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, Florida, North Carolina, Kentucky, Washington, D.C., Delaware, Virginia, Alabama, Georgia, Missouri, 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 financial objectives. 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 to meet the broad range of financial needs of our customers.

Our strategic priorities are designed to enhance value over the long term. A key priority is to build a leading banking franchise in our underpenetrated geographic markets. In addition, we are seeking to attract more of the investable assets of new and existing clients. PNC is focused on redefining the retail banking experience by transforming to a more customer-centric and sustainable model while lowering delivery costs as customer banking preferences evolve.

Additionally, we continue to focus on expense management while investing in technology to bolster critical business infrastructure and streamline core processes.

Our capital priorities are to support client growth and business investment, maintain appropriate capital in light of economic conditions and the Basel III framework and return excess capital to shareholders, in accordance with the currently effective capital plan included in our 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 2015 Form 10-K.

Key Factors Affecting Financial Performance

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 2015 Form 10-K and elsewhere in this Report.

Our financial performance is substantially affected by a number of external factors outside of our control, including the following:

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Domestic and global economic conditions, including the continuity, speed and stamina of the current U.S. economic expansion in general and its impact on our customers in particular;

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The monetary policy actions and statements of the Federal Reserve and the Federal Open Market Committee (FOMC);

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The level of, and direction, timing and magnitude of movement in, interest rates and the shape of the interest rate yield curve;

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The functioning and other performance of, and availability of liquidity in, the capital and other financial markets;

 

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Changes in the competitive and regulatory landscape and in counterparty creditworthiness and performance as the financial services industry restructures in the current environment;

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The impact of the extensive reforms enacted by the Dodd-Frank legislation and other legislative, regulatory and administrative initiatives and actions, including those outlined elsewhere in this Report, in our 2015 Form 10-K and in subsequent filings with the SEC;

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The impact of market credit spreads on asset valuations;

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Asset quality and the ability of customers, counterparties and issuers to perform in accordance with contractual terms;

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Loan demand, utilization of credit commitments and standby letters of credit; and

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Customer demand for non-loan products and services.

In addition, our success will depend upon, among other things:

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Focused execution of our strategic priorities and achieving targeted outcomes, including our ability to:

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Build a leading banking franchise in our underpenetrated geographic markets;

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Grow profitability through the acquisition and retention of customers and deepening relationships that meet our risk/return measures;

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Increase revenue from fee income and provide innovative and valued products and services to our customers;

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Bolster our critical infrastructure and streamline our core processes;

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Utilize technology to develop and deliver products and services to our customers and protect PNC’s systems and customer information; and

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Sustain our expense management.

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Effectively managing capital and liquidity including:

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Continuing to maintain and grow our deposit base as a low-cost stable funding source;

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Prudent liquidity and capital management to meet evolving regulatory capital, capital planning, stress testing and liquidity standards; and

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Actions we take within the capital and other financial markets.

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Managing credit risk in our portfolio;

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Our ability to manage and implement strategic business objectives within the changing regulatory environment;

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The impact of legal and regulatory-related contingencies; and

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The appropriateness of reserves needed for critical accounting estimates and related contingencies.

For additional information, see the Cautionary Statement Regarding Forward-Looking Information section in this

Financial Review and Item 1A Risk Factors in our 2015 Form 10-K.

Income Statement Highlights

Net income for the first quarter of 2016 was $943 million, or $1.68 per diluted common share, a decrease of 6%, compared to $1.0 billion, or $1.75 per diluted common share, for the first quarter of 2015. The decrease was driven by higher provision for credit losses and a decline in noninterest income, partially offset by lower noninterest expense and an increase in net interest income.

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Net interest income of $2.1 billion for the first quarter of 2016 increased 1% compared with the first quarter of 2015, primarily due to higher loan yields and higher loan and securities balances, partially offset by lower purchase accounting accretion and higher borrowing costs related to higher short-term interest rates.

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Net interest margin decreased to 2.75% for the first quarter of 2016 compared to 2.82% for the first quarter of 2015 principally as a result of lower benefit from purchase accounting accretion and higher securities balances, partially offset by lower balances on deposit with the Federal Reserve.

