PNC Rides Fee Income to Higher 2Q Profit, Denies Interest in Acquisitions

It's becoming a common occurrence: banks keep enduring declines in income from lending, but still find ways to improve their earnings.

The latest example came Wednesday, as PNC Financial Services Group (PNC) reported net income of $1.1 billion in the second quarter, despite a drop in net interest income.

PNC's net income was up 12% from the first quarter of the year, and up 105% from the second quarter of 2012, as the company continued to benefit from its 2012 acquisition of RBC Bank. Earnings per share came in at $1.99, which easily beat the $1.63 estimate of analysts surveyed by Bloomberg.

The Pittsburgh company's earnings were aided by a combination of rising fee income, continued belt-tightening, improvements in credit quality — and some one-time items that are unlikely to recur.

On a conference call with analysts, PNC executives promised a stay-the-course strategy, maintaining that the company is focused on organic growth and is not interested in additional acquisitions.

Analysts generally reacted positively to the results, though the weaker than expected interest income tempered their enthusiasm. "PNC's quarter included a lot of moving parts, but the core number looked better than we had anticipated," analysts at Sandler O'Neill wrote in a research note.

PNC Chief Executive Officer William Demchak has been outspoken in recent months about his unwillingness to enter the price war that he says characterizes some commercial loan markets, and he reiterated that stance Wednesday.

"I'm telling you that the market certainly in certain sectors is going to be increasingly competitive, and there are areas where we're choosing to walk away, given the spread or structure on a loan, where a year and a half ago we wouldn't have," he said during a conference call with analysts.

Demchak, who took the company's reins in April when James Rohr retired, was much more upbeat about PNC's opportunities in certain specialized lending markets, including asset-based lending, health-care lending, and equipment finance.

Still, the company's earnings report showed a company whose fate is becoming less tied to lending, the traditional bread-and-butter of the banking industry.

PNC's net interest income totaled $2.3 billion, which was down 5% from the first quarter, and down 11% from the same period a year ago. Meanwhile, total revenue was up 3% from the first quarter, and up 12% from the second quarter of 2012.

Industry-wide, earnings reached a record high in the first quarter as banks employed a playbook similar to PNC's. Rising fee income and falling loss provisions at banks across the country have compensated for declines in interest-related income.

At PNC, some of the second-quarter earnings growth was attributable to growth in asset management fees, as well as in fees paid by consumers and corporate customers. "Client fee income was really strong," Demchak said.

The company also reported one-time gains from sales of shares in Visa (NYSE: V) and from sales of certain securities. Oppenheimer Equity Research concluded that those items were largely responsible for the fact that PNC's earnings easily exceeded analysts' expectations.

PNC also lowered its provision for credit losses, as net chargeoffs fell sharply. "Chargeoffs on the commercial side were particularly low," Demchak said.

PNC executives expressed optimism about the company's potential for growth in the southeastern United States, where their RBC Bank franchise is located. Their long-term goal is to achieve returns in the Southeast that are similar to those in some of PNC's core geographic markets.

"We want to turn that into the next Philadelphia or Cleveland," Demchak said.

PNC bought RBC Bank from Royal Bank of Canada in a deal that closed in March 2012. Demchak said the acquired branches lag behind the legacy branches, though the company has enlarged its menu of products in the Southeast.

Despite their upbeat take on the RBC deal, PNC executives did not sound eager to pursue another acquisition. At one point during Wednesday's call, an analyst alluded to Royal Bank of Scotland's plan to divest at least part of its U.S. subsidiary, Citizens Financial Group, which overlaps with PNC's footprint in the Northeast. Demchak said flatly that he's not interested.

In a follow-up email, PNC spokesman Frederick Solomon wrote: "We already have an opportunity to grow the bank substantially by adding customers in under-penetrated markets," referring to the markets where RBC Bank operates, "without having to consider additional acquisitions."

Much of PNC's focus in recent quarters has been on cost-cutting. And while its noninterest expenses rose by 2% from the first quarter, they were still down 8% from the second quarter of last year.

Looking ahead, PNC executives are preparing for a decline in mortgage applications, due to the recent spike in interest rates.

The company's guidance for the second half of the year calls for solid growth in fee income and a modest decline in net interest income. In other words, more of the same.