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 commitments to our customers, shareholders, employees and 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 to our customers with the goal of addressing their financial objectives. Our strategies for growing fee income across our lines of business are focused on putting customers’ needs first. Our business model is built on customer loyalty and engagement, understanding our customers’ financial goals and offering our diverse products and services to help them achieve financial wellbeing. Our approach is concentrated on organically growing and deepening client relationships that meet our risk/return measures.

Our strategic priorities are designed to enhance value over the long term. One of our priorities 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 the retail distribution network and the home lending process 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). For more detail, see the 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.

Income Statement Highlights

Net income for the third quarter of 2016 was $1.0 billion, or $1.84 per diluted common share, a decrease of 6%, compared to $1.1 billion, or $1.90 per diluted common share, for the third quarter of 2015.

 

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Net interest income increased $33 million, or 2%, to $2.1 billion.

 

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Net interest margin increased to 2.68% compared to 2.67% in third quarter 2015.

 

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Noninterest income increased $21 million, or 1%, to $1.7 billion as growth in fee income was mostly offset by a decline in other noninterest income.

 

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Noninterest expense increased $42 million to $2.4 billion, reflecting a new Federal Deposit Insurance Corporation (FDIC) deposit insurance surcharge and higher costs associated with business activities as PNC continued to focus on disciplined expense management.

 

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The effective tax rate was 25.4% compared to 20.0% in the third quarter of 2015.

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

Credit Quality Highlights

Overall credit quality remained relatively stable at September 30, 2016.

 

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Nonperforming assets decreased $50 million, or 2%, to $2.4 billion compared to December 31, 2015.

 

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Overall loan delinquencies of $1.5 billion decreased $184 million, or 11% compared to December 31, 2015.

 

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Provision for credit losses increased modestly to $87 million for the third quarter of 2016 compared to $81 million for the third quarter of 2015.

 

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Net charge-offs of $154 million for the third quarter of 2016 increased $58 million compared to the third 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 and Liquidity Highlights

PNC’s balance sheet continued to be well positioned at September 30, 2016 compared to December 31, 2015.

 

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Total loans increased $3.8 billion to $210.4 billion.

 

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Total commercial lending grew $4.6 billion, or 3%.

 

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Total consumer lending decreased $.8 billion, or 1%.

 

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Total deposits increased $10.9 billion to $259.9 billion.

 

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Investment securities increased $8.0 billion, or 11%, to $78.5 billion.

 

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The Liquidity Coverage Ratio (LCR) at September 30, 2016 for both PNC and PNC Bank exceeded the 2017 fully phased-in requirement of 100%.

Capital Highlights

PNC maintained a strong capital position and continued to return capital to shareholders.

 

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The Transitional Basel III common equity Tier 1 capital ratio remained stable at 10.6% at September 30, 2016 compared to December 31, 2015.

 

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Pro forma fully phased-in Basel III common equity Tier 1 capital ratio, a non-GAAP financial measure, increased to an estimated 10.2% at September 30, 2016 compared to 10.0% at December 31, 2015 based on the standardized approach rules.

 

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In the third quarter of 2016, we returned $.8 billion of capital to common shareholders through repurchases of 5.9 million common shares for $.5 billion, made under new share repurchase programs, and dividends on common shares of $.3 billion.

 

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On October 4, 2016, the PNC Board of Directors declared a quarterly cash dividend on common stock of 55 cents per share effective with the November 5, 2016 payment date.

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 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 nine months of 2016 and 2015 and balances at September 30, 2016 and December 31, 2015, respectively.

Business Outlook

Statements regarding our business outlook are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to numerous assumptions, risks and uncertainties, including our current view that the U.S. economy will grow moderately in the latter half of 2016, boosted by stable oil/energy prices, improving housing activity and moderate job gains, and that short-term interest rates and bond yields will hold fairly steady before gradually rising late this year and do not take into account the impact of potential legal and regulatory contingencies. Specifically, our business outlook reflects our expectation of a 25 basis point increase in short-term interest rates by the Federal Reserve in December 2016. See the Cautionary Statement Regarding Forward-Looking Information section in this Financial Review and Item 1A Risk Factors in our 2015 From 10-K for other factors that could cause future events to differ, perhaps materially, from those anticipated in these forward-looking statements.