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Noninterest income of $1.6 billion for the first quarter of 2016 decreased $92 million, or 6%, compared to the first quarter of 2015 mainly attributable to weaker equity markets and lower capital markets activity as well as lower residential mortgage revenue.

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Noninterest expense of $2.3 billion for the first quarter of 2016 decreased $68 million compared to the first quarter of 2015 reflecting lower legal costs and lower variable compensation costs associated with lower business activity as well as a continued focus on expense management.

For additional detail, see the Consolidated Income Statement Review section in this Financial Review.

Credit Quality Highlights

Overall credit quality for the first quarter of 2016 remained relatively stable with the fourth quarter of 2015, except for certain energy related loans.

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The provision for credit losses increased to $152 million for the first quarter of 2016 compared to $54 million for the first quarter of 2015. Provision for credit losses for the first quarter of 2016 included $80 million for energy related loans in the oil, gas and coal sectors.

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Nonperforming assets increased $127 million, or 5%, to $2.6 billion at March 31, 2016 compared to December 31, 2015. Nonperforming assets to total assets were 0.71% at March 31, 2016, compared to 0.68% at December 31, 2015.

 

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Overall loan delinquencies of $1.5 billion at March 31, 2016 decreased $143 million, or 9%, compared with December 31, 2015.

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The allowance for loan and lease losses was 1.31% of total loans and 119% of nonperforming loans at March 31, 2016, compared with 1.32% and 128% at December 31, 2015, respectively.

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Net charge-offs of $149 million for the first quarter of 2016 increased by $46 million compared to net charge-offs for the first quarter of 2015. Annualized net charge-offs were 0.29% of average loans in the first quarter of 2016 and 0.20% of average loans in the first quarter of 2015.

For additional detail, see the Credit Risk Management portion of the Risk Management section of the Consolidated Balance Sheet Review of this Financial Review.

Balance Sheet, Liquidity and Capital Highlights

PNC’s balance sheet was well-positioned at March 31, 2016 reflecting strong liquidity and capital positions.

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Total loans increased by $.8 billion to $207.5 billion at March 31, 2016 compared to December 31, 2015.

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Total commercial lending grew $1.6 billion, or 1%, primarily in PNC’s corporate banking and real estate businesses.

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Total consumer lending decreased $.8 billion, or 1%, mainly due to declines in home equity and education loans as well as run-off in the non-strategic portfolio.

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Total deposits increased $1.4 billion, or 1%, to $250.4 billion at March 31, 2016 compared with December 31, 2015, reflecting growth in consumer deposits, partially offset by lower commercial deposits.

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Investment securities increased $2.0 billion, or 3%, to $72.6 billion at March 31, 2016 compared to December 31, 2015.

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PNC maintained a strong liquidity position.

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The Liquidity Coverage Ratio at March 31, 2016 exceeded 100% for both PNC and PNC Bank, above the minimum phased-in requirement of 90% in 2016.

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PNC maintained a strong capital position.

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The Transitional Basel III common equity Tier 1 capital ratio was 10.6% at both March 31, 2016 and December 31, 2015.

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Pro forma fully phased-in Basel III common equity Tier 1 capital ratio was an estimated 10.1% at March 31, 2016 and 10.0% at December 31, 2015 based on the standardized approach rules. See the Capital discussion and Table 15 in the Consolidated Balance Sheet Review section of this Financial Review and the December 31, 2015 capital ratio tables in the Statistical Information (Unaudited) section of this Report for more detail.

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PNC returned capital to shareholders during first quarter 2016 through share repurchases of 5.9 million common shares for $.5 billion and dividends on common shares of $.3 billion.

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PNC has repurchased a total of 23.8 million common shares for $2.2 billion under current share repurchase programs of up to $2.875 billion for the five quarter period ending in the second quarter of 2016.

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 other 2016 capital and liquidity actions.

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. For additional information, see the Supervision and Regulation section in Item 1 Business of our 2015 Form 10-K.

Our Consolidated Income Statement and Consolidated Balance Sheet Review sections of this Financial Review describe in greater detail the various items that impacted our results during the first quarters of 2016 and 2015 and balances at March 31, 2016 and December 31, 2015, respectively.

