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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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 second quarter of 2016 was $989 million, or $1.82 per diluted common share, a decrease of 5%, compared to $1.044 billion, or $1.88 per diluted common share, for the second quarter of 2015.

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Net interest income increased $16 million, or 1%, to $2.1 billion.

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Net interest margin decreased to 2.70% compared to 2.73% in second quarter 2015.

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Noninterest income decreased $88 million, or 5%, to $1.7 billion as higher fee income was more than offset by lower other income.

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Noninterest expense decreased $6 million to $2.4 billion reflecting PNC’s effective expense management.

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

Credit Quality Highlights

Overall credit quality remained relatively stable at June 30, 2016 compared to December 31, 2015, except for certain energy related loans.

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Nonperforming assets increased $90 million, or 4%, to $2.5 billion.

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Overall loan delinquencies of $1.5 billion decreased $179 million, or 11%.

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Provision for credit losses increased to $127 million for the second quarter of 2016 compared to $46 million for the second quarter of 2015. Second quarter 2016 provision included $48 million for energy related loans in the oil, gas and coal sectors.

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Net charge-offs of $134 million for the second quarter of 2016 increased $67 million compared to the second 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 continued to be well-positioned at June 30, 2016 compared to December 31, 2015 reflecting strong liquidity and capital.

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Total loans increased $2.4 billion to $209.1 billion.

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Total commercial lending grew $3.5 billion, or 3%.

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Total consumer lending decreased $1.1 billion, or 2%.

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Total deposits increased $.8 billion to $249.8 billion.

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Investment securities increased $1.3 billion, or 2%, to $71.8 billion.

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PNC maintained a strong liquidity position.

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The Liquidity Coverage Ratio (LCR) at June 30, 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 remained stable at 10.6%.

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Pro forma fully phased-in Basel III common equity Tier 1 capital ratio increased to an estimated 10.2% compared to 10.0% based on the standardized approach rules.

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PNC continued to return capital to shareholders.

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We completed common stock repurchase programs for the five quarter period that ended in the second quarter of 2016.

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We returned a total of $4.0 billion of capital to shareholders through repurchases of 29.9 million common shares for $2.7 billion and dividends on common shares of $1.3 billion over the five-quarter period.

 

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Second quarter 2016 repurchases were 6.1 million common shares for $.5 billion and dividends on common shares were $.3 billion.

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In June 2016, we announced share repurchase programs of up to $2.0 billion for the four-quarter period beginning in the third quarter of 2016.

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PNC’s Board of Directors raised the quarterly dividend on common stock to 55 cents per share, an increase of 4 cents per share, or 8 percent, effective with the August 5, 2016 dividend.

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 2016 capital and liquidity actions as well as more detail on our capital ratios.

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 our results during the first six months of 2016 and 2015 and balances at June 30, 2016 and December 31, 2015, respectively.

 

Average investment securities increased due to higher average agency residential mortgage-backed securities and U.S. Treasury and government agency securities, partially offset by a decrease in average non-agency residential mortgage-backed securities. Total investment securities increased from 19% to 23% of average interest-earning assets.

The increase in average loans was driven by growth in average commercial real estate loans of $3.9 billion and average

commercial loans of $1.4 billion, principally in our Corporate & Institutional Banking segment, partially offset by a decrease in consumer loans of $3.0 billion. The decline in consumer loans was primarily attributable to lower home equity and education loans, and included runoff in the non-strategic portfolio of residential mortgage and brokered home equity loans. Loans remained stable at 67% of average interest-earning assets in both periods.

 

Average interest-earning deposits with banks, which are primarily maintained with the Federal Reserve Bank, decreased in the comparison reflecting a shift to higher yielding investment securities and loans as well as lower borrowed funds, partially offset by an increase in deposits.

Average total deposits increased $11.4 billion, primarily due to higher average savings deposits, which reflected a shift from money market deposits to relationship-based savings products. Additionally, average interest-bearing demand

deposits and average noninterest-bearing deposits increased as overall deposits grew. Average total deposits increased from 67% to 69% of average assets in the comparison.

Average borrowed funds declined due to decreases in average commercial paper, Federal Home Loan Bank (FHLB) borrowings and federal funds purchased and repurchase agreements, partially offset by an increase in average bank notes and senior debt. The Liquidity Risk Management portion of this Financial Review includes additional information regarding our sources and uses of borrowed funds.

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. Total assets were $361.3 billion at June 30, 2016 compared with $358.5 billion at December 31, 2015. The Consolidated Balance Sheet Review section of this Financial Review provides information on changes in selected Consolidated Balance Sheet categories at June 30, 2016 compared with December 31, 2015.

Recent Market and Industry Developments

On June 29, 2016, the Federal Reserve announced the results of the 2016 CCAR exercise. As we previously announced, the Federal Reserve accepted the capital plan that PNC submitted in April 2016 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.

On July 6, 2016, the Federal Reserve granted the final one-year extension of the general conformance period available under the Volcker Rule provisions of the Dodd-Frank Act to give all banking entities until July 21, 2017, to conform their investments in, and relationships with, covered funds (as defined in the Volcker Rule) that were in place prior to December 31, 2013 (legacy covered funds). As a result, PNC now has until at least July 21, 2017, to divest or conform its remaining investments in, and relationships with, legacy covered funds, including certain of PNC’s REIT preferred securities that, as currently structured, are considered legacy covered funds. In the second quarter of 2016, PNC recorded negative valuation adjustments of $51 million in noninterest income primarily associated with nonconforming investments under the Volcker Rule. For additional information regarding the Volcker Rule and related considerations, see the Supervision and Regulation section in Item 1 Business and Item 1A Risk Factors of our 2015 Form 10-K. The Federal Reserve has the ability to provide up to an additional 5-year extended conformance period for investments held in, and relationships with, covered funds that qualify as illiquid funds under the Volcker Rule and the Federal Reserve’s regulations.

