DBRS Comments on Q1 2009 Earnings of PNC – Senior at A (high) – Ratings Unchanged

DBRS has today commented on the Q1 2009 earnings of PNC Financial Services Group, Inc. (PNC or the Company). For the first time, PNC’s results fully incorporated the acquisition of National City Corporation (acquired on December 31, 2008). While the year end balance sheet included National City, Q1 2009 is the first period in which the income statement was that of the enlarged company, making prior period comparisons difficult. In DBRS’s view, however, PNC’s first quarter results reflected a relatively strong operating performance in a still-challenging environment.

PNC reported net income of $530 million for the quarter compared to a loss in Q4 2008 of $246 million and net income of $384 million in the prior year’s quarter. First quarter revenues of $3.9 billion were split 60% and 40% between net interest income and noninterest income, respectively. Benefitting fee revenue in Q1 2009 was a strong quarter in mortgage banking ($431 million in revenue), which included MSR hedging gains of $202 million. While it is unlikely that the Company will repeat the same level of hedging gains in subsequent quarters, DBRS expects this business, acquired from National City, will continue to perform well given high levels of refinancing activity due to the record low interest rate environment. Other more market-sensitive items (notably fund servicing and asset management) were impacted by declining asset values and PNC had an OTTI charge on debt securities of $149 million in the quarter, as compared to $174 million in Q4 2008.

The addition of National City’s loan portfolios (which were marked to fair value at the time of acquisition) and lower funding costs in the current rate environment drove the Company’s net interest income performance in the quarter. Net interest margin expanded to 3.81% in Q1 2009 from 3.37% in the fourth quarter. Low cost deposit growth was a positive in the quarter as PNC grew overall balances while allowing $6 billion of brokered CDs to roll-off. DBRS also expects some modest deposit yield relief for PNC from maturing high-yielding National City CDs over the next few quarters. Positively, total deposits grew $1.8 billion to $194.6 billion at March 31, 2009 and noninterest-bearing deposits grew 9% (unannualized) in the quarter.

With respect to credit quality, non-performing assets (excluding purchased impaired loans) were 2.02% of loans and foreclosed assets at the end of the quarter, up sharply from 1.23% at year end. Commercial real estate was weaker with NPAs of $1.0 billion, up 53% from December 31. Driving the increase was deterioration in office properties and retail-related credits. In terms of geography, the Company saw weakness in acquired loans in Florida and Maryland. Other areas of commercial credit (especially healthcare, manufacturing and construction) also exhibited stress in the quarter, reflecting the prevailing recessionary conditions. Net charge-offs (NCOs) were 1.01% of average loans in the first quarter, down 8 basis points (bps) from the fourth quarter. PNC’s quarterly loan loss provision of $880 million declined $110 million from Q4 2008, but exceeded Q1 2009 NCOs by $449 million. DBRS believes that increases in credit costs and mark-to-market losses will likely be absorbed by PNC’s strong earnings generation capability, as evidenced by a robust $1.5 billion of income before provisions and taxes in the first quarter. That being said, credit quality deterioration is one of the risks that are incorporated in DBRS’s Negative Trend.

PNC’s Tier 1 Capital ratio improved to 10.2% at the end of the first quarter from 9.7% at year end and its tangible common equity (TCE) ratio was up 40 bps from Q4 2008 to 3.3% at March 31, 2009. Unrealized losses in the Company’s $46 billion investment securities portfolio declined by $1 billion in the first quarter to $4.4 billion, helping PNC’s TCE. While DBRS is concerned about potential pressure on TCE, it is somewhat mitigated by the high quality of the portfolio, its relative short duration and the Company’s ability and intent to hold the securities to maturity given their solid liquidity position. At just 88%, PNC has one of the best loan-to-deposit ratios among peers. Moreover, PNC has a sizable unrecognized gain in its ownership interest in Blackrock, Inc.

The Negative trend reflects the near- to medium-term risks the Company faces at a time of substantial turmoil in the credit and capital markets as it integrates National City. DBRS expects that PNC’s earnings will be pressured by deteriorating credit quality, security impairments and rising credit costs, primarily driven by declining housing prices, rising unemployment and stress on both residential and commercial real estate. Although the newly merged Company’s revenue base is well diversified, it increases reliance on spread income and adds exposure to some of the more challenging regions, especially the economically weaker Midwest.

Declining financial performance, including credit costs exceeding IBPT and impeding capital or a sustained decline in revenue; the inability to reduce high risk assets; and/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 methodologies are Rating Banks and Bank Holding Companies Operating in the United States, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.