Fitch Affirms PNC Financial Services Group's LT IDR at 'A ' Following Large Regional Bank Review
The rating action follows a periodic review of the large regional banking group, which includes BB&T Corporation (BBT), Capital One Finance Corporation (COF), Comerica Incorporated (CMA), Fifth Third Bancorp (FITB), Huntington Bancshares Inc. (HBAN), Keycorp (KEY), M&T Bank Corporation (MTB), MUFG Americas Holding Corporation (MUAH), PNC Financial Services Group (PNC), Regions Financial Corporation (RF), SunTrust Banks Inc. (STI), US Bancorp (USB), Wells Fargo & Company (WFC), and Zions Bancorporation (ZION).
Company-specific rating rationales for the other banks are published separately, and for further discussion of the large regional bank sector in general, refer to the special report titled 'Large Regional Bank Periodic Review,' to be published shortly.
KEY RATING DRIVERS
IDRs, VRs, AND SENIOR DEBT
The affirmation reflects the company's strong earnings profile, stable and diverse business model, and its consistency of performance through time. PNC's earnings remain solid, and compare well with other large regional banks. Earnings have benefited from diversified sources of non-interest income, well-controlled core expenses and lower credit costs.
PNC's net interest margin (NIM) still benefits from purchase accounting accretion (PAA), which added approximately 14 basis points (bps) to the margin in the second quarter of 2015 (2Q15). Including the PAA, PNC's NIM still lags many of its peers. Somewhat offsetting this dynamic, PNC generates a higher relative proportion of earnings from non-interest income than the other large regional banks. Noninterest income accounted for 46% of revenues in the first half of 2015 (1H15), as compared to the peer average of 38%. PNC benefits from asset management, corporate banking and consumer service fees, as well as its 22% ownership in BlackRock.
Noninterest income has also been aided by gains on the sale of the company's Visa shares, which have averaged over \\$40 million a quarter over the last year, or around 3% of quarterly pre-tax income. As of June 30, 2015, the unrealized gain on PNC's Visa shares totaled roughly \\$600 million, providing the company with the opportunity to likely sell down its holdings, and realize further gains.
PNC's capital profile is considered solid, and roughly in line with other large regional banks. PNC reported its estimated fully phased-in Common Equity Tier 1 ratio (CET1) under Basel III standardized approach rules was 10% at June 30, 2015, well above the 7% threshold. Given its advanced-approach institution status, it will face volatility in accumulated other comprehensive income (AOCI) due to interest rate movements, necessitating the need for an associated capital buffer, which Fitch expects the company to maintain.
Although PNC is subject to the advanced approach, it will not be subject to systemically important surcharge. Fitch also notes that PNC once again did well under annual regulatory stress testing, with modest declines in starting and ending capital ratios.
PNC's liquidity is good. At June 30, 2015, its loan to deposit ratio was 86%, roughly in line with peers'. While Fitch expects this ratio could rise as loan growth resumes to more normalized levels, we would expect PNC to manage its liquidity position in a conservative manner, as it has historically done so. The company also has access to a diversified array of funding sources. Fitch believes PNC has sufficient sources of cash at the parent to maintain acceptable levels of liquidity for the foreseeable future.
PNC disclosed that its estimated pro forma liquidity coverage ratio was in excess of 100% at both the consolidated and bank levels at quarter-end. This more than exceeds the minimum phased-in requirement of 80%, which became effective for Advanced Approach banks on Jan. 1, 2015.
The credit environment remains quite benign, and net charge-offs (NCOs) decreased again, to only 13bps in 2Q15. Fitch notes that NCOs at this level are unsustainable for the company and the industry. Given the commercial make-up of PNC's loan portfolio, comprising 64% of loans, loan losses can be a bit lumpy from quarter to quarter. However, PNC has historically reported lower loan losses than peers, with less volatility when viewed over many years. This also mitigates our concerns regarding PNC's relatively higher balance of nonperforming assets (NPAs) than peers.
