DBRS Comments on Q4 2008 Earnings of PNC Financial Services Group, Inc. – Senior at A (high) – Ratings Unchanged

DBRS has today commented on the Q4 2008 operating performance and earnings of PNC Financial Services Group, Inc. (PNC or the Company). PNC’s balance sheet included the acquisition of National City Corporation (acquired on December 31, 2008), but National City’s results were not reflected (except for conforming marks) in its consolidated income statement.

The challenging environment had a markedly negative impact on asset quality, investment security marks and non-interest income, yet PNC produced stable net interest income, strong deposit and loan growth and good expense control in the quarter, which has resulted in positive operating leverage for the quarter (excluding provisions) and year to date.

PNC reported a $248 million loss for the quarter compared to a $248 profit in Q3 2008 and $178 million in Q4 2007 primarily due to an outsized provision influenced by the merger and charges related to the difficult economic environment. Non-interest income rose modestly from Q3 2008, but weakened compared with the year-ago quarter primarily due to $172 million in securities losses in the quarter that were offset by a $177 million gain adjustment in the BlackRock Long-Term Incentive Plan (LTIP) shares obligation. As a result of the recent BlackRock share exchange agreement, the LTIP share adjustment volatility is expected to end in the first quarter of 2009, which DBRS views positively as it will reduce earnings volatility. Underlying fee income was down 17% from the linked quarter and 20% year-over-year quarter primarily due to the decline in asset values. Asset quality metrics, albeit weakening, remained relatively strong compared to peers at the end of the quarter, while liquidity remained healthy and regulatory capital ratios strengthened due to the issuance of TARP capital. PNC’s Q4 2008 results were within the lower end of DBRS’s expectations, resulting in no change in the Company’s ratings – A (high) for senior obligations – and Negative trend.

Non-performing assets, at 1.23% of loans and foreclosed assets at the end of the quarter (does not include National City’s stressed non-performing assets that were marked to market per purchase accounting), and net charge-offs, at 1.09% of average loans for the quarter, reflect a material worsening in asset quality that is still relatively strong compared to peers. Asset quality deterioration was primarily evident in commercial loans, residential real estate development, and commercial real estate projects. Meanwhile, increases in charge-offs were primarily in commercial and commercial real estate. Expected increases in credit costs and mark-to-market losses will be absorbed by PNC’s strong earnings generation – $545 million in income before provisions and taxes in the fourth quarter. Hence, further modest asset quality weakening is unlikely to impair PNC’s capital and other credit fundamentals.

PNC issued $7.6 billion in funds from the TARP Capital Purchase Program at the end of the year that enhanced PNC’s Tier 1 Capital ratio to 9.7% from 8.2% at Q3 2008 and Total Capital to 13.5% from 11.9%. However, the Company’s tangible common equity ratio remained under pressure dropping to a low 2.8% at December 31, 2008 compared to 3.6% in the prior quarter. The decline was driven by incremental net unrealized security losses of $1.8 billion ($5.4 billion in total) within the $43.5 billion securities available-for-securities portfolio. While DBRS is concerned about the pressure on tangible common equity, it is somewhat mitigated by the high quality of the portfolio, its relative short maturity and the Company’s ability and intent to hold the securities to maturity given their solid liquidity position. Moreover, PNC has a sizable unrecognized gain in its ownership interest in BlackRock, Inc.

The Negative trend, assigned on December 31, 2008, reflects the increase in near- to medium-term risk to the Company at a time of substantial turmoil in the credit and capital markets while executing the integration of National City. DBRS expects that PNC’s earnings will continue to be somewhat pressured by deteriorating credit quality, security impairment and rising credit costs, primarily driven by declining housing prices. The macroeconomic picture has also darkened in the past quarter as the U.S. economy, already well into a recession, tries to stem rapidly rising unemployment with a new administration in office. Although the newly-merged Company’s revenue base is well diversified, it increases the concentration of spread income in economically weaker Midwest markets, which are at risk of a deeper and longer recession.

Declining financial performance, including deteriorating credit quality or profitability; the inability to reduce high risk assets; or a troubled integration could lead to negative rating actions, while risk asset reduction, continuing strong profitability and a successful integration could restore the trends to Stable.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating Banks and Bank Holding Companies Operating in the United States, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.