In the fourth quarter of 2016, we expect:

 

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Modest loan growth compared to the third quarter of 2016;

 

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Stable net interest income compared to the third quarter, and purchase accounting accretion to be approximately $50 million;

 

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Stable fee income compared to the third quarter of 2016, with fee income consisting of asset management, consumer services, corporate services, residential mortgage and service charges on deposits;

 

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Provision for credit losses to be between $75 million and $125 million; and

 

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Noninterest expense to increase by low single digits, on a percentage basis, compared to the third quarter 2016.

We also expect full year 2016 noninterest expense to remain stable compared to full year 2015, and the full year 2016 effective tax rate to be approximately 25%.

 

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 $1.7 billion, partially offset by a decrease in consumer loans of $2.8 billion. The decline in consumer loans was primarily attributable to declines in the nonstrategic consumer and the government guaranteed education loan portfolios. Loans represented 66% of average interest-earning assets for the first nine months of 2016 and 67% in the same period of 2015.

Average interest-earning deposits with banks, which are primarily maintained with the Federal Reserve Bank, decreased in the comparison reflecting higher investment securities, loan growth and lower borrowed funds, partially offset by an increase in deposits.

Average total deposits increased $10.6 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 and Federal Home Loan Bank (FHLB) borrowings, 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 $369.3 billion at September 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 September 30, 2016 compared with December 31, 2015.

 

Recent Market and Industry Developments

As previously disclosed in our First Quarter 2016 Form 10-Q, the final rules adopted by the FDIC imposing a deposit insurance assessment surcharge (Surcharge) on insured depository institutions with total consolidated assets of $10 billion or more (including PNC Bank) became effective on July 1, 2016. The Surcharge took effect beginning with the third quarter 2016 assessment period. Based on data as of September 30, 2016, PNC Bank’s quarterly assessment increased by approximately $25 million compared to the second quarter of 2016, reflecting the impact of the Surcharge and the reduction of regular assessments that went into effect at the same time.

In September 2016, the Office of the Comptroller of the Currency (OCC) issued final enforceable guidelines under section 39 of the Federal Deposit Insurance Act that establish standards for recovery planning for insured national banks with average total consolidated assets of $50 billion or more, including PNC Bank. The guidelines require a covered bank to develop and maintain a recovery plan that, among other things, identifies a range of options that could be undertaken by the covered bank to restore its financial strength and viability should identified triggering events occur. For PNC Bank the compliance date for these guidelines is January 1, 2018.

Also in September 2016, the Federal Reserve proposed amendments to its capital plan rule that would, among other things, reduce, from 1% to 0.25% of Tier 1 capital, the amount of capital distributions that a bank holding company may make above the amounts included in its most recently approved capital plan without seeking the Federal Reserve’s prior approval and prohibit bank holding companies from seeking to use this “de minimis” capital distribution authority during the second calendar quarter of each year. The comment period on the proposal closes on November 25, 2016. Governor Daniel Tarullo of the Federal Reserve also outlined additional changes that the Federal Reserve is considering to its capital plan rule and CCAR process, including the establishment of a new “stress capital buffer,” in a speech delivered on September 26, 2016. Governor Tarullo indicated that such potential changes would be issued for public comment at a later date and, accordingly, the precise nature of these additional potential changes is not known at this time.

CONSOLIDATED INCOME STATEMENT REVIEW

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

Net income for the third quarter of 2016 was $1.0 billion, or $1.84 per diluted common share, a decrease of 6% compared with $1.1 billion, or $1.90 per diluted common share, for the third quarter of 2015. For the first nine months of 2016, net income was $2.9 billion, or $5.33 per diluted common share, a decrease of 6% compared with $3.1 billion, or $5.52 per diluted common share, for the first nine months of 2015.

Net income decreased in the quarterly comparison as revenue growth, driven by a 2% increase in net interest income and a 1% increase in noninterest income, was more than offset by a higher effective tax rate and a 2% increase in noninterest expense. Net income decreased in the year-to-date comparison driven by higher provision for credit losses and a 3% decline in noninterest income, partially offset by a 1% increase in net interest income and lower noninterest expense.

Net Interest Income

Table 3: Net Interest Income and Net Interest Margin

 

		Three months ended September 30								Nine months ended September 30
Dollars in millions		2016				2015				2016				2015
Net interest income		$	2,095			$	2,062			$	6,261			$	6,186
Net interest margin (a)			2.68	%			2.67	%			2.71	%			2.74	%

(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 by $33 million, or 2%, and $75 million, or 1%, for the third quarter and first nine 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, lower securities yields and an increase in borrowing costs.

