, 2014
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After a loan is determined to be a TDR, we continue to track its performance under its most recent restructured terms. In Table 63, we consider a TDR to have subsequently defaulted when it becomes 60 days past due after the most recent date the loan was restructured. The following table presents the recorded investment of loans that both (i) were classified as TDRs or were subsequently modified during each 12-month period preceding January 1, 2015 and January 1, 2014, respectively, and (ii) subsequently defaulted during these reporting periods.
Table 63: TDRs that were Modified in the Past Twelve Months which have Subsequently Defaulted
During the three months endedMarch 31, 2015
Impaired Loans
Impaired loans include commercial nonperforming loans and consumer and commercial TDRs, regardless of nonperforming status. TDRs that were previously recorded at amortized cost and are now classified and accounted for as held for sale are also included. Excluded from impaired loans are nonperforming leases, loans accounted for as held for sale other than the TDRs described in the preceding sentence, loans accounted for under the fair value option, smaller balance homogeneous type loans and purchased impaired loans. See Note 4 Purchased Loans for additional information. Nonperforming equipment lease financing loans of $2 million at both March 31, 2015 and December 31, 2014 are excluded from impaired loans pursuant to authoritative lease accounting guidance. We did not recognize any interest income on impaired loans that have not returned to performing status, while they were impaired during the three months ended March 31, 2015 and March 31, 2014. The following table provides further detail on impaired loans individually evaluated for impairment and the associated ALLL. Certain commercial impaired loans and loans to consumers discharged from bankruptcy and not formally reaffirmed do not have a related ALLL as the valuation of these impaired loans exceeded the recorded investment.
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Table 64: Impaired Loans
Impaired loans with an associated allowance
Total impaired loans with an associated allowance
Impaired loans without an associated allowance
Total impaired loans without an associated allowance
Total impaired loans
NOTE 4 PURCHASED LOANS
Purchased Impaired Loans
Purchased impaired loan accounting addresses differences between contractual cash flows and cash flows expected to be collected from the initial investment in loans if those differences are attributable, at least in part, to credit quality. Several factors were considered when evaluating whether a loan was considered a purchased impaired loan, including the delinquency status of the loan, updated borrower credit status, geographic information, and updated LTV. GAAP allows purchasers to account for loans individually or to aggregate purchased impaired loans acquired in the same fiscal quarter into one or more pools, provided that the loans have common risk characteristics. A pool is then accounted for as a single asset with a single composite interest rate and an aggregate expectation of cash flows. Purchased impaired homogeneous consumer, residential real estate and smaller balance commercial loans with common risk characteristics are aggregated into pools where appropriate, whereas commercial loans with a
80 The PNC Financial Services Group, Inc. – Form 10-Q
total commitment greater than a defined threshold are accounted for individually. For pooled loans, proceeds of individual loans are not applied individually to each loan within a pool, but to the pool’s recorded investment since it is accounted for as a single asset. Upon final disposition of a loan within a pool (e.g., payoff, short-sale, foreclosure, etc.), the loan’s carrying value is removed from the pool and any gain or loss associated with the transaction is retained in the pool’s recorded investment. For example, upon final disposition of a loan by short-sale, the proceeds of the short-sale may be less (or more) than the loan’s recorded investment. This shortfall or loss (excess or gain) is not accounted for as an individual loan sale in our income statement and is instead retained as part of the pool’s recorded investment consistent with our accounting for the pool as a single asset. This treatment is designed to maintain a constant effective yield for recognition of interest income. Accordingly, a pool’s recorded investment includes the net accumulation of realized losses or gains attributable to these final dispositions. As there are no future expected cash flows related to these dispositions, their net carrying value is $0. The recorded investment, including these realized losses and gains, is evaluated for collectability based upon the net present value of the pool’s remaining expected cash flows when establishing our allowance for loan losses. See below and Note 1 Accounting Policies and Note 5 Allowances for Loan and Lease Losses and Unfunded Loan Commitments and Letters of Credit for additional information.
The following table provides balances of purchased impaired loans at March 31, 2015 and December 31, 2014:
Table 65: Purchased Impaired Loans – Balances
Outstanding
Balance (a)
The excess of undiscounted cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized as interest income over the remaining life of the loan using the constant effective yield method. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the non-accretable difference and is not recognized in income. Subsequent changes in the expected cash flows of individual or pooled purchased impaired loans will either impact the accretable yield or result in an impairment charge to provision for credit losses in the period in which the changes become probable. Decreases to the net present value of expected cash flows will generally result in an impairment charge recorded as a provision for credit losses, resulting in an increase to the allowance for loan and lease losses, and a reclassification from accretable yield to non-accretable difference.
During the first three months of 2015, $12 million of provision recapture was recorded for purchased impaired loans compared to $43 million of provision recapture during the first three months of 2014. Charge-off recoveries (which were specifically for commercial loans greater than a defined threshold) during the first three months of 2015 were $1 million compared to charge-offs of $14 million during the first three months of 2014. At March 31, 2015, the allowance for loan and lease losses was $.9 billion on $4.3 billion of purchased impaired loans while the remaining $.4 billion of purchased impaired loans required no allowance as the net present value of expected cash flows equaled or exceeded the recorded investment. As of December 31, 2014, the allowance for loan and lease losses related to purchased impaired loans was $.9 billion. If any allowance for loan losses is recognized on a purchased impaired pool, which is accounted for as a single asset, the entire balance of that pool would be disclosed as requiring an allowance. Subsequent increases in the net present value of cash flows will result in a provision recapture of any previously recorded allowance for loan and lease losses, to the extent applicable, and/or a reclassification from non-accretable difference to accretable yield, which will be recognized prospectively. Individual loan transactions where final dispositions have occurred (as noted above) result in removal of the loans from their applicable pools for cash flow estimation purposes. The cash flow re-estimation process is completed quarterly to evaluate the appropriateness of the allowance associated with the purchased impaired loans.
The PNC Financial Services Group, Inc. – Form 10-Q 81
Activity for the accretable yield during the first three months of 2015 and 2014 follows:
Table 66: Purchased Impaired Loans – Accretable Yield
Accretion (including excess cash recoveries)
Net reclassifications to accretable from non-accretable (a)
Disposals
NOTE 5 ALLOWANCES FOR LOAN ANDLEASE LOSSES AND UNFUNDED LOAN COMMITMENTS AND LETTERS OF CREDIT
We maintain the ALLL at levels that we believe to be appropriate to absorb estimated probable credit losses incurred in the portfolios as of the balance sheet date. We use the two main portfolio segments – Commercial Lending and Consumer Lending – and develop and document the ALLL under separate methodologies for each of these segments as discussed in Note 1 Accounting Policies. A rollforward of the ALLL and associated loan data follows.
82 The PNC Financial Services Group, Inc. – Form 10-Q
Table 67: Rollforward of Allowance for Loan and Lease Losses and Associated Loan Data
Charge-offs
Recoveries
TDRs individually evaluated for impairment
Other loans individually evaluated for impairment
Loans collectively evaluated for impairment
Loan Portfolio
TDRs individually evaluated for impairment (a)
Loans collectively evaluated for impairment (b)
Fair value option loans (c)
Portfolio segment ALLL as a percentage of total ALLL
Ratio of the allowance for loan and lease losses to total loans
March 31, 2014
Loans collectively evaluated for impairment (b) (c)
Fair value option loans (c) (d)
The PNC Financial Services Group, Inc. – Form 10-Q 83
We maintain the allowance for unfunded loan commitments and letters of credit at a level we believe is appropriate to absorb estimated probable credit losses on these unfunded credit facilities as of the balance sheet date as discussed in Note 1 Accounting Policies. A rollforward of the allowance is presented below.
Table 68: Rollforward of Allowance for Unfunded Loan Commitments and Letters of Credit
84 The PNC Financial Services Group, Inc. – Form 10-Q
NOTE 6 INVESTMENT SECURITIES
Table 69: Investment Securities Summary
Amortized
Cost
Fair
Value
Securities Available for Sale
Debt securities
Residential mortgage-backed
Agency
Non-agency
Commercial mortgage-backed
Asset-backed
Total debt securities
Corporate stocks and other
Total securities available for sale
Securities Held to Maturity (a)
Total securities held to maturity
The PNC Financial Services Group, Inc. – Form 10-Q 85
The fair value of investment securities is impacted by interest rates, credit spreads, market volatility and liquidity conditions. Net unrealized gains and losses in the securities available for sale portfolio are included in Shareholders’ equity as Accumulated other comprehensive income or loss, net of tax, unless credit-related. Securities held to maturity are carried at amortized cost. At March 31, 2015, Accumulated other comprehensive income included pretax gains of $91 million from derivatives that hedged the purchase of investment securities classified as held to maturity. The gains will be accreted into interest income as an adjustment of yield on the securities.
Table 70 presents gross unrealized losses on securities available for sale at March 31, 2015 and December 31, 2014. The securities are segregated between investments that have been in a continuous unrealized loss position for less than twelve months and twelve months or more based on the point in time that the fair value declined below the amortized cost basis. The table includes debt securities where a portion of other-than-temporary impairment (OTTI) has been recognized in Accumulated other comprehensive income (loss).
Table 70: Gross Unrealized Loss and Fair Value of Securities Available for Sale
Unrealized loss position less
than 12 months
The gross unrealized loss on debt securities held to maturity was $15 million at March 31, 2015 and $22 million at December 31, 2014. The fair value of debt securities held to maturity that were in a continuous loss position for less than 12 months was $494 million and $134 million at March 31, 2015 and December 31, 2014, respectively, and for positions that were in a continuous loss
86 The PNC Financial Services Group, Inc. – Form 10-Q
position for 12 months or more was $1.0 billion and $1.6 billion at March 31, 2015 and December 31, 2014, respectively. For securities transferred to held to maturity from available for sale, the unrealized loss for purposes of this analysis is determined by comparing the security’s original amortized cost to its current estimated fair value.
Evaluating Investment Securities for Other-than-Temporary Impairments
For the securities in the preceding Table 70, as of March 31, 2015 we do not intend to sell and believe we will not be required to sell the securities prior to recovery of the amortized cost basis.
At least quarterly, we conduct a comprehensive security-level assessment on all securities. For those securities in an unrealized loss position we determine if OTTI exists. An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. An OTTI loss must be recognized for a debt security in an unrealized loss position if we intend to sell the security or it is more likely than not we will be required to sell the security prior to recovery of its amortized cost basis. In this situation, the amount of loss recognized in income is equal to the difference between the fair value and the amortized cost basis of the security. Even if we do not expect to sell the security, we must evaluate the expected cash flows to be received to determine if we believe a credit loss has occurred. In the event of a credit loss, only the amount of impairment associated with the credit loss is recognized in income. The portion of the unrealized loss relating to other factors, such as liquidity conditions in the market or changes in market interest rates, is recorded in accumulated other comprehensive income (loss).
The security-level assessment is performed on each investment security. Our assessment considers the security structure, recent security collateral performance metrics if applicable, external credit ratings, failure of the issuer to make scheduled interest or principal payments, our judgment and expectations of future performance, and relevant independent industry research, analysis and forecasts. Results of the periodic assessment are reviewed by a cross-functional senior management team representing Asset & Liability Management, Finance, and Market Risk Management. The senior management team considers the results of the
assessments, as well as other factors, in determining whether the impairment is other-than-temporary.
