DBRS Comments on Q3 2009 Earnings of PNC – Senior at A (high) – Ratings Unchanged

DBRS has today commented on the Q3 2009 earnings of PNC Financial Services Group, Inc. (PNC or the Company). In DBRS’s view, PNC’s third quarter results reflected a strong operating performance in what is still a challenging environment. The Company generated solid revenue growth and reported moderating credit deterioration, leading to a linked-quarter decline in provisions. PNC reported third quarter earnings (before TARP-related dividends) of $559 million compared to $207 million in the prior quarter. The National City merger appears to be on track with solid accretion to earnings, ahead of schedule expense savings and conversions scheduled to begin in November. Quarterly results were ahead of DBRS’s expectations and its ratings including Issuer and Senior Debt at A (high) and Negative trend remain unchanged.

In maintaining the Negative trend, which was put on December 31, 2008, DBRS notes that significant near- to medium-term risks for the Company remain. Should positive trends in credit quality continue and earnings generation remain robust, the trend could revert to Stable. That being said, DBRS sees the economic recovery as fragile at this point, with unemployment likely to climb in the coming months and remain elevated throughout 2010. In addition, housing markets remain unsettled and the Company retains significant exposure to higher-risk real estate assets. Further, the Negative trend continues to reflect the integration risks posed by acquiring an institution the size of National City. Upcoming conversions in the fourth quarter will be a key test in what DBRS acknowledges has, to-date, been a smooth integration.

A strong net interest income performance resulted from significantly lower funding costs as higher cost deposits rolled off or were repriced at significantly lower rates. Net interest income (NII) was $2.2 billion for Q3 2009, up 2% from Q2 2009 despite a 12% linked-quarter annualized decline in average earning assets. The Company’s net interest margin (NIM) expanded 16 basis points (bps) from Q2 2009 to 3.76%. PNC expects this level of NII to be sustainable as maturing high cost deposits (of both NatCity and PNC) will continue to reprice lower in the coming quarters, benefiting the NIM. Since year-end 2008, PNC’s rates paid on deposits have declined 88 bps to 1.04%. The Company reported that average deposits, which were impacted by the divestiture of 61 branches in September, declined 2% (unannualized) in Q3 2009 to $189 billion. DBRS notes that deposits continue to fund PNC’s loan portfolio with deposits representing 114% of gross loans (excluding loans held for sale) at the end of the third quarter.

Third quarter fee revenues of $1.8 billion were essentially flat from Q2 2009 and represented 45% of PNC’s total third quarter revenues. Consumer-related fees, including service charges on deposits remained strong and market-sensitive items (notably fund servicing and asset management) continued to benefit from improving asset values. Assets under Management increased $6 billion (24% annualized) due to improved valuations and inflows and were $104 billion at September 30, 2009. PNC benefited from $168 million of net gains on securities sales (primarily non-Agency MBS) which more than offset third quarter OTTI charges of $129 million. At $207 million, the contribution from mortgage banking declined 15.5% to reflect lower refinance activity but was still considered a solid performance. Origination volumes declined $2.8 billion from the second quarter to $3.6 billion. Expenses were well-controlled in the quarter. Excluding integration costs and various non-recurring items (most notably the second quarter $133 million FDIC assessment), expenses declined $44 million in the quarter to $2.36 billion. Year-to-date, the Company has realized $460 million in cost savings from the National City merger, well on the way to achieving its two-year goal of $1.2 billion. This performance also enabled PNC to achieve positive operating leverage over the quarter.

As noted, asset quality worsened in the quarter, but at a slower pace than prior periods. Non-performing assets (excluding purchased impaired loans) were 3.50% of loans and foreclosed assets at the end of the quarter, up from 2.81% at June 30, 2009. Total NPAs of $5.6 billion increased 21% from Q2 2009, slower than the 32% increase seen from Q1 to Q2. Delinquency trends also showed some improvement in the quarter. Balances 90+ days past due but still accruing declined to $875 million as of the end of the third quarter, down from $1,043 million at June 30, 2009. PNC’s quarterly loan loss provision of $914 million decreased $173 million from Q2 2009 and was $264 million in excess of third quarter NCOs. The Company’s $4.8 billion reserve for loan losses represented 2.99% of total loans and leases, up 22 bps from June 30, 2009.

With respect to the Company’s $20 billion distressed asset portfolio which includes large exposures to residential development and construction, brokered home equity and residential mortgages, DBRS takes some comfort from the fact that this portfolio is being carried at around 75% of outstanding balances (when reserves are included). Further, impaired loans have been marked down significantly more. To date, these assets have performed within the Company’s expectations. While DBRS believes that elevated credit costs remain manageable and are still being absorbed by PNC’s strong earnings generation capability, as evidenced by $1.7 billion of income before provisions and taxes, the potential for credit quality deterioration remains a risk that is incorporated into DBRS’s Negative trend for PNC’s ratings.

PNC’s estimated Tier 1 Capital ratio improved 30 bps to 10.8% at the end of the third quarter while Tier 1 Common was up 20 bps to 5.5%. Unrealized losses in the Company’s $54 billion investment securities portfolio declined by about $1.6 billion in the third quarter to $2.2 billion, helping PNC’s tangible ratios. While DBRS is concerned about potential pressure on tangible common equity, it is somewhat mitigated by the improving trend, the high quality of the portfolio, its relative short duration and the Company’s ability and intent to hold these securities given their solid liquidity position. Moreover, PNC has a sizable unrecognized gain in its ownership interest in Blackrock, Inc. and expects to record an after-tax gain of more than $700 million upon closing of Blackrock’s pending acquisition of Barclays Global Investors which is expected in the fourth quarter.

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

The applicable methodologies are Rating Banks and Bank Holding Companies Operating in the United States, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.