 

Total assets were $361.0 billion at March 31, 2016 compared with $358.5 billion at December 31, 2015. Various seasonal and other factors impact our period-end balances, whereas average balances are generally more indicative of underlying business trends apart from the impact of acquisitions and divestitures. The Consolidated Balance Sheet Review section of this Financial Review provides information on changes in selected Consolidated Balance Sheet categories at March 31, 2016 compared with December 31, 2015.

Average investment securities increased in the first three months of 2016 compared with the first three months of 2015, mainly due to increases in average agency residential mortgage-backed securities and U.S. Treasury and government agency securities. Investment securities comprised 23% of average interest-earning assets for the first quarter of 2016 and 19% for the first quarter of 2015.

Average loans increased in the first quarter of 2016 compared to the prior year quarter due to increases in average commercial real estate loans of $4.0 billion and average commercial loans of $1.2 billion mainly attributable to growth in our Corporate & Institutional Banking segment. These increases were partially offset by a decrease in average consumer loans of $3.3 billion driven by lower home equity loans, including runoff in the nonstrategic portfolio, and lower education loans, partially offset by growth in automobile and credit card loans. Average loans represented 67% of average

interest-earning assets for the first quarter of 2016 and 68% of average interest-earning assets for the first quarter of 2015.

Average interest-earning deposits with banks, which are primarily maintained with the Federal Reserve Bank, decreased in the first quarter of 2016 compared to first quarter 2015, reflecting a shift towards higher yielding assets, such as investment securities and loans.

Average total deposits increased $13.0 billion in the first quarter of 2016 compared with the prior year quarter, primarily due to higher average savings deposits, which included a shift from money market deposits to new relationship-based savings products. Additionally, average noninterest-bearing deposits and average interest-bearing demand deposits increased reflecting overall strong deposit growth. Average total deposits represented 69% of average total assets for the first quarter of 2016 and 67% for the first quarter of 2015.

Average borrowed funds decreased in the current year first quarter compared with the prior year first quarter primarily due to declines in average commercial paper, average federal funds purchased and repurchase agreements and average Federal Home Loan Bank (FHLB) borrowings, partially offset by an increase in average bank notes and senior debt. 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.

 

Recent Market and Industry Developments

In March 2016, the Federal Deposit Insurance Corporation (FDIC) adopted final rules to impose a surcharge on the quarterly deposit insurance assessments of insured depository institutions with total consolidated assets of $10 billion or more (including PNC Bank) in order to fund the Dodd-Frank Act mandated increase in the Designated Reserve Ratio from 1.15 percent to 1.35 percent. The final rules take effect July 1, 2016. The surcharge, which is equal to 4.5 basis points of the institution’s deposit insurance assessment base, will take effect for assessments billed after the Designated Reserve Ratio reaches 1.15 percent, and will continue until the reserve ratio reaches 1.35 percent (estimated by the FDIC to occur before the end of 2018). Based on data as of March 31, 2016, we estimate that the net effect of the proposed surcharge, together with the scheduled reduction of regular assessments that will go into effect when the Designated Reserve Ratio reaches 1.15 percent, will increase PNC Bank’s quarterly assessment by approximately $22 million beginning no earlier than the third quarter of 2016.

Also in March 2016, the Federal Reserve re-proposed rules, originally proposed in December 2011, to implement the single-counterparty credit limit (SCCL) under section 165(e) of the Dodd-Frank Act. Under the proposal, the net credit exposure of a bank holding company (BHC) with total consolidated assets of $50 billion or more (covered BHC), including its subsidiaries, to any single, unaffiliated counterparty would be subject to an aggregate limit. For covered BHCs with $250 billion or more in total consolidated assets or $10 billion or more in on-balance sheet foreign exposures (large covered BHCs), including PNC, the applicable limit would be 25 percent of tier 1 capital and would be calculated at the end of each business day. The proposed limit would cover credit exposure resulting from, among other transactions, extensions of credit, repurchase and reverse repurchase transactions, purchases or investments in securities, and derivative transactions. Compliance with the proposed rules would be required one year after the effective date. The comment period on the proposal is scheduled to close on June 3, 2016.