Substantially all of the credit impairment we have recognized relates to non-agency residential mortgage-backed securities and asset-backed securities collateralized by first-lien and second-lien non-agency residential mortgage loans. Potential credit losses on these securities are evaluated on a security-by-security basis. Collateral performance assumptions are developed for each security after reviewing collateral composition and collateral performance statistics. This includes analyzing recent delinquency roll rates, loss severities, voluntary prepayments and various other collateral and performance metrics. This information is then combined with general expectations on the housing market, employment and other macroeconomic factors to develop estimates of future performance.
Security level assumptions for prepayments, loan defaults and loss given default are applied to each non-agency residential mortgage-backed security and asset-backed security collateralized by first-lien and second-lien non-agency residential mortgage loans using a third-party cash flow model. The third-party cash flow model then generates projected cash flows according to the structure of each security. Based on the results of the cash flow analysis, we determine whether we expect that we will recover the amortized cost basis of our security.
The following table presents a rollforward of the cumulative OTTI credit losses recognized in earnings for all debt securities for which a portion of an OTTI loss was recognized in Accumulated other comprehensive income (loss).
Table 71: Rollforward of Cumulative OTTI Credit Losses Recognized in Earnings
Three months ended March 31,
Balance at beginning of period
Additional loss where credit impairment was previously recognized
Reduction due to credit impaired securities sold or matured
Balance at end of period
The PNC Financial Services Group, Inc. – Form 10-Q 87
Information relating to gross realized securities gains and losses from the sales of securities is set forth in the following table.
Table 72: Gains (Losses) on Sales of Securities Available for Sale
The following table presents, by remaining contractual maturity, the amortized cost, fair value and weighted-average yield of debt securities at March 31, 2015.
Table 73: Contractual Maturity of Debt Securities
Total debt securities available for sale
Fair value
Weighted-average yield, GAAP basis
Securities Held to Maturity
Total debt securities held to maturity
88 The PNC Financial Services Group, Inc. – Form 10-Q
Based on current interest rates and expected prepayment speeds, the weighted-average expected maturity of the investment securities portfolio (excluding corporate stocks and other) was 4.1 years at March 31, 2015 and 4.3 years at December 31, 2014. The weighted-average expected maturities of mortgage and other asset-backed debt securities were as follows as of March 31, 2015:
Table 74: Weighted-Average Expected Maturity of Mortgage and Other Asset-Backed Debt Securities
Agency residential mortgage-backed securities
Non-agency residential mortgage-backed securities
Agency commercial mortgage-backed securities
Non-agency commercial mortgage-backed securities
Asset-backed securities
Weighted-average yields are based on historical cost with effective yields weighted for the contractual maturity of each security. At March 31, 2015, there were no securities of a single issuer, other than FNMA, that exceeded 10% of Total shareholders’ equity.
The following table presents the fair value of securities that have been either pledged to or accepted from others to collateralize outstanding borrowings.
Table 75: Fair Value of Securities Pledged and Accepted as Collateral
Pledged to others
Accepted from others:
Permitted by contract or custom to sell or repledge
Permitted amount repledged to others
The securities pledged to others include positions held in our portfolio of investment securities, trading securities, and securities accepted as collateral from others that we are permitted by contract or custom to sell or repledge, and were used to secure public and trust deposits, repurchase agreements, and for other purposes.
NOTE 7 FAIR VALUE
Fair Value Measurement
PNC measures certain financial assets and liabilities at fair value in accordance with GAAP. Fair value is defined in GAAP as the price that would be received to sell an asset or the price that would be paid to transfer a liability on the measurement date. GAAP focuses on the exit price in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants. GAAP also establishes a fair value hierarchy to maximize the use of observable inputs when measuring fair value. For more information regarding the fair value hierarchy see Note 7 Fair Value in our Notes To Consolidated Financial Statements under Item 8 of our 2014 Form 10-K.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
For more information on the valuation methodologies used to measure assets and liabilities at fair value on a recurring basis, see Note 7 Fair Value in our Notes To Consolidated Financial Statements under Item 8 of our 2014 Form 10-K. The following table summarizes our assets and liabilities measured at fair value on a recurring basis, including instruments for which PNC has elected the fair value option.
The PNC Financial Services Group, Inc. – Form 10-Q 89
Table 76: Fair Value Measurements – Recurring Basis Summary
Fair Value
Financial derivatives (a) (b)
Interest rate contracts
Other contracts
Total financial derivatives
Residential mortgage loans held for sale (c)
Trading securities (d)
Debt (e)
Total trading securities
Trading loans (a)
Residential mortgage servicing rights (f)
Commercial mortgage servicing rights (f)
Commercial mortgage loans held for sale (c)
Equity investments (a)
Direct investments
Indirect investments (g)
Total equity investments
Customer resale agreements (h)
Loans (i)
BlackRock Series C Preferred Stock (j)
Total other assets
Financial derivatives (b) (k)
BlackRock LTIP
Trading securities sold short (l)
Debt
Total trading securities sold short
Other borrowed funds (l)
Other liabilities (k)
90 The PNC Financial Services Group, Inc. – Form 10-Q
Reconciliations of assets and liabilities measured at fair value on a recurring basis using Level 3 inputs for 2015 and 2014 follow.
Table 77: Reconciliation of Level 3 Assets and Liabilities
Three Months Ended March 31, 2015
Unrealizedgains(losses)
on assets and
liabilities held onConsolidatedBalance Sheet
at Mar. 31,2015 (c)
Level 3 Instruments Only
FairValue
Dec. 31,2014
Included
in Othercomprehensiveincome
Residential mortgage-backed non-agency
Commercial mortgage backed non-agency
Financial derivatives
Residential mortgage loans held for sale
Trading securities – Debt
Trading loans
Residential mortgage servicing rights
Commercial mortgage servicing rights
Commercial mortgage loans held for sale
Indirect investments
BlackRock Series C Preferred Stock
Totalassets
Financial derivatives (d)
Totalliabilities
The PNC Financial Services Group, Inc. – Form 10-Q 91
Three Months Ended March 31, 2014
Settlements
Loans (h)
BlackRock Series C
Preferred Stock
Other borrowedfunds (h)
An instrument’s categorization within the hierarchy is based on the lowest level of input that is significant to the fair value measurement. Changes from one quarter to the next related to the observability of inputs to a fair value measurement may result in a reclassification (transfer) of assets or liabilities between hierarchy levels. PNC’s policy is to recognize transfers in and transfers out as of the end of the reporting period. There were no significant transfers between Level 2 and Level 3 during the first three months of 2015 and 2014.
92 The PNC Financial Services Group, Inc. – Form 10-Q
Quantitative information about the significant unobservable inputs within Level 3 recurring assets and liabilities follows.
Table 78: Fair Value Measurements – Recurring Quantitative Information
Residential mortgage-backed non-agency securities
Constant prepayment rate (CPR) Constant default rate (CDR)
Loss severity
1.0%-24.2% (6.9%) 0%-16.7% (5.4%)
1.0%-100.0% (53.2%)
State and municipal securities
Other debt securities
6.4%-20.0% (7.5%)
1.1%-8.8% (6.5%)
Equity investments – Direct investments
Equity investments – Indirect (d)
Loans – Residential real estate
Loans – Home equity
Swaps related to sales of certain Visa Class B common shares
Estimated conversion factor of
Class B shares into Class A shares
Other borrowed funds – non-agency securitization
Insignificant Level 3 assets, net of liabilities (f)
Total Level 3 assets, net of liabilities (g)
The PNC Financial Services Group, Inc. – Form 10-Q 93
Spread over the benchmark curve (b)
0.0% - 16.7% (5.6%)
6.1% - 100.0% (53.1%)
249bps weighted average
(a
)
Priced by a third-party vendor
using a discounted cash flow
pricing model (a)
Constant prepayment rate (CPR)
Constant default rate (CDR)
1.7% - 13.9% (7.6%)
14.6% - 100.0% (73.5%)
352bps weighted average
Discounted cash flow
Consensus pricing (c)
Credit and Liquidity discount
0.0% - 20.0% (14.9%)
Trading securities - Debt
889bps - 1,888bps (1,036bps)
Estimated servicing cash flows
0.0% - 2.0% (1.2%)
Equity investments - Direct investments
Equity investments - Indirect (d)
Loans - Residential real estate
154
Cumulative default rate
Discount rate
0.0% - 100.0% (35.6%)
5.4% - 7.0% (6.4%)
8.0% weighted average
3.4% weighted average
Loans - Home equity
Swaps related to sales of certainVisa Class B common shares
Class B shares into Class A shares Estimated growth rate of Visa
Class A share price
14.8%
Other borrowed funds - non-agency securitization
113bps
Financial Assets Accounted for at Fair Value on a Nonrecurring Basis
We may be required to measure certain financial assets at fair value on a nonrecurring basis. These adjustments to fair value usually result from the application of lower of amortized cost or fair value accounting or write-downs of individual assets due to impairment and are included in Table 79 and Table 80. For more information regarding the valuation methodologies of our financial assets measured at fair value on a nonrecurring basis, see Note 7 Fair Value in our Notes To Consolidated Financial Statements under Item 8 of our 2014 Form 10-K.
94 The PNC Financial Services Group, Inc. – Form 10-Q
Table 79: Fair Value Measurements – Nonrecurring
Nonaccrual loans
Long-lived assets held for sale
Quantitative information about the significant unobservable inputs within Level 3 nonrecurring assets follows.
Table 80: Fair Value Measurements – Nonrecurring Quantitative Information
Nonaccrual loans (a)
Other (c)
Financial Instruments Accounted For Under Fair Value Option
We elect the fair value option to account for certain financial instruments. For more information on these financial instruments for which the fair value option election has been made, please refer to Note 7 Fair Value in our Notes To Consolidated Financial Statements under Item 8 of our 2014 Form 10-K.
The changes in fair value included in Noninterest income for items for which we elected the fair value option follow.
Table 81: Fair Value Option – Changes in Fair Value (a)
Gains (Losses)
Three months ended
Customer resale agreements
Residential mortgage loans held for sale (b)
Residential mortgage loans – portfolio (b)
The PNC Financial Services Group, Inc. – Form 10-Q 95
Fair values and aggregate unpaid principal balances of items for which we elected the fair value option follow.
Table 82: Fair Value Option – Fair Value and Principal Balances
Performing loans
Accruing loans 90 days or more past due
Commercial mortgage loans held for sale (a)
Residential mortgage loans – portfolio
96 The PNC Financial Services Group, Inc. – Form 10-Q
Additional Fair Value Information Related to Other Financial Instruments
The following table presents the carrying amounts and estimated fair values, including the level within the fair value hierarchy, of all other financial instruments that are not measured on the consolidated financial statements at fair value as of March 31, 2015 and December 31, 2014.
Table 83: Additional Fair Value Information Related to Other Financial Instruments
Carrying
Amount
Short-term assets
Net loans (excludes leases)
Demand, savings and money market deposits
Time deposits
Unfunded loan commitments and letters of credit
The aggregate fair values in the preceding table represent only a portion of the total market value of PNC’s assets and liabilities as, in accordance with the guidance related to fair values of financial instruments, Table 83 excludes the following:
financial instruments recorded at fair value on a recurring basis,
real and personal property,
lease financing,
loan customer relationships,
deposit customer intangibles,
mortgage servicing rights,
retail branch networks,
fee-based businesses, such as asset management and brokerage, and
trademarks and brand names.