PNC has indicated that its through the cycle loss expectations are between 50bps and 60bps. Given PNC's relatively stronger earnings profile, the company should be able to provision at higher levels, without materially impacting earnings.
PNC exposure to the energy sector is very manageable. At June 30, 2015, PNC reported \\$2.6 billion of oil and gas outstandings, which were down 10% from last quarter. This represents less than 2% of total loans. PNC reported an increase in commercial NPAs, but overall NPAs balances continue to improve.
Fitch views home equity reset risk as an industry concern. PNC has approximately \\$4.1 billion of HELOCs (currently paying interest only) resetting to fully amortizing loans in the next few years, potentially under a higher interest rate environment. The performance of those borrowers that enter the repayment period is significantly worse than those still in the draw period, with 3% of balances 30 to 89 days past due at June 30, 2015, and another 5% more than 90 days past due, as compared to just 0.26% past due for the entire home equity portfolio. While this warrants close monitoring, PNC's reserves and capital should be sufficient to withstand higher levels of related delinquencies, losses and modifications.
Fitch considers PNC's stake in BlackRock as providing an overall benefit to the credit profile, since BlackRock's fees add an additional source of revenues to the earnings mix. PNC may attempt to monetize some of its ownership in BlackRock over time given the concentration risk that resides with such a large holding in one company. At June 30, 2015, PNC had a significant unrecognized pre-tax gain of \\$5.7 billion (excluding any liquidity discount or deferred tax liability). BlackRock contributed 13% of consolidated income in 1H15, and provided nice revenue diversification.
In June 2015, the Comptroller of the Currency (OCC) terminated the mortgage servicing consent order against PNC, which is viewed favorably, and representative of PNC's sound risk management infrastructure. Some of PNC's peers were deemed to not have met all the requirements yet.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
PNC's subordinated debt is notched one level below its VR of 'a+' for loss severity. PNC's preferred stock is notched five levels below its VR, two times for loss severity and three times for non-performance, while PNC's trust preferred securities are notched two times from the VR for loss severity and two times for non-performance. These ratings are in accordance with Fitch's criteria and assessment of the instruments non-performance and loss severity risk profiles and have thus been affirmed due to the affirmation of the VR.
LONG- AND SHORT-TERM DEPOSIT RATINGS
The uninsured deposit ratings of PNC Bank, N.A. are rated one notch higher than PNC's IDR and senior unsecured debt because U.S. uninsured deposits benefit from depositor preference. U.S. depositor preference gives deposit liabilities superior recovery prospects in the event of default.
HOLDING COMPANY
PNC's IDR and VR are equalized with those of its operating companies and bank, reflecting its role as the bank holding company, which is mandated in the U.S. to act as a source of strength for its bank subsidiaries. Ratings are also equalized reflecting the very close correlation between holding company and subsidiary failure and default probabilities.
SUBSIDIARY AND AFFILIATED COMPANY
The IDRs and VRs of PNC Funding Corp are equalized with PNC's IDR reflecting Fitch's view that it is core to PNC's business strategy and financial profile.
Fitch is withdrawing the ratings of National City Credit Corp. as the entity no longer exists, and there is no outstanding debt.
SUPPORT RATING AND SUPPORT RATING FLOOR
PNC has a Support Rating of '5' and Support Rating Floor of 'NF'. In Fitch's view, PNC is not systemically important and therefore, the probability of support is unlikely. IDRs and VRs do not incorporate any support.
RATING SENSITIVITIES
VR, IDRs, AND SENIOR DEBT
With a long-term IDR of 'A+', PNC remains one of the highest rated banks in the world. There is currently a low likelihood that PNC's ratings would be upgraded over the near term. However, over time, upwards ratings migration would be predicated on a superior earnings profile relative to peers, maintenance of capital at appropriate levels, and consistent through the cycle asset quality measures.
Conversely, a meaningful deterioration in asset quality, coupled with weaker profitability metrics, or more aggressive capital management could lead to a negative rating action, although Fitch currently views a downgrade as unlikely.