In April 2016, the Department of Labor (DOL) published a final rule expanding the definition of “investment advice” related to retirement accounts and certain other accounts that are subject to DOL interpretive authority. The rule will increase the scope of activities that give rise to fiduciary status under the Employee Retirement Income Security Act of 1974, as amended (ERISA), and the Internal Revenue Code. The rule, which will primarily apply to aspects of PNC’s retail and asset management business lines, will require new disclosures, development of policies and procedures, and contractual obligations for some account types, among other things. The rule is effective April 10, 2017 and there is a transition period between April 10, 2017 and January 1, 2018 during which time reduced requirements apply. Full compliance is required on January 1, 2018.

Also in April 2016, the FDIC and Office of the Comptroller of the Currency (OCC) requested comment on proposed rules that would implement the net stable funding ratio (NSFR). The Federal Reserve is expected to propose similar rules shortly. The proposed rules, which are based on standards developed by the Basel Committee on Banking Supervision, are designed to ensure the stability of a covered banking organization’s funding profile over a one-year time horizon. The NSFR is measured as the ratio of a banking organization’s available stable funding (ASF) amount to its required stable funding (RSF) amount, each as defined in the proposed rules, over a one-year horizon. The regulatory minimum ratio for all covered banking organizations is 100 percent. For BHCs with assets of $50 billion or more, but less than $250 billion, the RSF amount is scaled by a factor of 70 percent. The proposal also includes requirements for quarterly quantitative and qualitative NSFR disclosures. The requirements of the proposed rules would take effect January 1, 2018. The comment period on the proposed rules is scheduled to close on August 5, 2016. Although the impact on PNC will not be fully known until the rules are final, PNC has taken several actions to prepare for implementation of the NSFR and we expect to be in compliance with the NSFR requirements when they become effective.

In 2011, several federal regulators jointly proposed regulations required by Dodd-Frank regarding incentive-based compensation arrangements at large financial institutions. In April and May 2016, the OCC, Federal Reserve, FDIC, Federal Housing Finance Agency, and National Credit Union Administration re-proposed these regulations, and the SEC is expected to re-propose similar regulations shortly. The regulations would apply to, among other entities, bank holding companies, national banks, investment advisers and SEC-registered broker dealers with total assets of $1 billion or more (“covered financial institutions”). The new proposed rules would require covered financial institutions with total assets of $50 billion or more to defer the vesting of specified percentages of incentive-based compensation awarded to the institution’s “senior executive officers” and “significant risk-takers” for specific periods, and require that all unvested and vested incentive-based compensation to these individuals be subject to forfeiture and clawback, respectively, under circumstances specified by the rules. PNC is currently evaluating the proposal and the comment period on the proposed rules will end on July 22, 2016. The nature, scope and terms of any final regulations could negatively affect PNC’s ability to attract and retain officers and employees with appropriate skill and experience and compete with financial institutions that are either not subject to the proposed rules, or are not subject to the rules to the same extent as PNC.

 

CONSOLIDATED INCOME STATEMENT REVIEW

Our Consolidated Income Statement is presented in Part I, Item 1 of this Report.

Net income for the first quarter of 2016 was $943 million, or $1.68 per diluted common share, a decrease of 6%, compared to $1.0 billion, or $1.75 per diluted common share, for the first quarter of 2015. The decrease was driven by higher provision for credit losses and a 2% decline in revenue, partially offset by a 3% decrease in noninterest expense. Lower revenue in the comparison reflected a 6% decline in noninterest income, partially offset by a 1% increase in net interest income.

Net Interest Income

Table 4: Net Interest Income and Net Interest Margin

 

		Three months ended March 31
Dollars in millions		2016				2015
Net interest income		$	2,098			$	2,072
Net interest margin			2.75	%			2.82	%

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 for additional information.

Net interest income increased by $26 million, or 1%, in the first quarter of 2016 compared with the first quarter of 2015 due to higher loan and securities balances, partially offset by lower purchase accounting accretion and higher borrowing costs related to higher short-term interest rates.