The PNC Financial Services Group, Inc. – Form 10-Q 97
For more information regarding the methods and assumptions used to estimate the fair values of financial instruments included in Table 83, see Note 7 Fair Value in our Notes To Consolidated Financial Statements under Item 8 of our 2014 Form 10-K.
NOTE 8 GOODWILL AND INTANGIBLEASSETS
Goodwill by business segment consisted of the following:
Table 84: Goodwill by Business Segment (a)
Mortgage Servicing Rights
We recognize the right to service mortgage loans for others as an intangible asset. MSRs are purchased or originated when loans are sold with servicing retained. MSRs totaled $1.3 billion and $1.4 billion at March 31, 2015 and December 31, 2014, respectively, and consisted of loan servicing contracts for commercial and residential mortgages measured at fair value.
MSRs are subject to declines in value from actual or expected prepayment of the underlying loans and defaults as well as market driven changes in interest rates. We manage this risk by economically hedging the fair value of MSRs with securities and derivative instruments which are expected to increase (or decrease) in value when the value of MSRs declines (or increases).
See the Sensitivity Analysis section of this Note 8, as well as Note 7 Fair Value for more detail on our fair value measurement of MSRs. Refer to Note 8 Goodwill and Other Intangible Assets in our Notes To Consolidated Financial Statements under Item 8 of our 2014 Form 10-K for more information on our accounting and measurement of MSRs.
Changes in the commercial and residential MSRs follow:
Table 85: Mortgage Servicing Rights
Additions:
From loans sold with servicing retained
Changes in fair value due to:
Time and payoffs (a)
Other (b)
Unpaid principal balance of loans serviced for others at March 31
Sensitivity Analysis
The fair value of commercial and residential MSRs and significant inputs to the valuation models as of March 31, 2015 are shown in the tables below. The expected and actual rates of mortgage loan prepayments are significant factors driving the fair value. Management uses both internal proprietary models and a third-party model to estimate future commercial mortgage loan prepayments and a third-party model to estimate future residential mortgage loan prepayments. These models have been refined based on current market conditions and management judgment. Future interest rates are another important factor in the valuation of MSRs. Management utilizes market implied forward interest
rates to estimate the future direction of mortgage and discount rates. The forward rates utilized are derived from the current yield curve for U.S. dollar interest rate swaps and are consistent with pricing of capital markets instruments. Changes in the shape and slope of the forward curve in future periods may result in volatility in the fair value estimate.
A sensitivity analysis of the hypothetical effect on the fair value of MSRs to adverse changes in key assumptions is presented below. These sensitivities do not include the impact of the related hedging activities. Changes in fair value generally cannot be extrapolated because the relationship of the change in the assumption to the change in fair value may
98 The PNC Financial Services Group, Inc. – Form 10-Q
not be linear. Also, the effect of a variation in a particular assumption on the fair value of the MSRs is calculated independently without changing any other assumption. In reality, changes in one factor may result in changes in another (for example, changes in mortgage interest rates, which drive changes in prepayment rate estimates, could result in changes in the interest rate spread), which could either magnify or counteract the sensitivities.
The following tables set forth the fair value of commercial and residential MSRs and the sensitivity analysis of the hypothetical effect on the fair value of MSRs to immediate adverse changes of 10% and 20% in those assumptions:
Table 86: Commercial Mortgage Loan Servicing Rights – Key Valuation Assumptions
Weighted-average life (years)
Weighted-average constant prepayment rate
Decline in fair value from 10% adverse change
Decline in fair value from 20% adverse change
Effective discount rate
Table 87: Residential Mortgage Loan Servicing Rights – Key Valuation Assumptions
Weighted-average option adjusted spread
Fees from mortgage and other loan servicing, comprised of contractually specified servicing fees, late fees and ancillary fees, follows:
Table 88: Fees from Mortgage and Other Loan Servicing
We also generate servicing fees from fee-based activities provided to others for which we do not have an associated servicing asset.
Fees from commercial and residential MSRs are reported on our Consolidated Income Statement in the line items Corporate services and Residential mortgage, respectively.
Other Intangible Assets
Other intangible assets consist primarily of core deposit intangibles, customer lists and non-compete agreements. Core deposit intangibles are amortized on an accelerated basis, whereas the remaining other intangible assets are amortized on a straight-line basis. The estimated remaining useful lives of our other intangible assets range from 2 years to 10 years, with a weighted-average remaining useful life of 6 years.
Other intangible assets were as follows at March 31, 2015 and December 31, 2014:
Table 89: Other Intangible Assets
Gross carrying amount
Accumulated amortization
Net carrying amount
Amortization expense on existing other intangible assets follows:
Table 90: Amortization Expense on Existing Other Intangible Assets
2020
The PNC Financial Services Group, Inc. – Form 10-Q 99
NOTE 9 CAPITAL SECURITIES OF ASUBSIDIARY TRUST AND PERPETUAL TRUST SECURITIES
Capital Securities of a Subsidiary Trust
Our capital securities of a subsidiary trust (“Trust”) are described in Note 12 Capital Securities of a Subsidiary Trust and Perpetual Trust Securities in our 2014 Form 10-K. This Trust is a wholly-owned finance subsidiary of PNC. In the event of certain changes or amendments to regulatory requirements or federal tax rules, the capital securities are redeemable in whole. In accordance with GAAP, the financial statements of the Trust are not included in PNC’s consolidated financial statements.
The obligations of the parent of the Trust, when taken collectively, are the equivalent of a full and unconditional guarantee of the obligations of the Trust under the terms of the Capital Securities. Such guarantee is subordinate in right of payment in the same manner as other junior subordinated debt. There are certain restrictions on PNC’s overall ability to obtain funds from its subsidiaries. For additional disclosure on these funding restrictions, including an explanation of dividend and intercompany loan limitations, see Note 20 Regulatory Matters in our 2014 Form 10-K.
PNC is also subject to restrictions on dividends and other provisions potentially imposed under the Exchange Agreement with PNC Preferred Funding Trust II, as described in Note 12 in our 2014 Form 10-K in the Perpetual Trust Securities section, and to other provisions similar to or in some ways more restrictive than those potentially imposed under that agreement.
Perpetual Trust Securities
Our perpetual trust securities are described in Note 12 in our 2014 Form 10-K. Our 2014 Form 10-K also includes additional information regarding the PNC Preferred Funding Trust I and Trust II Securities, including descriptions of replacement capital and dividend restriction covenants.
NOTE 10 CERTAIN EMPLOYEE BENEFITAND STOCK BASED COMPENSATION PLANS
Pension And Postretirement Plans
As described in Note 13 Employee Benefit Plans in our 2014 Form 10-K, we have a noncontributory, qualified defined benefit pension plan covering eligible employees. Benefits are determined using a cash balance formula where earnings credits are a percentage of eligible compensation. Pension contributions are based on an actuarially determined amount necessary to fund total benefits payable to plan participants.
We also maintain nonqualified supplemental retirement plans for certain employees and provide certain health care and life insurance benefits for qualifying retired employees (postretirement benefits) through various plans. The nonqualified pension and postretirement benefit plans are unfunded. PNC reserves the right to terminate plans or make plan changes at any time.
The components of our net periodic pension and postretirement benefit cost for the first three months of 2015 and 2014, respectively, were as follows:
Table 91: Net Periodic Pension and Postretirement Benefits Costs
Net periodic cost consists of:
Service cost
Interest cost
Expected return on plan assets
Amortization of prior service credit
Amortization of actuarial losses
Net periodic cost/(benefit)
Stock Based Compensation Plans
As more fully described in Note 14 Stock Based Compensation Plans in our 2014 Form 10-K, we have long-term incentive award plans (Incentive Plans) that provide for the granting of incentive stock options, nonqualified stock options, stock appreciation
100 The PNC Financial Services Group, Inc. – Form 10-Q
rights, incentive shares/performance units, restricted stock, restricted share units, other share-based awards and dollar-denominated awards to executives and, other than incentive stock options, to non-employee directors. Certain Incentive Plan awards may be paid in stock, cash or a combination of stock and cash. We typically grant a substantial portion of our stock-based compensation awards during the first quarter of the year. As of March 31, 2015, no stock appreciation rights were outstanding.
Total compensation expense recognized related to all share-based payment arrangements during the first three months of 2015 and 2014 was $40 million and $50 million, respectively. At March 31, 2015, there was $285 million of unamortized share-based compensation expense related to nonvested equity compensation arrangements, including liability awards granted under the Incentive Plans. This unamortized cost is expected to be recognized as expense over a period of no longer than five years.
Nonqualified Stock Options
Beginning in 2014, PNC discontinued the use of stock options as a standard element of our long-term equity incentive compensation programs under our Incentive Plans. Additional information regarding PNC stock options is more fully described in Note 14 Stock Based Compensation Plans in our 2014 Form 10-K.
The following table represents the stock option activity for the first three months of 2015.
Table 92: Stock Option Rollforward
Outstanding at December 31, 2014
Granted (a)
Exercised
Cancelled
Outstanding at March 31, 2015
Exercisable at March 31, 2015
During the first three months of 2015, we issued approximately 0.7 million common shares from treasury stock in connection with stock option exercise activity. As with past exercise activity, we currently intend to utilize primarily treasury stock for any future stock option exercises.
Incentive/Performance Unit Share Awards and Restricted Stock/Share Unit Awards
Information on incentive/performance unit share awards and restricted stock/share unit awards is more fully described in Note 14 Stock Based Compensation Plans in our 2014 Form 10-K.
Table 93: Nonvested Incentive/Performance Unit Share Awards and Restricted Stock/Share Unit Awards – Rollforward
Granted
Vested/Released
Forfeited
In the preceding table, the unit shares and related weighted-average grant date fair value of the incentive/performance awards exclude the effect of dividends on the underlying shares, as those dividends will be paid in cash if and when the underlying unit shares are released to the participants.
The PNC Financial Services Group, Inc. – Form 10-Q 101
Liability Awards
A summary of all nonvested, cash-payable incentive/performance units and restricted share unit activity follows:
Table 94: Nonvested Cash-Payable Incentive/Performance Units and Restricted Share Units – Rollforward
Vested and Released
Included in the preceding table are cash-payable restricted share units granted to certain executives. These grants were made primarily as part of an annual bonus incentive deferral plan. While there are time-based and other vesting criteria, there are generally no market or performance criteria associated with these awards. Prior to the 2015 grant, compensation expense recognized related to these awards was recorded in prior periods as part of the annual cash bonus process. Due to certain requisite service period changes in the award agreements starting with the 2015 grant (for the 2014 performance year), compensation expense is recognized ratably over a four year period commensurate with the performance year plus the three years of service-based vesting requirements. As of March 31, 2015, the aggregate intrinsic value of all outstanding nonvested cash-payable incentive/performance units and restricted share units was approximately $72 million.
NOTE 11 FINANCIAL DERIVATIVES
We use derivative financial instruments (derivatives) primarily to help manage exposure to interest rate, market and credit risk and reduce the effects that changes in interest rates may have on net income, the fair value of assets and liabilities, and cash flows. We also enter into derivatives with customers to facilitate their risk management activities. Derivatives represent contracts between parties that usually require little or no initial net investment and result in one party delivering cash or another type of asset to the other party based on a notional amount and an underlying as specified in the contract.
For more information regarding derivatives see Note 1 Accounting Policies and Note 15 Financial Derivatives in our Notes To Consolidated Financial Statements under Item 8 of our 2014 Form 10-K.
