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Mortgage Repurchase Hurt PNC's Profit

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PNC Financial Services Group Inc.’s (PNC - Free Report) second quarter 2012 earnings per share of 98 cents missed the Zacks Consensus Estimate of $1.09 on higher provisions for residential mortgage loan repurchase obligations. Results were also below the earnings per share of $1.44 in the prior quarter and $1.67 in the year-ago quarter.

Earnings included 54 cents per share negative impact from the provision for residential mortgage loan repurchase obligations. Moreover, redemption of trust preferred securities and integration costs also reduced earnings per share by 16 cents and 6 cents, respectively.

Excluding those impact, the company would have earned $1.74 per share in the quarter under review. Also, excluding the impact of the comparable items, earnings came in at $1.66 per share in the prior quarter and $1.71 per share in the year-ago quarter.

Notably, PNC Financial anticipates elevated levels of residential mortgage loan repurchase demands as a result of a change in behavior and demand patterns of two government-sponsored enterprises, FNMA and FHLMC. These are largely associated with loans sold in 2006 through 2008 in agency securitizations.

Quarter in Detail

Total revenue for the quarter at PNC Financial came in at $3.6 billion, down 3% sequentially. Moreover, it fell short of the Zacks Consensus Estimate of $3.7 billion. While the company experienced a solid growth in net interest income as well as in consumer and corporate client fee income, the positives were offset by the provision for residential mortgage repurchase obligations.

Net interest income was $2.5 billion, up 10% sequentially. The full quarter benefit from the RBC Bank (USA) acquisition, organic loan growth and lower funding costs contributed to the uptick in net interest income. 

Moreover, PNC Financial’s net interest margin climbed 18 basis points (bps) sequentially to 4.08%. Higher yield on loans resulting from the full quarter benefit of the RBC Bank acquisition attributed to the expansion of the net interest margin.

However, non-interest income at PNC Financial fell 24% sequentially to $1.1 billion. While the company experienced sequential increases in revenues from the consumer and corporate clients, the increase in provision for residential mortgage loan repurchase obligations primarily pulled the non-interest income figure down in the quarter.

Also, PNC Financial’s non-interest expense came in at $2.6 billion, up 8% sequentially. Results comprised of noncash charges related to redemption of trust preferred securities, a full quarter of operating expense for the RBC Bank acquisition and integration costs. 

Credit Quality

Credit quality was a mixed bag in the quarter at PNC Financial. Nonperforming assets decreased 4% sequentially to $4.2 billion in the quarter, mainly due to decline in commercial real estate nonperforming loans and other real estate owned. Nonperforming assets to total assets were 1.39% as of June 30, 2012, down from 1.47% as of March 31, 2012 and 1.70% as of June 30, 2011.

Net charge-offs fell 5% sequentially to $315 million in the quarter. Sequentially, decreases in commercial real estate and home equity loan net charge-offs were partly offset by increases mainly in commercial loan net charge-offs. Net charge-offs for the reported quarter came at 0.71% of average loans on an annualized basis, down from 0.81% reported in the prior quarter and 1.11% in the year-ago quarter.

However, PNC Financial’s provision for credit losses during the quarter was $256 million, up 38% sequentially. Results reflected credit provisions associated with the RBC Bank acquisition.

Capital Position

Capital ratios remained stable in the quarter at PNC Financial. Higher risk-weighted assets from loan growth offset the positive impact from growth in retained earnings and therefore, as of June 30, 2012, PNC Financial’s Tier 1 common capital ratio was an estimated 9.3%, flat sequentially.

Moreover, the Tier 1risk-based capital ratio was an estimated 11.4% as of June 30, 2012, unchanged sequentially as the impact of trust preferred securities redemptions were offset by the issuance of preferred stock.

As of June, 2012, total assets under administration were $214 billion, down 5% sequentially, primarily resulting from lower equity markets, partially offset by strong sales performance and client retention.

Capital Deployment Update

Recently, PNC Financial declared a quarterly common stock cash dividend of 40 cents to be paid on August 5, 2012. Moreover, during the second quarter, the company bought back shares worth $50 million under its current share buyback authorization.

Notably, in April 2012, PNC Financial announced a 14% hike in its quarterly common stock cash dividend to 40 cents from 35 cents. That increased dividend was paid on May 5, 2012. At that time, the company also announced plans to buyback up to $250 million of common stock under its existing 25 million share repurchase program through the rest of 2012.

Performance by peer

Among PNC Financial’s peers, U.S. Bancorp (USB - Free Report) has come up with an encouraging result in the second quarter of 2012. Aided by a growth in revenue and lower provision for credit losses, the company reported earnings per share of 71 cents, which breezed past the Zacks Consensus Estimate of 69 cents.

Another peer, Comerica Inc. (CMA - Free Report) reported earnings per share of 73 cents, comfortably beating the Zacks Consensus Estimate of 62 cents. Results reflected growth in its top line. Comerica experienced growth in its average loans, helped by higher average commercial loans. Average deposits also advanced in the quarter. Furthermore, the company experienced growth in fee income. Also, expenses were well-controlled.

Another peer, BB&T Corporation (BBT - Free Report) will be reporting its second-quarter 2012 earnings on July 19, before the market opens.

Our Viewpoint

Going forward, we believe PNC Financial is well positioned to grow given its diverse revenue mix, balance sheet strengthening efforts, strategic acquisitions and solid capital levels. The RBC Bank (USA) acquisition is expected to be accretive to 2012 earnings, excluding integration costs. Stress test clearance, dividend hikes and share buybacks also serve as positive catalysts.

Yet, a protracted economic recovery, continued low interest rate environment, increased regulatory headwinds as well as elevated mortgage repurchase costs seem to somewhat limit growth in profitability of PNC Financial.

PNC Financial shares maintain a Zacks #3 Rank, which translates into a short-term Hold recommendation.

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