Net interest margin of 2.75% for the first quarter of 2016 declined from 2.82% in the first quarter of 2015 due to lower benefit from purchase accounting accretion and higher securities balances, partially offset by lower balances on deposit with the Federal Reserve.

In the second quarter of 2016, we expect net interest income to increase modestly compared to the first quarter of 2016.

For full year 2016, we expect purchase accounting accretion to be down approximately $175 million compared to 2015.

 

Noninterest Income

Table 5: Noninterest Income

 

Three months ended March 31 Dollars in millions										Change
		2016				2015				$				%
Noninterest income
Asset management		$	341			$	376			$	(35	)			(9	)%
Consumer services			337				311				26				8	%
Corporate services			325				344				(19	)			(6	)%
Residential mortgage			100				164				(64	)			(39	)%
Service charges on deposits			158				153				5				3	%
Net gains on sales of securities			9				42				(33	)			(79	)%
Other			297				269				28				10	%
Total noninterest income		$	1,567			$	1,659			$	(92	)			(6	)%

Noninterest income decreased during the first quarter of 2016 compared to first quarter of 2015 primarily reflecting the impact of weaker equity markets and lower capital markets activity as well as lower residential mortgage revenue. Noninterest income as a percentage of total revenue was 43% in the first quarter of 2016 compared to 44% in the first quarter of 2015.

Lower asset management revenue in the first three months of 2016 was driven by decreased earnings from our BlackRock equity investment mainly attributable to the impact of lower equity markets. Discretionary client assets under management of $135 billion at March 31, 2016 were relatively stable compared to $136 billion at March 31, 2015.

Consumer service fees increased in the first quarter of 2016 compared to the prior year quarter primarily due to growth in payment-related products including debit card, credit card and merchant services, as well as increased brokerage fees.

Corporate services revenue decreased in the first quarter of 2016 compared to the first quarter of 2015, principally due to lower commercial mortgage servicing rights valuation, net of economic hedge, and lower capital markets activity.

Residential mortgage fee revenue decreased in the first three months of 2016 compared to the prior year quarter as a result of lower residential mortgage servicing rights valuation, net of economic hedge, and lower loan sales revenue, partially offset by higher servicing fee income.

Net gains on sales of securities decreased in the first quarter of 2016 compared to the first quarter of 2015 mainly due to a higher volume of securities sales in the prior year quarter.

Other noninterest income for the first quarter of 2016 included a gain of $44 million on the sale of 0.5 million Visa Class B common shares and lower gains on sales of other assets compared to first quarter 2015. There were no sales of Visa shares in first quarter 2015.

In the second quarter of 2016, we expect the fee income categories of noninterest income, consisting of asset management, consumer services, corporate services, residential mortgage and service charges on deposits, to be up approximately 10 to 12 percent, compared to the first quarter of 2016, reflecting higher anticipated business levels in the second quarter.

For full year 2016, we expect modest growth in revenue.

Provision For Credit Losses

The provision for credit losses totaled $152 million for the first quarter of 2016 compared with $54 million for the first quarter of 2015. The first quarter 2016 provision included $80 million for energy related loans in the oil, gas, and coal sectors.

We expect our provision for credit losses in the second quarter of 2016 to be between $125 million and $175 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 decreased $68 million, or 3%, to $2.3 billion for the first quarter of 2016 compared with first quarter 2015 reflecting lower legal costs and lower variable compensation as well as a continued focus on expense management.

As of the end of the first quarter of 2016, we have completed actions to capture more than one-third of our 2016 continuous improvement savings goal of $400 million, and are on track to achieve the full-year goal. Through this program, we intend to help fund our continued investments in technology and business infrastructure throughout 2016.

In the second quarter of 2016, we expect noninterest expense to increase by mid-single digits, on a percentage basis, compared to the first quarter of 2016, primarily as a result of higher anticipated business activity and seasonality.

For full year 2016, we expect noninterest expense to remain stable compared to 2015.

Effective Income Tax Rate

The effective income tax rate was 23.5% in the first quarter of 2016 compared with 24.4% in the first quarter of 2015. 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 full-year 2016 effective tax rate to be approximately 25%.