The following table presents the notional amounts and gross fair values of all derivative assets and liabilities held by PNC:
Table 95: Total Gross Derivatives
Total gross derivatives
All derivatives are carried on our Consolidated Balance Sheet at fair value. Derivative balances are presented on the Consolidated Balance Sheet on a net basis taking into consideration the effects of legally enforceable master netting agreements and any related cash collateral exchanged with counterparties. Further discussion regarding the rights of setoff associated with these legally enforceable master netting agreements is included in the Offsetting, Counterparty Credit Risk, and Contingent Features section below. Our exposure related to risk participations where we sold protection is discussed in the Credit Derivatives section below. Any nonperformance risk, including credit risk, is included in the determination of the estimated net fair value of the derivatives.
Derivatives Designated As Hedging Instruments under GAAP
Certain derivatives used to manage interest rate and foreign exchange risk as part of our asset and liability risk management activities are designated as accounting hedges under GAAP. Derivatives hedging the risks associated with changes in the fair value of assets or liabilities are considered fair value hedges, derivatives hedging the variability of expected future cash flows are considered cash flow hedges, and derivatives hedging a net investment in a foreign subsidiary are considered net investment hedges. Designating derivatives as accounting hedges allows for gains and losses on those derivatives, to the extent effective, to be recognized in the income statement in the same period the hedged items affect earnings.
102 The PNC Financial Services Group, Inc. – Form 10-Q
Further detail regarding the notional amounts and fair values related to derivatives designated in hedge relationships is presented in the following table:
Table 96: Derivatives Designated As Hedging Instruments under GAAP
Interest rate contracts:
Fair value hedges:
Receive-fixed swaps
Pay-fixed swaps (c)
Subtotal
Cash flow hedges:
Forward purchase commitments
Foreign exchange contracts:
Net investment hedges
Fair Value Hedges
We enter into receive-fixed, pay-variable interest rate swaps to hedge changes in the fair value of outstanding fixed-rate debt and borrowings caused by fluctuations in market interest rates. We also enter into pay-fixed, receive-variable interest rate swaps and zero-coupon swaps to hedge changes in the fair value of fixed rate and zero-coupon investment securities caused by fluctuations in market interest rates. For these hedge relationships, we use statistical regression analysis to assess hedge effectiveness at both the inception of the hedge relationship and on an ongoing basis. There were no components of derivative gains or losses excluded from the assessment of hedge effectiveness.
Further detail regarding gains (losses) on fair value hedge derivatives and related hedged items is presented in the following table:
Table 97: Gains (Losses) on Derivatives and Related Hedged Items – Fair Value Hedges
Total (a)
The PNC Financial Services Group, Inc. – Form 10-Q 103
Cash Flow Hedges
We enter into receive-fixed, pay-variable interest rate swaps to modify the interest rate characteristics of designated commercial loans from variable to fixed in order to reduce the impact of changes in future cash flows due to market interest rate changes. For these cash flow hedges, any changes in the fair value of the derivatives that are effective in offsetting changes in the forecasted interest cash flows are recorded in Accumulated other comprehensive income and are reclassified to interest income in conjunction with the recognition of interest received on the loans. In the 12 months that follow March 31, 2015, we expect to reclassify from the amount currently reported in Accumulated other comprehensive income, net derivative gains of $257 million pretax, or $167 million after-tax, in association with interest received on the hedged loans. This amount could differ from amounts actually recognized due to changes in interest rates, hedge de-designations, and the addition of other hedges subsequent to March 31, 2015. The maximum length of time over which forecasted loan cash flows are hedged is 10 years. We use statistical regression analysis to assess the effectiveness of these hedge relationships at both the inception of the hedge relationship and on an ongoing basis.
We also periodically enter into forward purchase and sale contracts to hedge the variability of the consideration that will be paid or received related to the purchase or sale of investment securities. The forecasted purchase or sale is consummated upon gross settlement of the forward contract itself. As a result, hedge ineffectiveness, if any, is typically minimal. Gains and losses on these forward contracts are recorded in Accumulated other comprehensive income and are recognized in earnings when the hedged cash flows affect earnings. In the 12 months that follow March 31, 2015, we expect to reclassify from the amount currently reported in Accumulated other comprehensive income, net derivative gains of $38 million pretax, or $25 million after-tax, as adjustments of yield on investment securities. As of March 31, 2015, the maximum length of time over which forecasted purchase contracts are hedged is three months.
There were no components of derivative gains or losses excluded from the assessment of hedge effectiveness related to either cash flow hedge strategy.
During the first three months of 2015 and 2014, there were no gains or losses from cash flow hedge derivatives reclassified to earnings because it became probable that the original forecasted transaction would not occur.
Further detail regarding gains (losses) on derivatives and related cash flows is presented in the following table:
Table 98: Gains (Losses) on Derivatives and Related Cash Flows – Cash Flow Hedges (a) (b)
Gains (losses) on derivatives recognized in OCI – (effective portion)
Less: Gains (losses) reclassified from accumulated OCI into income – (effective portion)
Interest income
Total gains (losses) reclassified from accumulated OCI into income – (effective portion)
Net Investment Hedges
We enter into foreign currency forward contracts to hedge non-U.S. Dollar (USD) net investments in foreign subsidiaries against adverse changes in foreign exchange rates. We assess whether the hedging relationship is highly effective in achieving offsetting changes in the value of the hedge and hedged item by qualitatively verifying that the critical terms of the hedge and hedged item match at the inception of the hedging relationship and on an ongoing basis. There were no components of derivative gains or losses excluded from the assessment of the hedge effectiveness.
For the first three months of 2015 and 2014, there was no net investment hedge ineffectiveness.
Further detail on gains (losses) on net investment hedge derivatives is presented in the following table:
Table 99: Gains (Losses) on Derivatives – Net Investment Hedges
Gains (losses) on derivatives recognized in OCI (effective portion)
Foreign exchange contracts
104 The PNC Financial Services Group, Inc. – Form 10-Q
Derivatives Not Designated As Hedging Instruments under GAAP
We also enter into derivatives that are not designated as accounting hedges under GAAP.
For additional information on derivatives not designated as hedging instruments under GAAP see Note 15 Financial Derivatives in our Notes To Consolidated Financial Statements under Item 8 of our 2014 Form 10-K.
Further detail regarding the notional amounts and fair values related to derivatives not designated in hedge relationships is presented in the following table:
Table 100: Derivatives Not Designated As Hedging Instruments under GAAP
Derivatives used for residential mortgage banking activities:
Residential mortgage servicing
Swaps
Swaptions
Futures (c)
Futures options
Mortgage-backed securities commitments
Loan sales
Bond options
Residential mortgage loan commitments
Derivatives used for commercial mortgage banking activities:
Commercial mortgage loan commitments
Credit contracts:
Credit default swaps
Derivatives used for customer-related activities:
Caps/floors – Sold
Caps/floors – Purchased
Risk participation agreements
Derivatives used for other risk management activities:
Other contracts (d)
The PNC Financial Services Group, Inc. – Form 10-Q 105
Further detail regarding the gains (losses) on derivatives not designated in hedging relationships is presented in the following table:
Table 101: Gains (Losses) on Derivatives Not Designated As Hedging Instruments under GAAP
Gains (losses) included in residential mortgage banking activities (a)
Interest rate contracts (b) (c)
Credit contracts (c)
Gains (losses) from commercial mortgage banking activities
Credit contracts
Gains (losses) from customer-related activities (c)
Gains (losses) from other risk management activities (c)
Total gains (losses) from derivatives not designated as hedging instruments
Credit Derivatives
We enter into credit derivatives, specifically credit default swaps and risk participation agreements, as part of our commercial mortgage banking hedging activities and for customer and other risk management purposes. The credit derivative underlying is based on the credit risk of a specific entity, entities, or an index. Detail regarding credit default swaps purchased and risk participations sold follows.
Table 102: Credit Default Swaps (a)
Credit Default Swaps – Purchased (b)
Single name
Index traded
The notional amount of these credit default swaps by credit rating is presented in the following table:
Table 103: Credit Ratings of Credit Default Swaps (a)
Credit Default Swaps – Purchased
Investment grade (b)
Subinvestment grade (c)
The referenced/underlying assets for these credit default swaps are presented in the following table:
Table 104: Referenced/Underlying Assets of Credit Default Swaps
Corporate debt
Commercial mortgage-backed securities
Risk Participation Agreements
We also periodically enter into risk participation agreements to share some of the credit exposure with other counterparties related to interest rate derivative contracts or to take on credit exposure to generate revenue. We will make/receive payments under these agreements if a customer defaults on its obligation to perform under certain derivative swap contracts. Risk participation agreements purchased and sold are included in these derivative tables: Tables 100, 101, and 105.
106 The PNC Financial Services Group, Inc. – Form 10-Q
Further detail regarding the notional amount, fair value and weighted-average remaining maturities in years for risk participation agreements sold is presented in the following table:
Table 105: Risk Participation Agreements Sold
Risk Participation Agreements Sold
Based on our internal risk rating process of the underlying third party customers referenced in the swap contracts, all exposure related to risk participation agreements sold have an internal credit rating of pass, which indicates the expected risk of default is currently low.
We have sold risk participation agreements with terms ranging from less than 1 year to 22 years. We will be required to make payments under these agreements if a customer defaults on its obligation to perform under certain derivative swap contracts with third parties. Assuming all underlying third party customers referenced in the swap contracts defaulted at March 31, 2015, the exposure from these agreements would be $147 million based on the fair value of the underlying swaps, compared with $124 million at December 31, 2014.
Offsetting, Counterparty Credit Risk, and Contingent Features
We, generally, utilize a net presentation on the Consolidated Balance Sheet for those derivative financial instruments entered into with counterparties under legally enforceable master netting agreements. The master netting agreements reduce credit risk by permitting the closeout netting of various types of derivative instruments with the same counterparty upon the occurrence of an event of default.
For additional information on derivative offsetting, counterparty credit risk, and contingent features see Note 15 Financial Derivatives in our Notes To Consolidated Financial Statements under Item 8 of our 2014 Form 10-K. Refer to Note 16 Commitments and Guarantees in this Report for additional information related to resale and repurchase agreements offsetting.
The following derivative Table 106 shows the impact legally enforceable master netting agreements had on our derivative assets and derivative liabilities as of March 31, 2015 and December 31, 2014. The table also includes the fair value of any securities collateral held or pledged under legally enforceable master netting agreements. Cash and securities collateral amounts are included in the table only to the extent of the related net derivative fair values.
Table 106: Derivative Assets and Liabilities Offsetting
GrossFair Value
DerivativeAssets
NetFair Value
SecuritiesCollateralHeld Under
Master NettingAgreements
NetAmounts
Derivative assets
Total derivative assets (a) (b)
DerivativeLiabilities
Net FairValue
SecuritiesCollateralPledged Under
Derivative liabilities
Total derivative liabilities (a) (b)
The PNC Financial Services Group, Inc. – Form 10-Q 107
MasterNettingAgreements
SecuritiesCollateralPledgedUnder
In addition to using master netting and related collateral agreements to reduce credit risk associated with derivative instruments, we also seek to manage credit risk by evaluating credit ratings of counterparties, by taking collateral and by using internal credit analysis, limits, and monitoring procedures. Collateral may also be exchanged under certain derivative agreements that are not considered master netting agreements.