PNC is more exposed to home equity reset risk than its peers. While Fitch's base case is that deterioration in this portfolio will not lead to outsized losses, PNC's ratings may be vulnerable under a more stressful scenario in which reserves prove inadequate and its mitigation plans for addressing the end of draws are not effective.
BlackRock's operations are relatively low risk, with little balance sheet-related risk. That said, any strategic missteps or operational errors at BlackRock could create earnings volatility on PNC's profit and loss statement since this ownership typically accounts for more than 10% of consolidated earnings. A complete divestiture of its ownership of BlackRock would be evaluated for any rating implications depending on the intended use of the proceeds, and plans to generate the foregone recurring revenues. However, Fitch views PNC's ability to fully monetize its ownership as limited, at least in the near term, though we expect some incremental sales may occur.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The ratings for PNC and its operating companies' subordinated debt and preferred stock are sensitive to any change to PNC's VR.
LONG- AND SHORT-TERM DEPOSIT RATINGS
The long- and short-term deposit ratings are sensitive to any change to PNC's long-and short-term IDR.
HOLDING COMPANY
Should PNC's holding company begin to exhibit signs of weakness, demonstrate trouble accessing the capital markets, or have inadequate cash flow coverage to meet near-term obligations, there is the potential that Fitch could notch the holding company IDR and VR from the ratings of the operating companies.
RATING SENSITIVITIES - SUBSIDIARY AND AFFILIATED COMPANY
As the IDRs and VRs of the subsidiaries are equalized with those of PNC to reflect support from their ultimate parent, they are sensitive to changes in the parent's propensity to provide support, which Fitch currently does not expect, or from changes in PNC's IDRs.
To the extent that one of PNC's subsidiary or affiliated companies is not considered to be a core business, Fitch could also notch the subsidiary's rating from PNC's IDR.
SUPPORT RATING AND SUPPORT RATING FLOOR
Since PNC's Support and Support Rating Floors are '5' and 'NF', respectively, there is limited likelihood that these ratings will change over the foreseeable future.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
PNC Financial Services Group Inc.
--Long-term Issuer Default Rating (IDR) at 'A+'; Outlook Stable;
--Short-term IDR at 'F1';
--Viability at 'a+';
--Support at '5';
--Support floor at 'NF';
--Senior unsecured at 'A+';
--Short-term debt at 'F1';
--Subordinated at 'A';
--Preferred stock at 'BBB-'.
PNC Bank N.A.
--Long-term IDR at 'A+'; Outlook Stable;
--Long-term deposits at 'AA-';
--Viability at 'a+';
--Subordinated at 'A';
--Senior unsecured at 'A+';
--Short-term IDR at 'F1';
--Short-term deposits at 'F1+';
--Short-term debt at 'F1';
--Support at '5';
--Support floor at 'NF'.
PNC Funding Corp
--Long-term IDR at 'A+'; Outlook Stable;
--Senior unsecured at 'A+';
--Subordinated at 'A';
--Short-term IDR at 'F1';
--Short-term debt at 'F1';
--Support at '5';
--Support floor at 'NF'.
PNC Financial Corp.
--Subordinated at 'A'.
PNC Capital Trust C
Fort Wayne Capital Trust I
--Trust preferred at 'BBB'.
PNC Preferred Funding Trust I, II
--Hybrid capital instruments at 'BBB'.
National City Corporation
--Senior unsecured at 'A+';
--Subordinated at 'A';
--Convertible preferred (trust preferred securities) at 'BBB';
--Preferred stock at 'BBB-'.
National City Bank (Cleveland)
--Long-term deposits at 'AA-';
--Senior unsecured at 'A+';
--Subordinated at 'A';
--Short-term deposits at 'F1+'.
National City Bank of Indiana
--Long-term deposits at 'AA-';
--Subordinated at 'A'.
National City Bank of Kentucky
The Provident Bank
--Long-term deposits at 'AA-'.
Fitch has affirmed and withdraw the following ratings:
National City Credit Corporation
--Short-term IDR at 'F1';
--Support at '5';
--Commercial paper at 'F1'.
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