DBRS Comments on PNC’s Q4 2009 Earnings – Senior at A (high) Unchanged

DBRS has today commented on the Q4 2009 earnings of PNC Financial Services Group, Inc. (PNC or the Company). In DBRS’s view, PNC’s fourth quarter results reflected a solid operating performance in what remains a challenging environment. The Company generated strong revenues and reported a slowing pace of credit deterioration. Importantly, PNC continues to produce income before provisions and taxes (IBPT) that exceeds its quarterly credit costs demonstrating its ability to earn its way through the difficult operating environment. Fourth quarter results benefited from a $687 million after-tax gain related to BlackRock’s acquisition of Barclays Global Investors (BGI). Excluding this gain and $101 million of NatCity integration costs, PNC reported Q4 2009 net income (before TARP-related dividends) of $521 million compared to net income of $617 million in Q3 2009 and $134 million in Q4 2008.

In maintaining the Negative trend, which was put on December 31, 2008, DBRS notes that while near- to medium-term risks for the Company remain, they may be abating. DBRS sees the economic recovery as fragile at this point as economic growth has yet to translate into meaningful job creation. Unemployment remains elevated and households remain stressed. As a result, housing markets remain unsettled and the Company retains significant exposure to higher-risk real estate assets. That being said, should positive trends in credit quality continue and earnings generation remain robust, DBRS anticipates that the trend would revert to Stable. DBRS also notes that the integration of NatCity continued to progress smoothly in the fourth quarter and NatCity was again accretive to earnings in the quarter. In addition, the first major system conversion was completed without incident in November and the Company realized cost savings of more than $800 million in 2009. PNC also increased its multi-year cost savings goal to $1.5 billion from $1.2 billion. DBRS sees a continued smooth integration of NatCity as another factor that would contribute to the trend on the Company’s ratings returning to Stable.

Another strong net interest income performance was attributed to higher than expected collections on impaired commercial loans, but also benefited from the continued roll off or repricing at significantly lower rates of higher cost deposits. Net interest income was $2.3 billion for Q4 2009, up 5.5% from a strong Q3 2009 despite further declines (2%) in average earning assets. The Company’s NIM expanded 29 basis points (bps) from Q3 2009 to 4.05%. Rates paid on deposits declined 11 bps from the prior quarter to 0.93%. PNC’s average deposits declined 1.3% in Q4 2009 to $186 billion as a significant ($3.8 billion) decline in average retail CD’s was mostly offset by $2.5 billion of growth in average non-interest bearing deposits. DBRS notes that deposits continue to fund PNC’s loan portfolio and represented 119% of gross loans (excluding loans held for sale) at year end.

The strong net interest income performance offset a 9% linked-quarter decline in fee revenues (excluding the BlackRock gain). PNC’s fourth quarter fee revenues were $1.7 billion and represented 41% of PNC’s Q4 2009 operating revenues compared to 45% last quarter. A weaker quarter for mortgage banking, down 48% from Q3 to $107 million, drove the decline. The decline in mortgage banking results was attributed to lower origination volumes and a $50 million addition to recourse reserves for 2007 vintage prime mortgage originations. The residential mortgage servicing portfolio declined $13 billion in the quarter to $145 billion. Other fee revenues were similar to the prior quarter. The Q4 2009 decline in asset management fees reflected, in part, PNC’s share of BlackRock’s integration costs related to the BGI acquisition. Operating expenses were well-controlled in the quarter. Excluding integration costs, expenses declined $53 million in the quarter to $2.3 billion led by a 9% decline in personnel costs. This performance enabled PNC to again achieve positive core operating leverage over the quarter.

As noted, the pace of asset quality deterioration slowed in the fourth quarter. NPAs increased $0.7 billion to $6.3 billion. This compares to a $1.0 billion increase in the third quarter and a $1.1 billion increase in Q2 2009. Non-performing assets represented 3.99% of loans and foreclosed assets at year end, up from 3.50% at September 30, 2009. Early stage delinquencies and balances 90+ days past due, but still accruing (excluding purchased impaired loans) were essentially flat in the quarter, evidencing further signs of stability in credit. PNC’s quarterly loan loss provision of $1.0 billion added $262 million to loan loss reserves and at year end and the Company’s $5.1 billion reserve represented 3.22% of total loans and leases, up 23 bps from September 30, 2009. NCOs increased $185 million from Q3 2009 to $835 million in Q4 2009 and represented 2.09% of average loans. PNC noted that $130 million of the increase in the quarter was due to an alignment in charge-off policy on small dollar commercial loans that resulted from the bank charter consolidation in Q4 2009.

With respect to the Company’s $19 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 has been marked down conservatively and continues to perform within the Company’s expectations. Nevertheless, provisions for this portfolio were up considerably from Q3, increasing $146 million to $314 million in Q4 2009. 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 IBPT (excluding the BlackRock gain and NatCity integration costs), 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 60 bps to 11.5% at the end of the fourth quarter while Tier 1 Common was up 50 bps to 6.0% thanks to solid earnings and a reduction in risk-weighted assets. The Company indicated that it intends to repay TARP some time in 2010, subject to regulatory approval.

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.