At March 31, 2015, we held cash, U.S. government securities and mortgage-backed securities totaling $943 million under master netting and other collateral agreements to collateralize net derivative assets due from counterparties, and we have pledged cash totaling $610 million under these agreements to collateralize net derivative liabilities owed to counterparties. These totals may differ from the amounts presented in the preceding offsetting table because they may include collateral exchanged under an agreement that does not qualify as a master netting agreement or because the total amount of collateral held or pledged exceeds the net derivative fair value with the counterparty as of the balance sheet date due to timing or other factors. To the extent not netted against the derivative fair value under a master netting agreement, the receivable for cash pledged is included in Other assets and the
obligation for cash held is included in Other borrowed funds on our Consolidated Balance Sheet. Securities held from counterparties are not recognized on our balance sheet. Likewise securities we have pledged to counterparties remain on our balance sheet.
Certain of the master netting agreements and certain other derivative agreements also contain provisions that require PNC’s debt to maintain an investment grade credit rating from each of the major credit rating agencies. If PNC’s debt ratings were to fall below investment grade, we would be in violation of these provisions and the counterparties to the derivative instruments could request immediate payment or demand immediate and ongoing full overnight collateralization on derivative instruments in net liability positions. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that were in a net liability position on March 31, 2015 was $.8 billion for which PNC had posted collateral of $.6 billion in the normal course of business. The maximum additional amount of collateral PNC would have been required to post if the credit-risk-related contingent features underlying these agreements had been triggered on March 31, 2015 would be $.2 billion.
108 The PNC Financial Services Group, Inc. – Form 10-Q
NOTE 12 EARNINGS PER SHARE
Table 107: Basic and Diluted Earnings per Common Share
Net income attributable to common shares
Net income attributable to basic common shares
Basic weighted-average common shares outstanding
Basic earnings per common share (a)
Less: Impact of BlackRock earnings per share dilution
Dilutive potential common shares (b) (c)
Diluted weighted-average common shares outstanding
Diluted earnings per common share (a)
The PNC Financial Services Group, Inc. – Form 10-Q 109
NOTE 13 TOTAL EQUITY AND OTHERCOMPREHENSIVE INCOME
Activity in total equity for the first three months of 2014 and 2015 follows.
Table 108: Rollforward of Total Equity
Non-controlling
Interests
Balance at December 31, 2013
Cumulative effect of adopting ASC 860-50 (a)
Balance at January 1, 2014
Other comprehensive income (loss), net of tax
Cash dividends declared
Common ($.44 per share)
Preferred
Preferred stock discount accretion
Common stock activity (b)
Treasury stock activity
Balance at March 31, 2014 (c)
Balance at January 1, 2015
Common ($.48 per share)
Balance at March 31, 2015 (c)
Warrants
We had 15,796,592 warrants outstanding as of March 31, 2015 compared to 16,885,192 as of December 31, 2014. The reduction was due to 1,088,600 warrants that were exercised during the first quarter of 2015. Each warrant entitles the holder to purchase one share of PNC common stock at an exercise price of $67.33 per share. In accordance with the terms of the warrants, the warrants are exercised on a non-cash net basis with the warrant holder receiving PNC common shares determined based on the excess of the market price of PNC common stock on the exercise date over the exercise price of the warrant. In the first quarter of 2015, we issued
316,897 common shares resulting from the exercise of the warrants. The issuance of these shares resulted in a reclassification within Capital surplus – Common stock and other with no impact on PNC’s Shareholder’s equity. The remaining outstanding warrants will expire as of December 31, 2018, and are considered in the calculation of diluted earnings per common share in Note 12 Earnings Per Share in this Report.
110 The PNC Financial Services Group, Inc. – Form 10-Q
Table 109: Other Comprehensive Income
Details of other comprehensive income (loss) are as follows:
First Quarter 2014 activity
Increase in net unrealized gains (losses) on non-OTTI securities
Less: Net gains (losses) realized as a yield adjustment reclassified to investment securities interest income
Less: Net gains (losses) realized on sales of securities reclassified to noninterest income
Balance at March 31, 2014
Balance at December 31, 2014
First Quarter 2015 activity
Balance at March 31, 2015
Increase in net unrealized gains (losses) on OTTI securities
Less: OTTI losses realized on securities reclassified to noninterest income
Increase in net unrealized gains (losses) on cash flow hedge derivatives
Less: Net gains (losses) realized as a yield adjustment reclassified to loan interest income (a)
Less: Net gains (losses) realized as a yield adjustment reclassified to investment securities interest income (a)
Less: Net gains (losses) realized on sales of securities reclassified to noninterest income (a)
The PNC Financial Services Group, Inc. – Form 10-Q 111
Net pension and other postretirement benefit plan activity
Amortization of actuarial loss (gain) reclassified to other noninterest expense
Amortization of prior service cost (credit) reclassified to other noninterest expense
Total First Quarter 2014 activity
Total First Quarter 2015 activity
First Quarter 2014 Activity
PNC’s portion of BlackRock’s OCI
Net investment hedge derivatives (b)
Foreign currency translation adjustments (c)
First Quarter 2015 Activity
Table 110: Accumulated Other Comprehensive Income (Loss) Components
Accumulated other comprehensive income (loss)
112 The PNC Financial Services Group, Inc. – Form 10-Q
NOTE 14 INCOME TAXES
Table 111: Net Operating Loss Carryforwards and Tax Credit Carryforwards
Net Operating Loss Carryforwards:
Federal
State
Tax Credit Carryforwards:
The federal net operating loss carryforwards expire in 2032. The state net operating loss carryforwards will expire from 2015 to 2031. The majority of the tax credit carryforwards expire in 2032. All federal and most state net operating loss and credit carryforwards are from acquired entities and utilization is subject to various statutory limitations. It is anticipated that the company will be able to fully utilize its carryforwards for federal tax purposes, but a valuation allowance of $65 million has been recorded against certain state tax carryforwards as of March 31, 2015. If select uncertain tax positions were successfully challenged by a state, the state net operating losses listed above could be reduced by $60 million.
The Internal Revenue Service (IRS) is currently examining PNC’s 2011 through 2013 returns. National City’s consolidated federal income tax returns through 2008 have been audited by the IRS. Certain adjustments remain under review by the IRS Appeals Division for years 2004 through 2008.
The Company had unrecognized tax benefits of $83 million at March 31, 2015 and $77 million at December 31, 2014. At March 31, 2015, $68 million of unrecognized tax benefits, if recognized, would favorably impact the effective income tax rate.
It is reasonably possible that the balance of unrecognized tax benefits could increase or decrease in the next twelve months due to completion of tax authorities’ exams or the expiration of statutes of limitations. Management estimates that the balance of unrecognized tax benefits could decrease by $58 million within the next twelve months.
During the three months ended March 31, 2015, we recognized $51 million of amortization, $55 million of tax credits, and $19 million of other tax benefits associated with qualified investments in low income housing tax credits within Income taxes.
NOTE 15 LEGAL PROCEEDINGS
We establish accruals for legal proceedings, including litigation and regulatory and governmental investigations and inquiries, when information related to the loss contingencies represented by those matters indicates both that a loss is probable and that the amount of loss can be reasonably estimated. Any such accruals are adjusted thereafter as appropriate to reflect changed circumstances. When we are able to do so, we also determine estimates of possible losses or ranges of possible losses, whether in excess of any related accrued liability or where there is no accrued liability, for disclosed legal proceedings (“Disclosed Matters,” which are those matters disclosed in this Note 15 as well as those matters disclosed in Note 21 Legal Proceedings in Part II, Item 8 of our 2014 Form 10-K (such prior disclosure referred to as “Prior Disclosure”)). For Disclosed Matters where we are able to estimate such possible losses or ranges of possible losses, as of March 31, 2015, we estimate that it is reasonably possible that we could incur losses in an aggregate amount of up to approximately $725 million. The estimates included in this amount are based on our analysis of currently available information and are subject to significant judgment and a variety of assumptions and uncertainties. As new information is obtained we may change our estimates. Due to the inherent subjectivity of the assessments and unpredictability of outcomes of legal proceedings, any amounts accrued or included in this aggregate amount may not represent the ultimate loss to us from the legal proceedings in question. Thus, our exposure and ultimate losses may be higher, and possibly significantly so, than the amounts accrued or this aggregate amount.
In our experience, legal proceedings are inherently unpredictable. One or more of the following factors frequently contribute to this inherent unpredictability: the proceeding is in its early stages; the damages sought are unspecified, unsupported or uncertain; it is unclear whether a case brought as a class action will be allowed to proceed on that basis or, if permitted to proceed as a class action, how the class will be defined; the other party is seeking relief other than or in addition to compensatory damages (including, in the case of regulatory and governmental investigations and inquiries, the possibility of fines and penalties); the matter presents meaningful legal uncertainties, including novel issues of law; we have not engaged in meaningful settlement discussions; discovery has not started or is not complete; there are significant facts in dispute; the possible outcomes may not be amenable to the use of statistical or quantitative analytical tools; predicting possible outcomes depends on making assumptions about future decisions of courts or regulatory bodies or the behavior of other parties; and there are a large number of parties named as defendants (including where it is uncertain how damages or liability, if any, will be shared among multiple defendants). Generally, the less progress that has been made in the proceedings or the broader the range of potential results, the harder it is for us to estimate losses or ranges of losses that it is reasonably possible we could incur.
The PNC Financial Services Group, Inc. – Form 10-Q 113
As a result of these types of factors, we are unable, at this time, to estimate the losses that it is reasonably possible that we could incur or ranges of such losses with respect to some of the matters disclosed, and the aggregate estimated amount provided above does not include an estimate for every Disclosed Matter. Therefore, as the estimated aggregate amount disclosed above does not include all of the Disclosed Matters, the amount disclosed above does not represent our maximum reasonably possible loss exposure for all of the Disclosed Matters. The estimated aggregate amount also does not reflect any of our exposure to matters not so disclosed, as discussed below under “Other.”
We include in some of the descriptions of individual Disclosed Matters certain quantitative information related to the plaintiff’s claim against us as alleged in the plaintiff’s pleadings or other public filings or otherwise publicly available information. While information of this type may provide insight into the potential magnitude of a matter, it does not necessarily represent our estimate of reasonably possible loss or our judgment as to any currently appropriate accrual.
Some of our exposure in Disclosed Matters may be offset by applicable insurance coverage. We do not consider the possible availability of insurance coverage in determining the amounts of any accruals (although we record the amount of related insurance recoveries that are deemed probable up to the amount of the accrual) or in determining any estimates of possible losses or ranges of possible losses.
Captive Mortgage Reinsurance Litigation
In March 2015, the parties in White, et al. v. The PNC Financial Services Group, Inc., et al. (Civil Action No. 11-7928), pending in the United States District Court for the Eastern District of Pennsylvania, stipulated to, and the court ordered, a stay of all proceedings pending the outcome of another matter currently on appeal before the United States Court of Appeals for the Third Circuit that involves overlapping issues.
Lender Placed Insurance Litigation
In March 2015, in Montoya vs. PNC Bank, N.A., et al.(Case No. 14-cv-20474-JG), the United States District Court for the Southern District of Florida denied PNC’s motion to dismiss, except that it granted the motion as to the Ohio good faith and fair dealing claim.