In June 2016, following a period of public comments, the FDIC revised and updated its FAQs concerning brokered deposits that were originally released in 2015. Federal banking laws and regulations apply a variety of requirements or restrictions on insured depository institutions with respect to brokered deposits. For example, as explained in these FAQs, only a “well capitalized” insured depository institution may accept or retain brokered deposits without prior regulatory approval and brokered deposits are generally subject to higher outflow assumptions than other types of deposits for purposes of the LCR. We do not anticipate that these revised FAQs will have a material impact on PNC’s deposit-taking activities or LCR.

 

CONSOLIDATED INCOME STATEMENT REVIEW

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

Net income for the second quarter of 2016 was $989 million, or $1.82 per diluted common share, a decrease of 5%, compared with $1.044 billion, or $1.88 per diluted common share, for the second quarter of 2015. For the first six months of 2016, net income was $1.9 billion, or $3.49 per diluted common share, a decrease of 6%, compared with $2.0 billion, or $3.63 per diluted common share, for the first six months of 2015.

Net income decreased in both comparisons driven by higher provision for credit losses and a 2% decline in revenue, partially offset by a 2% decrease in noninterest expense in the year-to-date comparison. Lower revenue in both comparisons reflected a 5% 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 June 30								Six months ended June 30
Dollars in millions		2016				2015				2016				2015
Net interest income		$	2,068			$	2,052			$	4,166			$	4,124
Net interest margin (a)			2.70	%			2.73	%			2.73	%			2.78	%

(a)	See footnote (c) in Table 1: Consolidated Financial Highlights on page 1.

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 $16 million, or 1%, and $42 million, or 1%, for the second quarter and first six months of 2016, respectively, compared to the same periods in 2015. The increases in both comparisons were attributable to increases in loan and securities balances and higher loan yields, partially offset by lower purchase accounting accretion, higher borrowing costs and lower securities yields.

Net interest margins decreased in both comparisons mainly due to lower benefit from purchase accounting accretion, partially offset by the impact of lower balances on deposit with the Federal Reserve.

In the third quarter of 2016, we expect net interest income to be stable with the second quarter of 2016.

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

 

Noninterest income decreased in both the quarterly and year-to-date comparisons. Noninterest income as a percentage of total revenue was 45% for the second quarter of 2016 compared to 47% for the same period in 2015. The comparable amounts for the year-to-date periods of 2016 and 2015 were 44% and 46%, respectively.

Asset management revenue decreased in both comparisons driven by lower earnings from our BlackRock equity investment and the impact of lower equity markets on both BlackRock and our asset management business segment. The decreases also included the impact from a $30 million trust settlement during the second quarter of 2015 in our asset management business segment. Discretionary client assets under management were $135 billion at June 30, 2016 compared with $134 billion at June 30, 2015.

Consumer services fees increased in both the quarterly and year-to-date comparisons, 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 increased in both comparisons primarily as a result of higher merger and acquisition advisory fees and higher loan syndication fees.

Residential mortgage revenue decreased in the year-to-date comparison 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 revenue.

Other noninterest income decreased in both comparisons mainly attributable to second quarter valuation adjustments of $51 million primarily associated with nonconforming investments under the Volcker Rule as well as lower net gains on sales of Visa Class B common shares. Net gains on the sale of Visa Class B common shares were $63 million on sales of 1.35 million shares for the first six months of 2016, including $31 million on the sale of 0.85 million shares in the second

quarter of 2016, compared to $79 million on the sale of 1.0 million shares in the second quarter of 2015. Net gains consist of gains on Visa sales reduced by derivative fair value adjustments related to swap agreements with purchasers of Visa Class B common shares in connection with all prior sales.

In the third quarter of 2016, we expect fee income to remain stable with the second quarter of 2016. Fee income, a non-GAAP financial measure, refers to noninterest income categories of asset management, consumer services, corporate services, residential mortgage and service charges on deposits.

For full year 2016, we expect total revenue to be stable compared to 2015.

Provision For Credit Losses

The provision for credit losses increased $81 million to $127 million in the second quarter of 2016 compared to the second quarter of 2015 and increased $179 million to $279 million for the first six months of 2016 compared to the same period in 2015. The increase in both comparisons was primarily due to provision for energy related loans in the oil, gas, and coal sectors, which was $128 million for the first six months of 2016, including $48 million in the second quarter of 2016. The energy related loan portfolio weakened slightly in the second quarter of 2016 compared to the first quarter of 2016, but at a slower pace.

We expect our provision for credit losses in the third quarter of 2016 to be between $100 million and $150 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 for the second quarter of 2016 remained stable at $2.4 billion compared to the second quarter of 2015. Noninterest expense decreased $74 million, or 2%, to $4.6 billion for the first six months of 2016 compared to the same period in 2015, primarily due to the release of $24 million in residential mortgage foreclosure-related reserves and lower legal accruals, and reflected our effective expense management.

As of June 30, 2016, we have completed actions to capture more than two-thirds 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.

We expect noninterest expense in the third quarter of 2016 to remain stable compared to the second quarter 2016, and full year 2016 noninterest expense to remain stable compared to full year 2015.

Effective Income Tax Rate

The effective income tax rate was 24.3% in the second quarter of 2016 compared to 28.2% in the second quarter of 2015 and 23.9% in the first six months of 2016 compared to 26.4% in the same period of 2015. Both declines were primarily attributable to increased tax credit investments and a change in 2015 to record the impact of historic tax credits as a reduction to the associated investment asset balance.

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%.