Net interest margin increased in the quarterly comparison largely reflecting the impact of the December 2015 increase in the federal funds rate and decreased in the year-to-date comparison as the impact of the rate increase was more than offset by a lower benefit from purchase accounting accretion.

 

Noninterest income increased in the third quarter of 2016 compared to the third quarter of 2015 and decreased in the first nine months compared to the same period in 2015. Noninterest income as a percentage of total revenue was 45% in both the third quarters of 2016 and 2015 and 45% and 46% on a year-to-date basis, respectively.

Asset management revenue increased in the quarterly comparison primarily due to the impact of higher average equity markets on both BlackRock and our asset management business segment. The year-to-date comparison decreased mainly due to lower earnings from BlackRock and 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 $138 billion at September 30, 2016 compared with $132 billion at September 30, 2015.

Consumer services fees increased in the year-to-date comparison primarily due to growth in payment-related products including debit card, credit card and merchant services, as well as higher brokerage fees.

Corporate services revenue increased in the year-to-date comparison primarily reflecting higher capital markets-related revenue and higher treasury management fees.

Residential mortgage revenue increased in the quarterly comparison as a result of higher loan sales revenue from higher origination volumes and increased benefit from residential mortgage servicing rights valuation, net of economic hedge. The year-to-date comparison decreased mainly due to lower loan sales revenue and a lower benefit from residential mortgage servicing rights valuation, net of economic hedge.

Other noninterest income decreased in both comparisons primarily attributable to the impact of third quarter 2015 net gains of $43 million on sales of 0.5 million Visa Class B

common shares and lower revenue from private equity investments. There were no sales of Visa shares in the third quarter of 2016. Net gains on the sale of Visa shares for the first nine months of 2016 were $52 million on sales of 1.35 million shares compared with net gains of $124 million on sales of 1.5 million shares in the first nine months of 2015. Net gains on Visa sales include derivative fair value adjustments related to swap agreements with purchasers of Visa shares in connection with all sales to date.

Provision For Credit Losses

The provision for credit losses increased modestly to $87 million in the third quarter of 2016 compared to $81 million in the third quarter of 2015 and increased $185 million to $366 million for the first nine months of 2016 compared to the same period in 2015. The increase in the year-to-date comparison was attributable to a higher provision for energy related loans in the oil, gas, and coal sectors of $130 million in the first nine months of 2016 compared to $86 million for the first nine months of 2015, as well as slowing credit quality improvement in our commercial and consumer lending portfolios and the impact of continued loan growth.

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 third quarter of 2016 increased $42 million to $2.4 billion compared to the third quarter of 2015, while noninterest expense for the first nine months of 2016 compared to the same period in 2015 decreased $32 million to $7.0 billion. Both comparisons reflected increases to noninterest expense resulting from a new FDIC deposit insurance surcharge, higher variable compensation costs associated with increased business activity and investments in technology and business infrastructure as PNC continued to

 

focus on disciplined expense management. These were offset by net lower contingency accruals and the impact from our effective expense management.

As of September 30, 2016, we have completed actions to capture more than 75% of our 2016 continuous improvement savings goal of $400 million, and are on track to achieve the full-year goal. Through this program, we are helping to fund our continued investments in technology and business infrastructure.

Effective Income Tax Rate

The effective income tax rate was 25.4% in the third quarter of 2016 compared to 20.0% in the third quarter of 2015 and 24.4% in the first nine months of 2016 compared to 24.3% in the same period of 2015. The lower effective tax rate for the third quarter of 2015 reflected tax benefits attributable to effectively settling acquired entity tax contingencies.

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.

 

The summarized balance sheet data above is based upon our Consolidated Balance Sheet in Part 1, Item 1 of this Report.

PNC’s balance sheet reflected asset growth compared to December 31, 2015 and strong liquidity and capital positions at September 30, 2016.

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Total assets increased primarily due to higher investment securities and loan balances, partially offset by lower interest-earning deposits with banks.

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Higher total liabilities were driven by deposit growth.

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The increase to total equity reflected increased retained earnings driven by net income, partially offset by share repurchases.