Mortgage Repurchase Litigation
In January 2015, the lawsuit pending in the United States District Court for the District of Minnesota under the captionResidential Funding Company, LLC v. PNC Bank, N.A., et al. (Civil No. 13-3498- JRT-JSM) was consolidated for pre-trial purposes with other lawsuits pending in the District of Minnesota filed by Residential Funding Company, LLC against other originators of mortgage loans that it had purchased. The consolidated action is captioned In Re: RFC and RESCAP Liquidating Trust Litigation, Civil File No. 13-cv-3451 (SRN/JJK/HB).
Pre-need Funeral Arrangements
In March 2015, in the case pending in the United States District Court for the Eastern District of Missouri under the caption Jo Ann Howard, P.C., et al. v. Cassity, et al.(No. 4:09-CV-1252-ERW), the court, after a jury trial, entered a judgment against National City Bank and PNC Bank (the PNC defendants) in the amount of $355.5 million in compensatory damages and $35.6 million in punitive damages. In April 2015, the plaintiffs filed motions with the court seeking $178.8 million in pre-judgment interest. Also, in April 2015, the PNC defendants filed motions with the court to reduce the compensatory damages by the amounts paid in settlement by other defendants, to strike the punitive damages award, for judgment as a matter of law, and for a new trial. If the PNC defendants do not obtain sufficient relief through these motions, they intend to appeal the judgment to the U.S. Court of Appeals for the Eighth Circuit.
Other Regulatory and Governmental Inquiries
PNC is the subject of investigations, audits and other forms of regulatory and governmental inquiry covering a broad range of issues in our banking, securities and other financial services businesses, in some cases as part of reviews of specified activities at multiple industry participants. Over the last few years, we have experienced an increase in regulatory and governmental investigations, audits and other inquiries. Areas of current regulatory or governmental inquiry with respect to PNC include consumer protection, fair lending, mortgage origination and servicing, mortgage and non mortgage-related insurance and reinsurance, municipal finance activities, conduct by broker-dealers, automobile lending practices, and participation in government insurance or guarantee programs, some of which are described in Prior Disclosure. These inquiries, including those described in Prior Disclosure, may lead to administrative, civil or criminal proceedings, and possibly result in remedies including fines, penalties, restitution, or alterations in our business practices, and in additional expenses and collateral costs.
Our practice is to cooperate fully with regulatory and governmental investigations, audits and other inquiries, including those described in Prior Disclosure.
In addition to the proceedings or other matters described above and in Prior Disclosure, PNC and persons to whom we may have indemnification obligations, in the normal course of business, are subject to various other pending and threatened legal proceedings in which claims for monetary damages and other relief are asserted. We do not anticipate, at the present time, that the ultimate aggregate liability, if any, arising out of such other legal proceedings will have a material adverse effect on our financial position. However, we cannot now determine whether or not any claims asserted against us or others to whom we may have indemnification obligations,
114 The PNC Financial Services Group, Inc. – Form 10-Q
whether in the proceedings or other matters described above or otherwise, will have a material adverse effect on our results of operations in any future reporting period, which will depend on, among other things, the amount of the loss resulting from the claim and the amount of income otherwise reported for the reporting period.
See Note 16 Commitments and Guarantees for additional information regarding the Visa indemnification and our other obligations to provide indemnification, including to current and former officers, directors, employees and agents of PNC and companies we have acquired.
NOTE 16 COMMITMENTS AND GUARANTEES
In the normal course of business, we have various commitments outstanding, certain of which are not included on our Consolidated Balance Sheet. The following table presents our outstanding commitments to extend credit along with significant other commitments as of March 31, 2015 and December 31, 2014, respectively.
Table 112: Commitments to Extend Credit and Other Commitments
Commitments to extend credit
Total commitments to extend credit
Net outstanding standby letters of credit (a)
Reinsurance agreements
Standby bond purchase agreements (b)
Other commitments related to equity investments (c)
Total commitments to extend credit and other commitments
Commitments to Extend Credit
Commitments to extend credit, or net unfunded loan commitments, represent arrangements to lend funds or provide liquidity subject to specified contractual conditions. These commitments generally have fixed expiration dates, may require payment of a fee, and contain termination clauses in the event the customer’s credit quality deteriorates. Based on our historical experience, some commitments expire unfunded, and therefore cash requirements are substantially less than the total commitment.
Net Outstanding Standby Letters of Credit
We issue standby letters of credit and share in the risk of standby letters of credit issued by other financial institutions, in each case to support obligations of our customers to third parties, such as insurance requirements and the facilitation of transactions involving capital markets product execution. Internal credit ratings related to our net outstanding standby letters of credit were as follows:
Table 113: Internal Credit Ratings Related to Net Outstanding Standby Letters of Credit
Internal credit ratings (as a percentage of portfolio):
Pass (a)
Below pass (b)
If the customer fails to meet its financial or performance obligation to the third party under the terms of the contract or there is a need to support a remarketing program, then upon a draw by a beneficiary, subject to the terms of the letter of
credit, we would be obligated to make payment to them. The standby letters of credit outstanding on March 31, 2015 had terms ranging from less than 1 year to 8 years.
As of March 31, 2015, assets of $989 million secured certain specifically identified standby letters of credit. In addition, a portion of the remaining standby letters of credit issued on behalf of specific customers is also secured by collateral or guarantees that secure the customers’ other obligations to us. The carrying amount of the liability for our obligations related to standby letters of credit and participations in standby letters of credit was $180 million at March 31, 2015 and is included in Other liabilities on our Consolidated Balance Sheet.
The PNC Financial Services Group, Inc. – Form 10-Q 115
Reinsurance Agreements
We have a wholly-owned captive insurance subsidiary which provides reinsurance for accidental death & dismemberment, credit life, accident & health and lender placed hazard, all of which are in run-off. Aggregate maximum exposure up to the specified limits for all reinsurance contracts is as follows:
Table 114: Reinsurance Agreements Exposure (a) (b)
Accidental Death & Dismemberment
Credit Life, Accident & Health
Lender Placed Hazard (c) (d)
Maximum Exposure (e)
Maximum Exposure to Quota Share Agreements with 100% Reinsurance
A rollforward of the reinsurance reserves for probable losses for the first three months of 2015 and 2014 follows:
Table 115: Reinsurance Reserves – Rollforward
Paid Losses
Net Provision
The reinsurance reserves are declining as the programs are in run-off. There were no other changes to existing agreements nor did we enter into any new relationships.
There is a reasonable possibility that losses could be more than or less than the amount reserved due to ongoing uncertainty in various economic, social and other factors that could impact the frequency and severity of claims covered by these reinsurance agreements. At March 31, 2015, the reasonably possible loss above our accrual was not material.
Indemnifications
We are a party to numerous acquisition or divestiture agreements under which we have purchased or sold, or agreed to purchase or sell, various types of assets. These agreements can cover the purchase or sale of entire businesses, loan
portfolios, branch banks, partial interests in companies, or other types of assets.
These agreements generally include indemnification provisions under which we indemnify the third parties to these agreements against a variety of risks to the indemnified parties as a result of the transaction in question. When PNC is the seller, the indemnification provisions will generally also provide the buyer with protection relating to the quality of the assets we are selling and the extent of any liabilities being assumed by the buyer. Due to the nature of these indemnification provisions, we cannot quantify the total potential exposure to us resulting from them.
We provide indemnification in connection with securities offering transactions in which we are involved. When we are the issuer of the securities, we provide indemnification to the underwriters or placement agents analogous to the indemnification provided to the purchasers of businesses from us, as described above. When we are an underwriter or placement agent, we provide a limited indemnification to the issuer related to our actions in connection with the offering and, if there are other underwriters, indemnification to the other underwriters intended to result in an appropriate sharing of the risk of participating in the offering. Due to the nature of these indemnification provisions, we cannot quantify the total potential exposure to us resulting from them.
In the ordinary course of business, we enter into certain types of agreements that include provisions for indemnifying third parties. We also enter into certain types of agreements, including leases, assignments of leases, and subleases, in which we agree to indemnify third parties for acts by our agents, assignees and/or sublessees, and employees. We also enter into contracts for the delivery of technology service in which we indemnify the other party against claims of patent and copyright infringement by third parties. Due to the nature of these indemnification provisions, we cannot calculate our aggregate potential exposure under them.
In the ordinary course of business, we enter into contracts with third parties under which the third parties provide services on behalf of PNC. In many of these contracts, we agree to indemnify the third party service provider under certain circumstances. The terms of the indemnity vary from contract to contract and the amount of the indemnification liability, if any, cannot be determined.
We are a general or limited partner in certain asset management and investment limited partnerships, many of which contain indemnification provisions that would require us to make payments in excess of our remaining unfunded commitments. While in certain of these partnerships the maximum liability to us is limited to the sum of our unfunded commitments and partnership distributions received by us, in the others the indemnification liability is unlimited. As a result, we cannot determine our aggregate potential exposure for these indemnifications.
116 The PNC Financial Services Group, Inc. – Form 10-Q
In some cases, indemnification obligations of the types described above arise under arrangements entered into by predecessor companies for which we become responsible as a result of the acquisition.
Pursuant to their bylaws, PNC and its subsidiaries provide indemnification to directors, officers and, in some cases, employees and agents against certain liabilities incurred as a result of their service on behalf of or at the request of PNC and its subsidiaries. PNC and its subsidiaries also advance on behalf of covered individuals costs incurred in connection with certain claims or proceedings, subject to written undertakings by each such individual to repay all amounts advanced if it is ultimately determined that the individual is not entitled to indemnification. We generally are responsible for similar indemnifications and advancement obligations that companies we acquire had to their officers, directors and sometimes employees and agents at the time of acquisition. We advanced such costs on behalf of several such individuals with respect to pending litigation or investigations during 2015. It is not possible for us to determine the aggregate potential exposure resulting from the obligation to provide this indemnity or to advance such costs.
Visa Indemnification
Our payment services business issues and acquires credit and debit card transactions through Visa U.S.A. Inc. card association or its affiliates (Visa). For additional information on our Visa indemnification and the related interchange litigation see Note 21 Legal Proceedings and Note 22 Commitments and Guarantees in the Notes To Consolidated Financial Statements in Item 8 of our 2014 Form 10-K.
Recourse and Repurchase Obligations
As discussed in Note 2 Loan Sale and Servicing Activities and Variable Interest Entities, PNC has sold commercial mortgage, residential mortgage and home equity loans/lines of credit directly or indirectly through securitization and loan sale transactions in which we have continuing involvement. One form of continuing involvement includes certain recourse and loan repurchase obligations associated with the transferred assets.
We originate and service certain multi-family commercial mortgage loans which are sold to FNMA under FNMA’s Delegated Underwriting and Servicing (DUS) program. We participated in a similar program with the FHLMC.
Under these programs, we generally assume up to a one-third pari passu risk of loss on unpaid principal balances through a loss share arrangement. At March 31, 2015 and December 31, 2014, the unpaid principal balance outstanding of loans sold as a participant in these programs was $12.6 billion and $12.3 billion, respectively. The potential maximum exposure
under the loss share arrangements was $3.8 billion at March 31, 2015 and $3.7 billion at December 31, 2014.
We maintain a reserve for estimated losses based upon our exposure. The reserve for losses under these programs totaled $38 million and $33 million as of March 31, 2015 and March 31, 2014, respectively, and is included in Other liabilities on our Consolidated Balance Sheet.
