Decrease in PNC income on COVID provisions – Fee income also decreases
The first quarter earnings season kicked off with a deluge of bank profits. The common theme so far has been a sharp increase in reserves set aside for future credit losses driven by COVID-19.
PNC Financial Services (PNC 0.43% ) reported earnings per share of $1.95, down 25% from a year ago and 34% from the fourth quarter of 2019. PNC’s return on assets fell to 0.89% , compared to 1.33% in the fourth quarter, and the return on equity fell from 11.5% to 7.5%. Let’s dive deeper into the earnings report and see if this bank is doing well in 2020.
Big jump in loan loss reserves
Provisions for credit losses increased 384% year-over-year to $914 million, largely due to expected future losses from COVID-19 and the new accounting standard on credit losses. Current Expected Credit (CECL) which became effective on January 1, 2020. The additional jump was $693 million, or 0.16% of assets and 0.27% of loans. They were applied approximately 55% to the commercial loan portfolio and 45% to the consumer portfolio.
PNC CEO Bill Demchak said on the conference call that economic conditions had deteriorated since the end of the quarter and that we could see further provisioning. Additionally, he thinks we are looking at more of a U-shaped recovery, compared to the V-shaped one when many CECL calculations were done.
Good credit in the face of a cash flow crisis
Commercial loans increased during the quarter, mainly due to the precautionary withdrawal of lines of credit by businesses. PNC has received thousands of applications under the Coronavirus Aid, Relief, and Economic Security (CARES) Act Paycheck Protection Program. About $2.5 billion of PNC’s loan portfolio goes to retailers, and 60% of that is secured by collateral. Exposure to oil and gas is approximately $4.6 billion, and restaurants and recreation are $1.2 billion.
So far, PNC makes loan modification decisions client by client, and most of them are agreements to defer interest or reduce fees. During the conference call, Demchak said most of those changes were “good credits” that address a “cash crisis.”
Forbearance and Mortgage Service
In the consumer portfolio, most of the exposure is in the mortgage sector. PNC has made 41,000 loan modifications related to COVID-19. These are loan extensions, deferrals and abstentions. PNC will also have to write down its mortgage service portfolio somewhat, although at the end of 2019 PNC was valuing the service at 83 basis points of the outstanding principal balance, which was likely conservative to begin with.
Note that PNC attributed the income to “the increase in the valuation of mortgage services net of hedges”, which is surprising given that other major banks have written down their service portfolios. Since delinquencies and prepayment periods are about to accelerate, it would seem appropriate to write them down, but perhaps the positive P/L of the hedge position was more important than the loss on the MSR wallet.
Blackrock’s commission income also fell
PNC generates a lot of commission income and owns 35 million shares of a global investment management company black rock, which is included on the balance sheet as income from equity. PNC also earns commissions on corporate asset management and treasury services. These companies generate commission income without assuming any credit risk.
In the first quarter, other income, which includes Blackrock, accounted for 32% of net income for the quarter. Last year, Blackrock accounted for 15% of net profit. Although fee income may help to mitigate the effect of provisioning and credit losses, it remains sensitive to the overall banking environment and asset markets.
PNC’s loan loss allowance is approximately 1.5% of loans. It’s towards the high side compared to some of the others big banks report last week. PNC’s Basel III Tier 1 capital ratio decreased by 10 basis points to 9.4% compared to the end of 2019. PNC also maintained its dividend of $1.15 per share, which equates to a dividend yield of 4.5%. The dividend is well covered at less than 60% of profits.
While we are in uncharted territory, economically, PNC Financial appears to be in good shape to weather the current financial storm.
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