If payment is required under these programs, we would not have a contractual interest in the collateral underlying the mortgage loans on which losses occurred, although the value of the collateral is taken into account in determining our share of such losses. Our exposure and activity associated with these recourse obligations are reported in the Corporate & Institutional Banking segment.
Table 116: Analysis of Commercial Mortgage Recourse Obligations
Reserve adjustments, net
Residential Mortgage Loan and Home Equity Loan/ Line of Credit Repurchase Obligations
While residential mortgage loans are sold on a non-recourse basis, we assume certain loan repurchase obligations associated with mortgage loans we have sold to investors. These loan repurchase obligations primarily relate to situations where PNC is alleged to have breached certain origination covenants and representations and warranties made to purchasers of the loans in the respective purchase and sale agreements. Repurchase obligation activity associated with residential mortgages is reported in the Residential Mortgage Banking segment.
PNC’s repurchase obligations also include certain brokered home equity loans/lines of credit that were sold to a limited number of private investors in the financial services industry by National City prior to our acquisition of National City. PNC is no longer engaged in the brokered home equity lending business, and our exposure under these loan repurchase obligations is limited to repurchases of loans sold in these transactions. Repurchase activity associated with brokered home equity loans/lines of credit is reported in the Non-Strategic Assets Portfolio segment.
Indemnification and repurchase liabilities are initially recognized when loans are sold to investors and are subsequently evaluated by management. Initial recognition and subsequent adjustments to the indemnification and repurchase liability for the sold residential mortgage portfolio are recognized in Residential mortgage revenue on the Consolidated Income Statement. Since PNC is no longer
The PNC Financial Services Group, Inc. – Form 10-Q 117
engaged in the brokered home equity lending business, only subsequent adjustments are recognized to the home equity loans/lines indemnification and repurchase liability. These adjustments are recognized in Other noninterest income on the Consolidated Income Statement.
Management’s subsequent evaluation of these indemnification and repurchase liabilities is based upon trends in indemnification and repurchase requests, actual loss experience, risks in the underlying serviced loan portfolios, and current economic conditions. As part of its evaluation, management considers estimated loss projections over the life of the subject loan portfolio. At March 31, 2015 and March 31, 2014, the total indemnification and repurchase liability for estimated losses on indemnification and repurchase claims totaled $134 million and $122 million, respectively, and was included in Other liabilities on the Consolidated Balance Sheet. An analysis of the changes in this liability during 2015 and 2014 follows:
Table 117: Analysis of Indemnification and Repurchase Liability for Asserted Claims and Unasserted Claims
Losses – loan repurchases and private investor settlements
Management believes the indemnification and repurchase liabilities appropriately reflect the estimated probable losses on indemnification and repurchase claims for all loans sold and outstanding as of March 31, 2015. In making these estimates, we consider the losses that we expect to incur over the life of the sold loans. While management seeks to obtain all relevant information in estimating the indemnification and repurchase liability, the estimation process is inherently uncertain and imprecise and, accordingly, it is reasonably possible that future indemnification and repurchase losses could be more or less than our established liability. Factors that could affect our estimate include the volume of valid claims driven by investor strategies and behavior, our ability to successfully negotiate claims with investors, housing prices and other economic conditions. At March 31, 2015, we estimate that it is reasonably possible that we could incur additional losses in excess of our accrued indemnification and repurchase liability of up to approximately $94 million for our portfolio of residential mortgage loans sold. At March 31, 2015, the reasonably possible loss above our accrual for our portfolio of home equity loans/lines of credit sold was not material. This estimate of potential additional losses in excess of our liability is based on assumed higher repurchase claims and lower claim rescissions than our current assumptions.
Resale and Repurchase Agreements
We enter into repurchase and resale agreements where we transfer investment securities to/from a third party with the agreement to repurchase/resell those investment securities at a future date for a specified price. Repurchase and resale agreements are treated as collateralized financing transactions for accounting purposes and are generally carried at the amounts at which the securities will be subsequently reacquired or resold, including accrued interest. Our policy is to take possession of securities purchased under agreements to resell. We monitor the market value of securities to be repurchased and resold and additional collateral may be obtained where considered appropriate to protect against credit exposure.
Repurchase and resale agreements are typically entered into with counterparties under industry standard master netting agreements which provide for the right to setoff amounts owed to one another with respect to multiple repurchase and resale agreements under such master netting agreement (referred to as netting arrangements) and liquidate the purchased or borrowed securities in the event of counterparty default. In order for an arrangement to be eligible for netting under GAAP, we must obtain the requisite assurance that the offsetting rights included in the master netting agreement would be legally enforceable in the event of bankruptcy, insolvency, or a similar proceeding of such third party. Enforceability is evidenced by obtaining a legal opinion that supports, with sufficient confidence, the enforceability of the master netting agreement in bankruptcy.
118 The PNC Financial Services Group, Inc. – Form 10-Q
Table 118 shows the amounts owed under resale and repurchase agreements and the securities collateral associated with those agreements where a legal opinion supporting the enforceability of the offsetting rights has been obtained. We do not present resale and repurchase agreements entered into with the same counterparty under a legally enforceable master netting agreement on a net basis on our Consolidated Balance Sheet or within Table 118. The amounts reported in Table 118 exclude the fair value adjustment on the structured resale agreements of $7 million at both March 31, 2015 and December 31, 2014, respectively, that we have elected to account for at fair value. Refer to Note 7 Fair Value for additional information regarding the structured resale agreements at fair value.
Refer to Note 11 Financial Derivatives for additional information related to offsetting of financial derivatives.
Table 118: Resale and Repurchase Agreements Offsetting
Gross
ResaleAgreements
Amounts
Offset
on theConsolidatedBalance Sheet
Net
ResaleAgreements (a)
SecuritiesCollateral
Held UnderMaster NettingAgreements (b)
Resale Agreements
AmountsOffset
Repurchase Agreements
NOTE 17 SEGMENT REPORTING
Results of individual businesses are presented based on our internal management reporting practices. There is no comprehensive, authoritative body of guidance for management accounting equivalent to GAAP; therefore, the financial results of our individual businesses are not necessarily comparable with similar information for any other company. We periodically refine our internal methodologies as management reporting practices are enhanced. To the extent practicable, retrospective application of new methodologies is made to prior period reportable business segment results and disclosures to create comparability with the current period.
Financial results are presented, to the extent practicable, as if each business operated on a stand-alone basis. Additionally, we have aggregated the results for corporate support functions within “Other” for financial reporting purposes.
Net interest income in business segment results reflects PNC’s internal funds transfer pricing methodology. Assets receive a funding charge and liabilities and capital receive a funding credit based on a transfer pricing methodology that incorporates product repricing characteristics, tenor and other factors. In the first quarter of 2015, enhancements were made to PNC’s funds transfer pricing methodology primarily for costs related to the new regulatory short-term liquidity standards. The enhancements incorporate an additional charge assigned to assets, including for unfunded loan commitments. Conversely, a higher transfer pricing credit has been assigned to those deposits that are accorded higher value under Liquidity Coverage Ratio rules for liquidity purposes. Please see the Supervision and Regulation section in Item 1 and the Liquidity Risk Management section in Item 7 of our 2014 Form 10-K for more information about the ratio. These
The PNC Financial Services Group, Inc. – Form 10-Q 119
adjustments apply to business segment results prospectively beginning with the first quarter of 2015. Excluding any changes in business volumes, the estimated impacts of this change to net interest income for Retail Banking and Corporate & Institutional Banking were approximately an increase of $55 million and a decrease of $60 million, respectively, for the first quarter of 2015. The impacts to the other business segments were not significant. Prior periods have not been adjusted due to the impracticability of estimating the impact of the change for prior periods.
A portion of capital is intended to cover unexpected losses and is assigned to our business segments using our risk-based economic capital model, including consideration of the goodwill at those business segments, as well as the diversification of risk among the business segments, ultimately reflecting PNC’s portfolio risk adjusted capital allocation.
We have allocated the allowances for loan and lease losses and for unfunded loan commitments and letters of credit based on the loan exposures within each business segment’s portfolio. Key reserve assumptions and estimation processes react to and are influenced by observed changes in loan portfolio performance experience, the financial strength of the borrower, and economic conditions. Key reserve assumptions are periodically updated.
Our allocation of the costs incurred by operations and other shared support areas not directly aligned with the businesses is primarily based on the use of services.
Total business segment financial results differ from total consolidated net income. The impact of these differences is reflected in the “Other” category in the business segment tables. “Other” includes residual activities that do not meet the criteria for disclosure as a separate reportable business, such as gains or losses related to BlackRock transactions, integration costs, asset and liability management activities including net securities gains or losses, other-than-temporary impairment of investment securities and certain trading activities, exited businesses, private equity investments, intercompany eliminations, most corporate overhead, tax adjustments that are not allocated to business segments, and differences between business segment performance reporting and financial statement reporting (GAAP), including the presentation of net income attributable to noncontrolling interests as the segments’ results exclude their portion of net income attributable to noncontrolling interests. Assets, revenue and earnings attributable to foreign activities were not material in the periods presented for comparative purposes.
Business Segment Products and Services
Retail Banking provides deposit, lending, brokerage, investment management and cash management services to consumer and small business customers within our primary
geographic markets. Our customers are serviced through our branch network, ATMs, call centers, online banking and mobile channels. The branch network is located primarily in Pennsylvania, Ohio, New Jersey, Michigan, Illinois, Maryland, Indiana, North Carolina, Florida, Kentucky, Washington, D.C., Delaware, Virginia, Alabama, Missouri, Georgia, Wisconsin and South Carolina.
Corporate & Institutional Banking provides lending, treasury management, and capital markets-related products and services to mid-sized and large corporations, government and not-for-profit entities. Lending products include secured and unsecured loans, letters of credit and equipment leases. Treasury management services include cash and investment management, receivables management, disbursement services, funds transfer services, information reporting and global trade services. Capital markets-related products and services include foreign exchange, derivatives, securities, loan syndications, mergers and acquisitions advisory, equity capital markets advisory and related services. We also provide commercial loan servicing and real estate advisory and technology solutions for the commercial real estate finance industry. Products and services are generally provided within our primary geographic markets, with certain products and services offered nationally and internationally.
Asset Management Group includes personal wealth management for high net worth and ultra high net worth clients and institutional asset management. Wealth management products and services include investment and retirement planning, customized investment management, private banking, tailored credit solutions, and trust management and administration for individuals and their families. Hawthorn provides multi-generational family planning including wealth strategy, investment management, private banking, tax and estate planning guidance, performance reporting and personal administration services to ultra high net worth families. Institutional asset management provides investment management, custody administration and retirement administration services. Institutional clients include corporations, unions, municipalities, non-profits, foundations and endowments, primarily located in our geographic footprint.
Residential Mortgage Banking directly originates first lien residential mortgage loans on a nationwide basis with a significant presence within the retail banking footprint. Mortgage loans represent loans collateralized by one-to-four family residential real estate. These loans are typically underwritten to government agency and/or third-party standards, and either sold, servicing retained, or held on PNC’s balance sheet. Loan sales are primarily to secondary mortgage conduits of FNMA, FHLMC, Federal Home Loan Banks and third-party investors, or are securitized and issued under the GNMA program. The mortgage servicing operation performs all functions related to servicing mortgage loans, primarily those in first lien position, for various investors and for loans owned by PNC.
120 The PNC Financial Services Group, Inc. – Form 10-Q
BlackRock is a leading publicly traded investment management firm providing a broad range of investment and risk management services to institutional and retail clients worldwide. Using a diverse platform of active and index investment strategies across asset classes, BlackRock develops investment outcomes and asset allocation solutions for clients. Product offerings include single- and multi-asset class portfolios investing in equities, fixed income, alternatives and money market instruments. BlackRock also offers an investment and risk management technology platform, risk analytics and advisory services and solutions to a broad base of institutional investors.
We hold an equity investment in BlackRock, which is a key component of our diversified revenue strategy. BlackRock is a
publicly traded company, and additional information regarding its business is available in its filings with the Securities and Exchange Commission (SEC). At March 31, 2015, our economic interest in BlackRock was 22%.
PNC received cash dividends from BlackRock of $80 million and $71 million during the first three months of 2015 and 2014, respectively.
Non-Strategic Assets Portfolio includes a consumer portfolio of mainly residential mortgage and brokered home equity loans and lines of credit, and a small commercial/commercial real estate loan and lease portfolio. We obtained a significant portion of these non-strategic assets through acquisitions of other companies.
Table 119: Results Of Businesses
Other noninterest expense
Income (loss) before income taxes and noncontrolling interests
Inter-segment revenue
Average Assets (a)
Net income (loss)
NOTE 18 SUBSEQUENT EVENTS
The PNC Financial Services Group, Inc. – Form 10-Q 121
STATISTICAL INFORMATION (UNAUDITED)
Average Consolidated Balance Sheet And Net Interest Analysis (a) (b) (c)
Taxable-equivalent basis
Interest-earning assets:
Total investment securities
Total interest-earning assets/interest income
Noninterest-earning assets:
Liabilities and Equity
Interest-bearing liabilities:
Time deposits in foreign offices and other time
Total interest-bearing deposits
Total interest-bearing liabilities/interest expense
Noninterest-bearing liabilities and equity:
Interest rate spread
Impact of noninterest-bearing sources
Net interest income/margin
122 The PNC Financial Services Group, Inc. – Form 10-Q
Average
Balances
Interest
Income/
Yields/
Rates
The PNC Financial Services Group, Inc. – Form 10-Q 123
Common stock, related surplus and retained earnings, net of treasury stock
Less regulatory capital adjustments:
Goodwill and disallowed intangibles, net of deferred tax liabilities
Basel III total threshold deductions
Accumulated other comprehensive income (c)
All other adjustments
Estimated Basel III Common equity Tier 1 capital
Estimated Basel I risk-weighted assets calculated in accordance with transition rules (d)
Estimated Basel III standardized approach risk-weighted assets (e)
Estimated Basel III Common equity Tier 1 capital ratio
Risk weight and associated rules utilized
124 The PNC Financial Services Group, Inc. – Form 10-Q
ITEM 1. LEGAL PROCEEDINGS
See the information set forth in Note 15 Legal Proceedings in the Notes To Consolidated Financial Statements under Part I, Item 1 of this Report, which is incorporated by reference in response to this item.
ITEM 1A. RISK FACTORS
There are no material changes from any of the risk factors previously disclosed in PNC’s 2014 Form 10-K in response to Part I, Item 1A.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Details of our repurchases of PNC common stock during the first quarter of 2015 are included in the following table:
In thousands, except per share data
Total sharespurchased
(a)
Averageprice
paid pershare
as part of
publiclyannouncedprograms(b)
Maximum
number
of shares
that may
yet be
purchasedunder the
programs(b)
January 1 – 31
February 1 – 28
March 1 – 31
The PNC Financial Services Group, Inc. – Form 10-Q 125
ITEM 6. EXHIBITS
The following exhibit index lists Exhibits filed, or in the case of Exhibits 32.1 and 32.2 furnished, with this Quarterly Report on Form 10-Q:
EXHIBIT INDEX
You can obtain copies of these Exhibits electronically at the SEC’s website at www.sec.gov or by mail from the Public Reference Section of the SEC at 100 F Street, N.E., Washington, DC 20549 at prescribed rates. The Exhibits are also available as part of this Form 10-Q on PNC’s corporate website at www.pnc.com/secfilings. Shareholders and bondholders may also obtain copies of Exhibits, without charge, by contacting Shareholder Relations at 800-843-2206 or via e-mail at investor.relations@pnc.com. The interactive data file (XBRL) exhibit is only available electronically.
CORPORATE INFORMATION
Corporate Headquarters
One PNC Plaza, 249 Fifth Avenue
Pittsburgh, Pennsylvania 15222-2707
412-762-2000
Stock Listing The common stock of The PNC Financial Services Group, Inc. is listed on the New York Stock Exchange under the symbol “PNC”.
Internet Information The PNC Financial Services Group, Inc.’s financial reports and information about its products and services are available on the internet at www.pnc.com. We provide information for investors on our corporate website under “About Us – Investor Relations,” such as Investor Events, SEC Filings, Financial Information (including Quarterly Earnings, Annual Reports, Proxy Statements and Regulatory Disclosures), Financial Press Releases, Message from the Chairman and Corporate Governance. Under “Investor Relations,” we will from time to time post information that we believe may be important or useful to investors. We use our Twitter account, @pncnews, as an additional way of disseminating public information from time to time to investors. We generally post the following on our corporate website shortly before or promptly following its first use or release: financially-related press releases (including earnings releases), various SEC filings, including annual, quarterly and current reports, presentation materials associated with earnings and other investor conference calls or events, and access to live and taped audio from earnings and other investor conference calls or events. In some cases, we may post the presentation materials for other investor conference calls or events several days prior to the call or event. For earnings and other conference calls or events, we generally include in our posted materials a cautionary statement regarding forward-looking and adjusted information and we provide GAAP reconciliations when we refer to adjusted information and results. Where applicable, we provide GAAP reconciliations for such additional information in materials for that event or in materials for other prior investor presentations or in our annual, quarterly or current reports. When warranted, we will also use our website to expedite public access to time-critical information regarding PNC in advance of distribution of a press release or a filing with the SEC disclosing the same information.
PNC was also required to provide additional public disclosure regarding estimated income, losses and pro forma regulatory capital ratios in March 2015 under a supervisory hypothetical severely adverse economic scenario and will provide in July 2015 similar public disclosure under a PNC-developed hypothetical severely adverse economic scenario, as well as information concerning its capital stress testing processes,
126 The PNC Financial Services Group, Inc. – Form 10-Q
pursuant to the stress testing regulations adopted by the Federal Reserve and the OCC. PNC is also required to make certain additional regulatory capital-related public disclosures about PNC’s capital structure, risk exposures, risk assessment processes, risk-weighted assets and overall capital adequacy, including market risk-related disclosures, under the regulatory capital rules adopted by the Federal banking agencies. Under these regulations, PNC may satisfy these requirements through postings on its website, and PNC has done so and expects to continue to do so without also providing disclosure of this information through filings with the SEC. We also post on our website communications to our shareholders, such as the letter to shareholders that accompanies the Form 10-K mailed to shareholders, and may not file them as exhibits to filings with the SEC when not expressly required.
You can also find the SEC reports and corporate governance information described in the sections below in the Investor Relations section of our website.
Where we have included web addresses in this Report, such as our web address and the web address of the SEC, we have included those web addresses as inactive textual references only. Except as specifically incorporated by reference into this Report, information on those websites is not part hereof.
Financial Information We are subject to the informational requirements of the Securities Exchange Act of 1934 (Exchange Act) and, in accordance with the Exchange Act, we file annual, quarterly and current reports, proxy statements, and other information with the SEC. Our SEC File Number is 001-09718. You can obtain copies of these and other filings, including exhibits, electronically at the SEC’s internet website at www.sec.gov or on PNC’s corporate internet website at www.pnc.com/secfilings. Shareholders and bond holders may also obtain copies of these filings without charge by contacting Shareholder Services at 800-982-7652 or via the online contact form at www.computershare.com/contactus for copies without exhibits, and by contacting Shareholder Relations at 800-843-2206 or via email at investor.relations@pnc.com for copies of exhibits, including financial statement and schedule exhibits where applicable. The interactive data file (XBRL) exhibit is only available electronically.
Corporate Governance at PNC Information about our Board of Directors and its committees and corporate governance at PNC is available on PNC’s corporate website at www.pnc.com/corporategovernance. Our PNC Code of Business Conduct and Ethics is available on our corporate website at www.pnc.com/corporategovernance. In addition, any future amendments to, or waivers from, a provision of the PNC Code of Business Conduct and Ethics that applies to our directors or executive officers (including our principal executive officer, principal financial officer, and principal accounting officer or controller) will be posted at this internet address.
Shareholders who would like to request printed copies of the PNC Code of Business Conduct and Ethics or our Corporate Governance Guidelines or the charters of our Board’s Audit, Nominating and Governance, Personnel and Compensation, or Risk Committees (all of which are posted on the PNC corporate website) may do so by sending their requests to PNC’s Corporate Secretary at corporate headquarters at the above address. Copies will be provided without charge to shareholders.
Inquiries For financial services call 888-PNC-2265.
Individual shareholders should contact Shareholder Services at 800-982-7652.
Analysts and institutional investors should contact William H. Callihan, Senior Vice President, Director of Investor Relations, at 412-762-8257 or via email at investor.relations@pnc.com.
News media representatives and others seeking general information should contact Fred Solomon, Senior Vice President, Corporate Communications, at 412-762-4550 or via email at corporate.communications@pnc.com.
Common Stock Prices/Dividends Declared The table below sets forth by quarter the range of high and low sale and quarter-end closing prices for The PNC Financial Services Group, Inc. common stock and the cash dividends declared per common share.
2015 Quarter
First
2014 Quarter
Second
Third
Fourth
Dividend Policy Holders of PNC common stock are entitled to receive dividends when declared by the Board of Directors out of funds legally available for this purpose. Our Board of Directors may not pay or set apart dividends on the common stock until dividends for all past dividend periods on any series of outstanding preferred stock have been paid or declared and set apart for payment. The Board presently intends to continue the policy of paying quarterly cash dividends. The amount of any future dividends will depend on economic and market conditions, our financial condition and
The PNC Financial Services Group, Inc. – Form 10-Q 127
operating results, and other factors, including contractual restrictions and applicable government regulations and policies (such as those relating to the ability of bank and non-bank subsidiaries to pay dividends to the parent company and regulatory capital limitations). The amount of our dividend is also currently subject to the results of the supervisory assessment of capital adequacy and capital planning processes undertaken by the Federal Reserve as part of the 2015 Comprehensive Capital Analysis and Review (CCAR) process as described in the Executive Summary section of the Financial Review of this Report and in Supervision and Regulation section in Item 1 of our 2014 Form 10-K.
Dividend Reinvestment And Stock Purchase Plan
The PNC Financial Services Group, Inc. Dividend Reinvestment and Stock Purchase Plan enables holders of our common and preferred Series B stock to conveniently purchase additional shares of common stock. You can obtain a prospectus and enrollment form by contacting Shareholder Services at 800-982-7652.
Stock Transfer Agent And Registrar
Computershare Trust Company, N.A.
250 Royall Street
Canton, MA 02021
800-982-7652
Registered shareholders may contact the above phone number regarding dividends and other shareholder services.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on May 7, 2015 on its behalf by the undersigned thereunto duly authorized.
/s/ Robert Q. Reilly
Robert Q. Reilly
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)
128 The PNC Financial Services Group, Inc. – Form 10-Q